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Debt cap regulations: do the clarifications to the 'available amount' go far enough?

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The worldwide debt cap seeks to cap the net UK interest deductions of groups at the amount of the consolidated worldwide finance expense. The computation of any disallowance under the debt cap rules is carried out by comparing the finance expense in the group’s consolidated accounts (the ‘available amount’) with the tax deductions claimed by the group on its loan relationships.

The rules which set out these computations are, however, very detailed, and a number of issues have arisen in practice where external finance costs of the group fall outside the detailed definition of the available amount even though they give rise to deductible loan relationship amounts. As a result, groups may effectively suffer disallowances for tax purposes on some of their external finance costs.

HMRC has powers to issue regulations in order to increase the types of expenses that qualify for the available amount calculation, and it has recently issued a draft of such regulations. It is anticipated that the regulations will apply for periods of account beginning on or after 1 January 2010, and so would have effect from the commencement date of the debt cap provisions.

What changes are proposed?

There are many situations where companies enter into arrangements which are not loans from a legal perspective, however they have the economic effect of loans and are treated as such for the purposes of corporation tax.

A company entering into these arrangements as the ‘borrower’ will typically be allowed a tax deduction for any amounts payable where these are equivalent to interest and they will be included in its ‘financing expense amounts’ for the purposes of the detailed rules in the debt cap. Currently, however, these amounts may not be included in the available amount as they would need to fall within the definition of ‘interest payable on borrowing’.

The regulations deal with a specific set of circumstances, being:

  • interest on trade debts (and other debts which don’t arise from lending transactions);
  • alternative finance arrangements (such as Islamic finance);
  • manufactured interest;
  • sale and repurchase arrangements; and
  • certain ‘structured finance arrangements’.

Amounts payable in respect of these specified matters are now to be included in the available amount provided they meet two conditions.

The first is that the amount falls within a UK company’s financing expense amount for the purposes of the debt cap calculation (ie, it is a deductible loan relationship amount for that company).

Second, the amount must be shown as a finance cost in the worldwide consolidated accounts.

This maintains the link between the available amount and the consolidated accounts such that any intragroup arrangements which are eliminated on consolidation could not be included in the available amount.

Do the regulations achieve their aims?

For those items covered by the regulations, the proposals should reduce the discrepancy between the financing expense amount and the available amount such that the comparison between the UK and worldwide financing cost is made on a more consistent basis.

Some issues may continue to arise where an overseas group company has entered into the types of arrangements covered by the regulations and has lent the funds raised to the UK group. In these circumstances the external finance cost will continue to fall outside the available amount, and, depending on the group’s overall position, this could lead to a disallowance in the UK.

Do the regulations go far enough?

There remain a number of common arrangements which may continue to give rise to a mismatch between the amount included in the available amount and the corresponding financing expense amount.

These have not been covered in the draft regulations, and include:

  • the accounting finance charge in respect of convertible loan notes arising from the bifurcation between debt and equity components;
  • accounting debits which arise from the initial recognition of debts for accounting purposes at fair value – typically these could arise where distressed debt has been refinanced / restructured;
  • fair value adjustments to debt arising due to hedge accounting applying to fixed rate debt which has been swapped into floating.

It is expected that HMRC may seek to deal with some of these further situations through either guidance or additional regulations to deal specifically with accounting mismatches.

An alternative approach could be to widen the current draft regulations so that they introduce a more general rule to cover all situations where the available amount is not consistent with the corresponding financing expense amount, however it currently seems unlikely that HMRC will adopt such an approach.

In the meantime, groups who have potential mismatches which may give rise to a material impact on their debt cap calculations may wish to obtain specific confirmation from HMRC on the application of the rules to their facts.

The draft regulations and details of how to submit comments are available on the HMRC website via


Neil Edwards, Partner, PricewaterhouseCoopers