Worldwide debt cap. The Bad bit of Foreign Profits 10 July 2009 Bill Dodwell
Debt Cap
WW debt cap - introduction Timeline Overall concept What s in the Finance Bill? Next steps Trailed at PBR2006 and Budget2007, consultation in 2007/08 July 2008 open Ministerial letter December 2008 draft clauses and consultation 7 April 2009 update Finance Bill proposals Limits UK interest deductions by reference to WW group interest expense in the consolidated accounts Principal targets are excess interest deductions ( debt-dumping ) and upstream loans The proposed legislation (Cl.35 and Sch.15) core rules Simplified, but with TAAR Further discussions on TAAR: regulations and guidance? Rules take effect for interest expense payable in periods beginning on or after 1 January 2010 3
Overview of WW debt cap Scheme Approach and requirements Gateway WW debt cap computation Returns Aims to remove groups that are not the target of the policy Gateway test failed if UK net debt of relevant group companies exceeds 75% of worldwide gross debt Determining the interest restriction and any corresponding excluded financing income Entity-basis computation disallowance of deductions = excess of tested expense amount over available amount exclusion of financing income = lower of tested income amount and above disallowance Statement of allocated disallowances applies to relevant group companies during the relevant period of account Statement of allocated exemptions applies to UK group companies during the relevant period of account A representative member of each may be appointed Allocation is pro rata if not otherwise specified 4
Debt Cap- the 7 step calculation 1. Identify the relevant worldwide group and subsidiaries 2. Has the Gateway test been passed? 3. Calculate Available Amount 4. Calculate Tested Expense Amount 5. Calculate Total Disallowed Amount 6. Allocate Total Disallowed Amount and corresponding income adjustment 7. Administration- Elections and returns 5
Debt Cap- Calculation Identify the relevant worldwide group and subsidiaries Large - based on EU definition Available Amount - Worldwide group based on IAS 51% Tested Expense Amount - Relevant Group Company 75% Definition of relevant subsidiary vs subsidiary Ultimate corporate parent - partnerships Joint ventures 6
Debt Cap - Calculation Has the Gateway test been passed? Debt cap only applies where UK net debt of the group exceeds 75% of the worldwide gross debt of the group. Only one test Average of net debt at Balance Sheet dates UK net debt Calculated on a company by company basis Based on company Balance Sheet Dormant companies not included de minimis of 3m includes any companies with negative debt (i.e. can t net asset companies) Consolidated gross debt Based on consolidated financial statements Where accounts not in sterling translate at spot rate (unless both parent and UK sub accounts in same currency) Companies with significant intra UK loans almost certain to fail 7
Gateway test Illustrative computation limited netting Relevant Relevant Sub-total "Net debt" liabilities assets m m m UK1 1,200 1,000 200 200 UK2 1,000 1,200 (200) 0 UK3 1,000 1,000 1,000 UK4 1,000 (1,000) 0 3,200 3,200 0 1,200 75% WW gross debt (say) 1,199 Gateway test passed? No 8
Debt Cap- Calculation Calculate Available amount Worldwide group s gross consolidated finance expense (both UK and non-uk). Interest receivable no longer netted off. Not reduced for UK third party interest costs. Interest payable on amounts borrowed Amortisation of discounts Amortisation of premiums Amortisation of ancillary costs Financing cost implicit in payments under finance leases Financing cost relating to debt factoring Likely to be larger Available Amount than under previous proposals 9
Debt Cap- Calculation Calculate Tested Expense Amount Sum of net financing deductions (now intragroup and third party) for each relevant company Type A: Loan relationships Type B: Finance leases Type C: Debt factoring Excludes Forex Net income Impairments of losses from relevant transactions De minimis of 500k Tested Expense Amounts for all UK relevant companies are then totalled. Note no interest like movements on derivative contracts Currency interest differential? Interest rate swap? 10
Debt Cap- Calculation Specific exemptions when calculating Tested Expense Amount Treasury companies Elect for treasury companies to be ignored for finance income/expense test. Limited application as companies normally have net interest? Treasury company needs >90% treasury revenue when compared to relevant income Treasury revenue is from treasury activities; relevant income is total income. Short term debt Elect to exclude short term debt interest Short term is <12months Compliance burden may be high- therefore, election welcome Trapped NTLRs and Management expenses Can elect to ignore financing expense of company Corresponding income also ignored Prevents losses being trapped in companies 11
Debt Cap- Calculation Calculate Total Disallowed Amount Available Amount less Tested Expense Amount Allocate Total Disallowed Amount and corresponding income adjustment Total Disallowed Amount Allocate to any relevant group company with a deduction noting whether Type A, B, C Exemption of financing income Allocate to any UK group company with Tested Income Amount De minimis of 500k Note - 51% subsidiary as defined by IAS not relevant 75% subsidiary Maximum exemption is lower of Total Disallowed Amount and Tested Income Amount Flexibility of allocation is an improvement Default calculation if no return submitted - 12 month deadline 12
Debt Cap- Calculation Administration Elections: Non trading deficits/management expenses Treasury companies - irrevocable Short term debt 36 month time limit Returns: 12 month time limit or default allocations Revise within 3 years Ability to amend post enquiry? Minority shareholders agree to give 75% shareholder the right to file returns on their behalf 13
TAARs part 6, Sch 15 Manipulating accounting period (part 2) Manipulating the net deduction (part 3), or the exempt amount (part 4) Manipulating exempt amounts EEA relief (part 5) As yet No guidance No excluded schemes 14
Some Examples
Example: external interest income and expense 600 1,000 Avail. amount = 1,000 UK plc Test d exp amount = UK plc (400) + UK1 (500) = 900 OS Interest 500 UK1 The Gateway Test is unlikely to be satisfied as the relevant net debt is not less than 75% of the groups worldwide gross debt. Assume: External financing cost 1,000 External financing income 600 Upstream UK-OS loan interest 500 As available amount greater than tested amount may be able to self certify that the rules do not apply but need to be comfortable that the TAAR will not be relevant in respect of UK plc s external interest expense and receipt 16 16
Example: gateway test failed UK1 OS Interest 2,000 1,000 UK2 Assume: External OS financing cost 1,000 UK-UK loan interest 2,000 - Avail amount = 1,000 - Test d exp amount = 2,000 - Gateway U = 40,000 W = 20,000 U>W so Gateway test failed - 1,000 Disallowed in UK1 with compensating adjustment of 1,000 in UK2 - This has severe administrative implications for large groups with intragroup debt within the UK where no tax saving is in point. All interest is 5% 17 17
Example: compensating adjustment Avail. Amount = 500 500 Test d Exp amount UK2 = 600 Interest 500 UK plc Total disallowed amount = 100 UK2 makes a disallowance of 100 A compensating adjustment can be allocated UK1 UK2 OS to any Group Company with finance income up to the lower of Interest 250 Interest 300 Interest 300 the total disallowed amount, and the tested income amount. Assume: External UK financing cost 500 External UK financing income 250 UK-UK loan interest 800 UK-OS loan interest 300 UK1 can make a compensating adjustment of 50 (limited to its net finance income) There is a net disallowance of 50. The UK external interest income of 250 neutralises 250 of the upstream loan. Again the TAAR should be considered. 18 18
Preliminary conclusions
Preliminary conclusions Complicated test Gateway unlikely to help UK headed groups Commercial issues with compensating adjustments e.g. Minority shareholders Banking covenant groups Return mechanics give authority to one company for the whole group Compliance burden for virtually every group Derivatives both excluded from Tested Expense Amount and Available Amount Impact on tax audit provisioning Quarterly Instalment Payments Problems for groups without consolidated accounts Strange mismatch between 51% and 75% rules 20
Other approaches
International comparisons Germany 30% of EBITDA rule override for 3 million of interest Override based on worldwide debt ratio (but not easy in practice) Italy 30% of EBITDA rule Introducing carry-forward, surrender to group members US Obama proposals Interest allocation rules Defer interest deductions until income repatriated Earning stripping limits related party interest 50% EBITDA 22
International Comparisons The Netherlands proposed 5% tax on group interest income/expense In addition, consult on 30% of EBITDA rule; or Limit interest deductions on acquisitions, equity injections France restrict group interest a thin cap criteria, equal to 1.5/1 not taking bank debt into account, only related party debt; or interest should be lower than 25 % of EBITDA. No other country has adopted a worldwide debt cap 23
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