To implement the G20/OECD base erosion and profit shifting project, the 2016 Budget announced measures limiting tax deductions that companies can claim from their interest expenses (read DLA Piper's earlier client alert on the announcement). The Government's response to the consultation on the proposed new legislation was published on 6 December, and indicates that the Public Benefit Infrastructure Exemption (PBIE) will be broader than originally envisaged.
Until 1 April 2017 a tax deduction for interest costs of up to 100% of UK profits is (broadly) available, provided it can be shown that a third party lender will lend. From 1 April 2017, subject to limited exceptions, deductions for interest will be capped at 30% of earnings.
This has a particular impact on infrastructure projects which are typically highly geared, with up to 90:10 debt:equity ratios.
The Government's response provides some comfort by introducing an elective Public Benefit Infrastructure Exemption, wider than that proposed in the consultation.
The exemption will apply on a company-by-company basis. Qualifying companies will be fully excluded from their group’s interest restriction calculations, with the exception of any non-qualifying interest expense.
- "Qualifying companies" are those which generate income from qualifying activities. They may only hold public benefit infrastructure, and ancillary fixed assets. Immaterial amounts of non-qualifying income or assets will not prevent a company from qualifying. Qualifying companies must also be within the charge to Corporation Tax on all their activities, must not hold any shares in non-qualifying companies and are required to make an irrevocable election.
- "Qualifying activities" are the provision, upgrade or maintenance of public benefit infrastructure and the undertaking of public benefit services or integral services using that infrastructure, provided that the infrastructure is recognised on the balance sheet, either as a fixed or finance asset, of a qualifying company within the same worldwide group.
- "Public benefit services" are services that are (i) procured by a public body or its wholly owned subsidiary or (ii) provided in consequence of specific arrangements made by Parliament, (iii) services performed in the interest of national security, and (iv) the provision of rental property to unrelated parties.
- "Public benefit infrastructure" is the physical objects used to deliver a public benefit service, and must have an expected economic life exceeding 10 years.
- "Specific arrangements" is expected to included licensed and other activities in the following markets (i) water, gas and electricity transmission, interconnectors, distribution and supply; (ii) thermal (coal and gas), renewable and nuclear energy generation; (iii) port and airport operators; and (iv) the rail network. In each case the activity will need to be governed by specific legislation and/or regulated by bodies established by statute.
Qualifying interest must be paid by a qualifying company to lenders which are not related parties, and which only have recourse to the income or assets of qualifying companies (including via security over shares in those companies). Interest will also qualify if it is paid to public bodies or other qualifying companies. However, interest will not qualify if paid on loans for which guarantees are provided, unless by qualifying companies or public bodies.
Implications for infrastructure clients
Draft legislation covering all aspects of PBIE will not be available until end January 2017, which will impact certainty in terms of negotiating projects currently in procurement.
The law will be in force on 1 April 2017 for all groups irrespective of the accounting date of a qualifying company.
Whilst the extended exemption is welcome, the Government has not accepted concerns that related party debt in the form of loan notes should also be covered by the exemption. However recognising the impact on investors who entered into agreements in good faith, deductibility of interest payable to related parties will be "grandfathered" to the extent the loan was agreed prior to publication of detailed proposals for the interest restriction rules on 12 May 2016. Grandfathering will be limited to cases where 80% of the qualifying company’s expected income has been materially fixed for 10 years or more by long-term contracts with public bodies or their wholly owned subsidiaries.