In 2013, the G20 Governments and the OECD launched a project looking at “base erosion and profit shifting” (”BEPS”) or, in other words, how multinationals "are exploiting the rules to pay little or no tax in many of the markets in which they operate". An Action Plan containing fifteen separate actions was drawn up by the OECD with the aim of blocking aggressive tax planning by multinationals. Action 4 of the plan focused on the use/manipulation of interest expense to reduce taxable earnings and to drive BEPS.. Three areas involving interest-expense were identified as being particularly problematic:
- Groups placing higher levels of third party debt in higher-tax jurisdictions (debt is then on-lent by way of intra group loan to an entity in a lower-tax environment, leaving interest on the commercial loan to be set against tax in the higher-tax jurisdiction)
- Groups using intra-group loans to generate interest deductions greatly in excess of actual third party interest expense
- Groups using third party or intra group debt to fund the generation of tax-exempt income.
The OECD’s proposal is to tackle the problem by limiting tax deductions for interest (and payments similar to interest) to a fixed percentage of a business’s EBITDA (the ‘’fixed ratio rule’’). The relevant percentage will be in the range of 10-30%. A ‘’group ratio rule’’ will allow a business to deduct net interest expense up to a group-wide limit, where that’s higher than the relevant fixed ratio. To soften the blow, the OECD contemplates exceptions for public-benefit projects and an overall de minimis monetary threshold to carve out businesses with a low level of net interest expense. Carry-forward of disallowed interest expense for use in future years could also be available.
The UK Government is currently looking at its rules on interest-deduction in light of the OECD's Action Plan. HM Treasury has issued a consultation paper on the topic (responses to be submitted by 14 January 2016). That paper mentions that although the OECD focused on multinationals, any new rules will bind domestic UK businesses too. It also points out, as regards BEPS legislation, that the ‘’government recognises that this would be a major change to the UK corporate tax regime and will require careful consideration’’ and notes that any new rules are unlikely to come into effect before 1 April 2017.