Worldwide debt cap rules were introduced as an extension to the UK thin capitalisation rules to ensure that UK companies bear their fair share of group debt. It applies to accounting periods beginning on or after 1 January 2010. In overview, the rules seek to ensure that the UK does not obtain a tax deduction for interest expenses that is greater than the worldwide group’s 3rd party interest expense.
UK companies that fall within the rules will suffer a significant compliance burden, which ultimately may or may not result in an actual restriction on the tax deductibility of interest. However, groups can establish whether they need to consider the rules in more detail by following two simple steps:
1. Is there a qualifying Worldwide Group?
- A qualifying Worldwide group is one that contains a large company i.e. broadly 250+ employees plus €50m+ turnover and/or €43m+ balance sheet total, and one or more relevant group companies
- A relevant group company is one that has a UK corporation tax residence i.e. generally either a UK company or a UK permanent establishment of a non-UK company. The relevant group company should also be either the parent company of the group or a 75% subsidiary of another group company.
- If the worldwide group definition is met then the group must go on and apply the gateway test.
2. Is the gateway test met?
- In order to determine whether the group passes the gateway test, an initial calculation is required to compare the level of UK net debt to the worldwide gross debt of the group. The test must be applied to each accounting period.
- Worldwide gross debt is the average of the closing debt at the end of the current and preceding accounting periods and is taken from the consolidated accounts, i.e. generally equal to the amount of group external debt.
- UK net debt is the average of the net debt at the beginning and end of the period for each company that was a relevant group company at any time during the period. Net debts of less than £3m and of dormant companies are treated as nil for this purpose.
- Company net debt is the company debt liabilities’ less liquid assets, as per the company balance sheet drawn up under IAS.
- Where UK net debt exceeds 75% of the worldwide gross debt of the group, the gateway test is failed and the detailed worldwide debt cap rules need to be applied. Further complex calculations are then required to determine the amount of interest and finance expenses that are disallowed for UK tax purposes.
Practical Next Steps
Because the gateway test requires the use of average balances, final calculations cannot be prepared until after the year end. Therefore, for the purposes of quarterly instalment payment calculations, forecasts should be used to determine whether a disallowance is likely to need to be calculated and updated for each instalment date.
There is a compliance burden and potential disallowance that comes with the application of the detailed worldwide debt cap rules, it is therefore advisable to fully understand whether the gateway test will be met or not. Generally, where the gateway test is failed, interest expenses in relevant group companies that are below £500,000 can be ignored for the purposes of calculating any UK tax disallowance.
Groups who meet the qualifying group definition should therefore review their debt structures to maximise the use of the £3m de-minimus and, where possible, make use of the £500,000 allowance.