This week we look at the CIR rules as they apply to corporate joint ventures.
This is the twenty seventh in our series of articles looking at some of the detail of the new corporate interest restriction (CIR) rules. The CIR legislation was included in Finance (No.2) Bill 2017, published on 8 September, with the start date continuing to be 1 April 2017. This week and next, we will take a short break from our series of articles about the impact of CIR on real estate to look at how the CIR regime applies to joint ventures (JVs). First, we will focus on JVs that are structured as companies, with next week’s article looking at JVs that are structured as partnerships.
Analysis at JV company level
A JV company that does not qualify as a ‘consolidated subsidiary’ of any of its investors under International Accounting Standards (IAS) (which would typically be the case for a standard 50:50 JV), will be the ultimate parent of its own CIR group.
However, the investors will commonly be ‘related parties’ of the group for CIR purposes. This means that, absent special provisions, where a corporate JV is heavily geared with loans from its investors, it is likely to have a low group ratio percentage (and group ratio debt cap), because funding costs on the related party debt would be excluded in calculating its qualifying net group-interest expense (QNGIE).
In such circumstances, the JV group might consider making a group ratio (blended) election, which, broadly speaking, allows it to replace its own group ratio percentage and group ratio debt cap with ‘blended’ figures based on its investors’ metrics.
In some cases, this may lead to the JV group being able to access a higher group ratio percentage and group ratio debt cap and thereby suffer a lower disallowance of interest costs under the CIR regime.
Analysis at corporate investor level
Under IAS principles, where an investor either has joint control over a JV or exercises significant influence over a JV, it will usually account for its investment in the JV using the ‘equity method’, under which it will initially recognise its investment in the JV at cost and then include its share of the JV’s net profit or loss in calculating its own profit or loss (as opposed to only recognising distributions paid on its interest).
For CIR purposes, any such net profit share recognised in calculating the investor group’s profit or loss in its consolidated accounts would normally be included in calculating the investor group’s Group-EBITDA. Any third party interest expenses incurred by the JV would simply be taken into account in reducing this net profit.
Where the JV is highly geared, this may have the effect of depressing the investor’s group ratio (as compared to the position if it were able to proportionately consolidate the JV in its accounts). In such circumstances, the investor might consider making an ‘interest allowance (non-consolidated investment) election’.
Where this election is made, for the purposes of calculating the investor’s debt cap amounts and group ratio percentage, the actual amounts recognised in the investor’s consolidated financial statements in respect of its interest in the JV (and any loan to the JV) are disregarded. Instead, the investor includes its proportionate share of the JV group’s measures of net interest taken from the JV group accounts and group-EBITDA in calculating its own metrics, with the JV group’s financial statements being treated as excluding, for this purpose, any interest costs on loans owed to the investor group.
In some cases, this may lead to the investor group being able to access a higher group ratio percentage and group ratio debt cap and thereby suffer a lower disallowance of interest costs under the CIR regime.
Before making any election, the potential benefits should be modelled to determine whether it would be beneficial. Appropriate provisions will also need to be included in any JV agreement to regulate how CIR issues are dealt with.
The previous articles in this series can be found here.
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