Tax - CIR / thin Cap / late interest

• Corporate Interest Restriction (CIR) – fixed ratio cap
• Thin Cap rules
• Late payment interest

Corporate Interest Restriction (CIR) – fixed ratio cap

The CIR is a mechanical cap on net tax‑interest expense at group level, separate from thin cap. Broadly, for large groups, deductible “tax‑interest” is limited to the lower of:

• £2m de minimis per 12‑month period;
• A fixed ratio percentage of the group’s UK tax‑EBITDA (typically 30%); or
• A higher “group ratio” percentage where the worldwide group’s external gearing supports it.

Disallowed interest under CIR is not lost: it can usually be carried forward as “disallowed amount” and may be re‑activated in later periods if headroom arises, subject to the detailed rules. CIR applies irrespective of whether the debt is related‑ or third‑party and can bite even where everything is at arm’s length commercially.

Thin Cap rules

Thin cap is essentially the application of the arm’s‑length principle to funding: the UK company should not obtain a tax advantage by being more highly geared to related parties than a third‑party lender would allow. If the overall debt level or the terms of that debt are not arm’s length, part of the interest is treated as non‑deductible for corporation tax.

HMRC’s thin cap analysis is holistic: it considers debt quantum, interest rate, maturity, security, subordination, covenants, currency and any guarantees. The benchmark is what independent lenders would have advanced to that borrower on those terms, often supported by credit rating analysis and market comparables.

Example opinion from a third party debt provider - Colombia Lake Partners

Hi Tom,

Updating your list for a couple of tweaks below:

• The Forma Innovations Group is currently doing c. £3M EBITDA (expensing R&D), or £3.5M EBITDA including a bolt on that is in exclusivity;
• Interest rate fixed at between 10-12%, plus closing and maturity fee 1-2% each
• Based on the figures above, you could provide a facility up to £22.5M, but subject to LTV and EBITDA restrictions noted below. Correct, we could commit up to £22.5m today with this broken down into tranches based on the tests I explained
• Typically lend at 3.5x-4.5x Debt: EBITDA ratio. So based on £3.5M EBITDA, £12.25M - £15.75M – Correct
• Typically lend 60%-70% of Day 1 completion value, plus 60% to 70% of the deferred amount. So we will typically have a total cap we wont go over (e.g. £5m per acquisition) but if you are below this we will fund 60/70% of the upfront and 60/70% of the deferred.
• In all deal structures, you take warrants, typically around 10%. So the all in cost of capital would be c. 15% - Warrants are between 10% to 12%. All in the cost is in the mid teens (14%-17%). As I said on the call, if there is a particular area you are sensitive on, we can adjust it to keep our investors happy
• Typical terms are up to 4 years, with an extendable IO period based on performance

Let me know if you want to chat through anything else.

Thanks,

Kevin

How Thin Cap rules interact with the CIR

The order of play in practice is: first apply transfer pricing/thin cap to arrive at arm’s‑length interest; then apply CIR to that arm’s‑length amount. Thin cap is a qualitative, facts‑and‑circumstances test focused on funding structure and terms, while CIR is a quantitative group‑wide formula that can restrict even fully arm’s‑length bank interest if leverage versus EBITDA is high.

For highly leveraged or PE‑backed structures, both need to be modelled: thin cap may reduce the “starting” deductible interest, and CIR may then cap what remains, meaning effective tax relief on financing costs can be materially below the accounting finance charge.

Late payment interest

Advice from Barnes Roffe

Assumptions

• The analysis below assumes that other tax rules (e.g. Corporate Interest Restriction (CIR)) is not breached as that can affect the below
• Sterna (UK entity), Opera (Luxembourg), OPR (Jersey)

12M rules (Late payment interest)

• Late payment rules do not apply for lending between UK entities. This is broadly because ultimately the Top Co (in this case Sterna) will be taxed on the interest income.
• Late payment rules do not apply for qualifying territories. See extract from HMRC guidance below - https://www.gov.uk/hmrc-internal-manuals/corporate-finance-manual/cfm35960
• Summary of where late payment interest rules may apply:
• UK entities: Does not apply - UK to UK lending

- Luxembourg entities: Does not apply (see above) - Luxembourg is a qualifying territory

- Jersey entities: Does apply given this is not a qualifying territory

• Interest on a loan from a Luxembourg entity to a UK entity is generally tax deductible for the UK borrower, even if not paid in cash, as long as the standard UK loan relationship rules apply and the lender is in a "qualifying territory" (such as Luxembourg, which is in the EU and not considered a tax haven). Under those rules, UK companies can deduct interest that accrues in their accounts on an accruals basis. HMRC’s “late interest” rule postpones relief only if the lender is in a non-qualifying territory or the loan is to an individual/pension, not to EU corporate lenders like those in Luxembourg. There may also be an obligation to withhold 20% tax when the interest is actually paid to the Luxembourg entity. It may be possible for the Luxembourg and Jersey resident company to seek treaty relief so that no 20% is deducted at all. Treaty relief should be sought prior to the payment of interest
• Ultimately for non-qualifying territories, you can only take the tax deduction at the point the interest is actually paid (or deemed to be paid in the example of issuing PIK notes)
• If you issue PIK notes (deemed payment of the interest), withholding tax may apply (20%).
• There may also be an obligation to withhold 20% tax when the interest is actually paid to the Luxembourg entity
• Issuing PIK notes to the Jersey lender will permit a deduction in respect of the interest being debited to the P+L, however there will be a 20% withholdings tax obligation absent of treaty relief.

So in summary, there is little benefit in issuing PIK notes for the Jersey entity, as 20% withholding tax is likely to apply anyway