Corporate Interest Restriction

The corporate interest restriction rules (Interest Barrier Rule) limit how much interest expense a company can deduct for tax purposes. Introduced to prevent aggressive tax planning, these rules can significantly affect how you finance your business. Understanding how they work is essential for proper tax planning and compliance.

Why the Rules Were Introduced

Historically, multinational groups and highly-leveraged businesses could reduce their UK tax bill by loading UK companies with debt. Interest paid on this debt was tax-deductible, reducing taxable profit.

The corporate interest restriction rules address this by limiting net interest deductions. The goal was to prevent "profit shifting" — moving profits out of the UK through high interest charges.

The Basic Rule: The Net Interest Expense Limit

The fundamental rule is simple in concept but complex in application: a company can only deduct net interest expense up to 30% of its tax EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization).

What This Means in Practice

If your company has:

• EBITDA of £1,000,000
• Net interest expense of £100,000

You can deduct interest up to: £1,000,000 × 30% = £300,000. Since your actual net interest is £100,000, you can deduct all of it.

However, if your net interest expense was £400,000, you could only deduct £300,000, leaving £100,000 of disallowed interest.

Understanding Net Interest Expense

"Net interest expense" includes not just interest on loans, but many financing costs.

What Counts as Interest Expense

• Interest on loans and credit facilities
• Interest on bonds and other debt securities
• Costs incurred financing debt (arrangement fees allocated over the life of the loan)
• Financing leases
• Implicit interest in hire purchase arrangements
• Dividend-equivalent payments on shares
• Discounts on debt securities

What Counts as Interest Income

• Interest received on loans and credit facilities you've extended
• Interest on bonds you hold
• Gains on debt securities

Net interest expense = Total interest expense minus total interest income.

The EBITDA Calculation

The 30% limit is applied against EBITDA (tax EBITDA, specifically), which is a non-standard definition.

What EBITDA Includes

Tax EBITDA for interest restriction purposes includes:

• Profit before interest, tax, depreciation, and amortization
• Profits from investments in associates (using equity accounting)
• Share of profits in partnerships
• Certain other financial income

Important: Loss-Making Companies

If your company is loss-making or has zero EBITDA, the 30% test provides no relief. You can't deduct any net interest expense beyond the amount allowed under the specific rules.

When the Interest Restriction Doesn't Apply

The rules are complex, and they include several exceptions and carve-outs.

Small Companies Exemption

If your company's net interest expense is less than £500,000 per year, you may be exempt from the interest restriction rules entirely (the "de minimis" exemption). This exemption is generous and means many small and mid-sized companies aren't affected.

Standalone Company Exemption

If your company is standalone (not part of a group with consolidated annual revenue exceeding €750 million), you may be exempt from the rules.

Group Ratio Exemption

If your entire group's net interest expense doesn't exceed 30% of group EBITDA, you may be exempt from the rules for the company in question.

Disallowed Interest and Carried Forward Interest

Interest that fails the restriction test isn't simply lost — it can be carried forward to future years.

Carrying Forward Disallowed Interest

Interest disallowed in one year can be deducted in subsequent years, provided:

• The company has available interest allowance in that future year
• The interest is carried forward in the correct manner with proper records

This means if you have a high-interest year followed by high-profit years, you can deduct the previously disallowed interest later.

Practical Impact on Financing Decisions

The rules affect how companies finance themselves.

Equity vs Debt

Companies that would previously finance expansion through debt now need to consider equity financing more seriously. Unlike debt with tax-deductible interest, equity dividends aren't tax-deductible.

Group Financing Structures

For multinational groups, the rules affect how cash is moved between companies. Back-to-back loans or complex financing chains are less attractive when interest deductibility is limited.

Compliance and Documentation

Compliance with the interest restriction rules requires careful documentation and record-keeping.

What You Need to Track

• All interest expense items, clearly documented
• All interest income items
• EBITDA calculations (often complex for complex companies)
• Evidence of group structure and consolidated revenue (for de minimis and group exemptions)
• Calculation of interest allowance and any carried-forward disallowed interest

Tax Returns and Disclosure

Companies subject to the rules must disclose the calculation and outcome on their corporation tax return. If you have disallowed interest or are claiming an exemption, HMRC expects to see the working and evidence.

Planning Opportunities

Within the rules, there are legitimate planning opportunities.

Maximizing Group EBITDA

For groups, ensuring that profit is generated in the most profitable companies (those with highest EBITDA) can maximize the group's total interest allowance.

Timing of Financing Decisions

The timing of taking on debt or refinancing can affect your available interest allowance. Year-end planning is important.

Choosing Between Debt and Equity

For some acquisitions or expansions, equity financing may be more tax-efficient than debt, even though debt might traditionally be cheaper.

The Impact of Recent Changes

Tax rules change, and HMRC has consulted on possible amendments to the interest restriction rules. It's important to stay informed about changes.

Getting Professional Advice

The corporate interest restriction rules are complex and the calculations can involve substantial amounts. If your company has significant interest expense, professional advice is worthwhile.

Your accountant should be able to:

• Assess whether the rules apply to your company
• Calculate your interest allowance and any disallowed interest
• Advise on compliance and documentation requirements
• Identify planning opportunities
• Help structure financing decisions for tax efficiency

The corporate interest restriction rules affect many businesses with debt financing. While the de minimis exemption provides relief for most smaller companies, larger entities and groups need careful planning. Understanding how the rules apply to your business is the first step toward compliance and optimal tax planning. If you'd like to discuss your company's interest restriction position, contact Figures UK for expert guidance on compliance and planning strategies.