New proposals to address tax avoidance by multi-national corporations could, unintentionally, delay or cancel much-needed UK infrastructure and real estate development, argues Rachel Kelly in Complexity, Uncertainty and Cost.
Endorsed by 17 leading companies in the sector - including British Land, Great Portland Estates and Hammerson - the report shows how OECD proposals for new tax relief restrictions could cost the sector £700 million per year.
Designed to address the tax-avoidance of multinational enterprises, such as certain tech giants and coffee brands, the OECD has proposed new tax relief restrictions. These proposals are due to be implemented by the UK from April 2017 (far in advance of most other OECD members). However, these restrictions will inadvertently impose significant burdens on those industry sectors which have high borrowing ratio, particularly real estate and infrastructure investment.
In addition, these changes would represent a huge shift in traditional tax principles in the UK. Until now, it was widely accepted that the genuine expenses of a businesses should be deductible for tax purposes. This allows a business to forecast approximately how much tax it will pay on its activities.
(Image: Creative Commons/Stròlic Furlàn - Davide Gabino)
Implementing these restrictions would risk serious damage to UK competitiveness and investment at a delicate time for the economy. It would also have a disproportionate effect on riskier development such as the regeneration of brown field sites and other more challenging infrastructure projects.
The proposed new tax relief restrictions are:
- for the tax relief on interest costs to be restricted to 30% of a company’s earnings;
- for a secondary “group ratio” rule for more capital intensive groups with commercially higher interest costs.
These proposals would damage the UK infrastructure and real estate sectors because:
- Real estate and infrastructure projects rely on debt finance far more than most other industries. It is not unusual for real estate investors to incur interest costs of as much as 60% of earnings. The 30% restriction would mean that real estate and infrastructure investors will be liable to a far higher tax liability than under the current rules.
- While the “group ratio” will offer some businesses a slightly more appropriate tax deduction, it still will not guarantee a full deduction for third party interest.
- Furthermore, the new rules will add considerable uncertainty for businesses. A number of factors will affect the group ratio calculation, including: loss of earnings e.g. due to a void period; a change in interest costs; a change in the value of the assets (even if they are not being sold and so do not result in realised earnings). All of these factors are completely outside the company’s control and so it is inappropriate for them to impact the tax relief available on their interest costs.
Three recommendations are made:
- Rules should be made to work for capital intensive industries.
The Government should not introduce the new proposals unless it is clear that they will not harm investment into capital intensive industries. As a matter of principle, all genuine third party debt relating to such investment should be tax deductible as it poses a low risk of tax avoidance. Removing tax relief for the cost of servicing such debt would mean that many real estate businesses’ mere running costs would become subject to tax.
As a minimum, there should be safeguards for debt which represents very low “BEPS” risk – such as third party debt secured against real estate and infrastructure in the UK or debt to wholly UK groups. Such a safeguard would help provide certainty for many investors; as well as ensure an appropriate tax outcome, as interest expense will be matched against the rental income which is taxable in the UK.
- Existing debt arrangements should not be affected
Applying the new proposals to existing debt arrangements will fundamentally undermine the basis on which businesses have made investment decisions. It would be extremely costly to restructure existing finance arrangements and these changes could put borrowers at risk of breaching their banking covenants or defaulting on loans. It would put exceptional and unprecedented pressure on businesses if the tax treatment of existing financing arrangements was not excluded from the new rules. As such, existing third party debt should be grandfathered indefinitely.
- The UK should not act in haste
Implementation from April 2017, as currently proposed, is too ambitious given the complexity of the new rules. It will not allow sufficient time to consider the impact of these new measures; nor will it allow sufficient time for business to adapt. The Government should not introduce any changes until it is clear how other countries will respond to the OECD’s recommendations.
Click here to read the full report.
This paper has received endorsements from a number of leading industry organisations. The following signatories have supported the following statement in support of the report:
“The Government’s proposals to restrict tax deductibility of interest will be particularly penal for capital intensive businesses. The restrictions will lead to lower investment available for real estate and infrastructure; and in turn, a reduction in the jobs and growth that the investment would have stimulated. We support a delay in the implementation of these measures, to allow the government time to ensure that the rules will work fairly and appropriately for all industries; without stemming investment into the housing and infrastructure that this country so badly needs.”
Capital & Regional
Great Portland Estates
Rachel Kelly - Wednesday 19th October 2016