CFM96640 – Corporate Finance Manual – HMRC Internal Manual

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TIOPA10/S423

The default approach for the calculation of group interest and group EBITDA is closely based on the amounts recognized in the group financial statements. In particular, the calculation of the group’s adjusted net interest expense (ANGIE) includes all amounts of interest capitalized during the period.

However, where the group has opted for the interest deduction (alternative calculation), certain adjustments are made to the default approach to align the calculations more closely with UK tax rules. One of these adjustments is to reflect the UK tax rule for capitalized interest.

context

  • Corporation tax rules relating to the treatment of capitalized interest and other amounts distinguish between the nature of the asset or liability into which the amounts are capitalized.
  • In most cases, tax relief is available for capitalized amounts at the time they are capitalized. However, when the asset or liability is taxed according to the accounts (referred to as “subject to GAAP”), the tax relief follows the accounting treatment. This applies in particular to commercial stock and intangible fixed assets.

Effect of election

  • When an interest deduction election (alternative calculation) is made, the adjustments made when calculating the group’s net interest expense adjusted for capitalized interest are no longer applied.
  • As a result, this aligns the treatment with UK tax principles for loan relationships and derivative contracts.
  • For the purposes of this section, all members of the group are treated as subject to corporation tax. Consequently, the same treatment applies regardless of the tax residence of the company holding the property.
  • For accounting periods beginning on or after January 1, 2019, S423 has been amended to ensure that where a GAAP taxable asset is also a relevant asset (such as an intangible asset), the ANGIE calculation includes (at by means of an increase or downward adjustment) the amount of any amortization or write-off of relevant amounts previously capitalized to the asset.
  • Where a business has elected to have an intangible asset exempt under CTA09/S730 (at a fixed rate of 4% per annum), it will fall for inclusion as a taxable asset under GAAP.

Examples

The following examples compare calculations under the default approach.

Example 1: Interest Capitalized to Capital Assets

JK plc prepares accounts as at 31 March each year. He is building a factory for £40million as new premises for his widget-making business. The company borrows money for this purpose and thereby capitalizes the interest of £4 million incurred during the financial year ended 31 March 2018 during the construction of the plant. This cost of borrowing increases the total value of the tangible fixed asset on the balance sheet to £44 million. The plant was completed on April 1, 2018 and is then depreciated over 10 years on a straight-line basis.

JK plc has relevant interest expense of £100m each year on other loans.

Since the plant is classified as tangible fixed assets in the company’s accounts, the interest is recognized in the income statement through the depreciation charge.

In this case, there is no difference with the default approach.

In summary:

NGIE ANGIE
Year ended March 31, 2018 £100 million £104 million
Year ended March 31, 2019 £100 million £100 million

Example 2: Interest capitalized in trading shares – building under development

YZ plc is a property development group. During the year ended March 31, 2018, the group built a new development property as part of its commercial stock. The actual construction cost of the building is £100 million and the associated capitalized interest is £10 million. In the second year, the group manages to sell the property for £150 million.

Assume YZ plc has relevant interest charges of £100m each year on other loans.

YZ plc has made an interest deduction (alternative calculation) election.

Year 1

In the first year, YZ plc capitalizes interest of £10 million. Consequently, this amount is not reflected in the group’s result for the period and is therefore not included in the calculation of the group’s net interest expense (in the same way as in the default approach) .

As an interest deduction election (alternative calculation) has been made, capitalized interest of £10 million is not included in the group’s adjusted net interest expense for the period.

Year 2

In the second year, YZ plc sells the property. Capitalized interest of £10 million is charged to profit or loss as part of the cost to sell.

As the £10m now relates to the write-off of an asset, the £10m should be included in the group’s net interest expense (in the same way as under the approach by default). This ensures that this interest cost is excluded from the calculation of group EBITDA.

Since an alternative calculation choice was made, no adjustment is made to NGIE in the calculation of ANGIE. Accordingly, the £10 million is included in ANGIE in the year of disposal.

In summary:

NGIE ANGIE
Year ended March 31, 2018 £100 million £100 million
Year ended March 31, 2019 £110 million £110 million
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