The Government confirmed today that the so-called “late interest” rules are to be abolished in respect of loans made and deeply discounted securities issued between connected companies. This will affect companies subject to UK corporation tax which have borrowed on deferred interest payment terms from connected company creditors in certain, mainly low tax, overseas territories or which have issued deeply discounted securities to such connected companies. Broadly, the measure restores the accruals basis for the deduction of late interest (being interest which is paid later than 12 months after the end of the accounting period in which it accrues) and also for discount on deeply discounted securities.
Generally, interest on corporate debt is allowed as a tax deduction on an accruals basis, regardless of the actual date of payment. The late interest rules are an exception to this general rule and were intended as an anti-avoidance measure, preventing UK companies from claiming deductions for accrued but unpaid interest if the lender is not liable to tax on interest until actual payment. Where they apply, they require interest and discount to be relieved when paid rather than relieved during the life of the loan or discount security on an accruals basis.
HMRC is concerned that the late interest rules have become a tool for tax avoidance as some companies use the late interest rules to manipulate the timing of tax losses, effectively ensuring that interest is paid and losses occur in an accounting period in which they can be surrendered to other group companies by way of group relief. The Guidance Notes to the new General Anti-abuse Rule (GAAR) confirm that this is not the type of planning which is caught by the GAAR so it is clear that legislation will be required to dis-apply the rules. The Government has recently been consulting on proposals for changes to these rules and other wide-ranging changes to the taxation of corporate debt and derivative contracts.
It appears that the late interest rules will continue to apply to loans from, and deeply discounted securities issued to, participators (essentially direct or indirect shareholders) in close companies where specified exemptions do not apply. Accordingly, in many cases close companies should still be able to manage the timing of interest deductions (for example, by paying interest by the issue of further securities (such as PIK notes)). This is however subject to any new anti-avoidance legislation that is introduced – see below.
Commencement: The late paid interest rules will have effect in respect of new loans entered into on or after 3 December 2014. For loans entered into before 3 December 2014, the late paid interest rules will continue to have effect in respect of interest accruing or discounts arising before 1 January 2016 but will cease to have effect for later periods. However, if material changes are made to the loan between 3 December 2014 and 31 December 2015, the revised late interest rules will be effective from the date of the change.
Other corporate debt changes: Other draft legislation for Finance Bill 2015 arising from the wider consultation will be published separately on 10 December 2014. It is expected that the legislation will include a regime-wide anti-avoidance rule for loan relationships, which will counter timing advantages in appropriate cases such as those originally targeted by the late-paid interest rules. It may also include amendments to the rules for capitalisation of loans and debt for equity swaps.