Tax issues in a high interest environment

UK interest rates have been increased 14 times over the last two years and the base rate is currently at 5.25%. This follows a long period of low interest rates in the UK. Low interest rates meant that taxpayers, including companies and businesses, could normally work on the basis that an interest expense would rarely be a decision ‘showstopper’. With higher interest rates now in force that is no longer the case, and this article sets out some of the ways in which businesses must take high interest rates into consideration in their cashflow and tax planning.

1. New Associated Company rules

New ‘Associated Company’ rules replaced the old ‘related 51% companies’ rules from 1 April 2023. These new rules are quite similar to the old rules; however, they could mean more companies have to be considered than previously when deciding how many associated companies a company has for tax payment purposes.

The more associated companies there are, the lower the threshold at which the main 25% corporation tax rate applies. This could mean that a company is unexpectedly liable to pay tax at 25% rather than 19%.

The number of associated companies also reduces the thresholds at which Large Company Quarterly Instalment Payments (QIPs) and Very Large Company QIPs apply. Falling into either of these regimes accelerates the timing of tax payments. Companies failing to plan for the impact of the new rules may find they pay tax late. With interest on late QIPs at 6.25% and on tax that is paid later than the normal due date charged at 7.75% this can result in a significant cost.

The analysis of the new rules can be particularly complicated for Family and Owner Managed Businesses and Private Equity backed businesses where identifying all associated companies can require looking beyond 51% relationships and into the wider ownership structures of these types of companies.

With more interest at stake, and additional complication on defining the number of associated companies, HMRC may be more inclined to pursue this line of investigation.

2. Tax payments and cashflow management

With interest on late tax payments now a potentially material amount, all companies whether they are Large Corporate International Groups, Family Owner Managed Businesses, or Private Equity backed businesses will need to include in their cashflow planning the interest impact of when they pay their tax liabilities.

The normal due date for corporation tax payments is nine months and one day after the end of the accounting period.

Quarterly Instalment Payments (QIPs)

Companies whose taxable annual profits exceed £1.5million (known as ‘Large for QIPs’) must pay their tax in quarterly instalments. Companies with taxable profits exceeding £20million also pay their tax in quarterly instalments, but these are on an accelerated timeline. These companies are ‘Very Large’ for QIPs purposes.

The first year a company falls into the QIPs regime is a ‘grace period’ meaning for that first year the company still pays tax on the normal due date. There is no grace period for Very Large companies, or where the tax liability is more than £10million for a company falling into QIPs for the first time, and corporation tax would immediately be due to be paid in 4 equal quarterly instalments with some of the corporation tax being due before the accounting period end.

Companies should pay one fourth of their estimated final liability at each payment date, and then once the taxable profits for the period are known, a final balancing payment is made on the normal due date, or a repayment is received from HMRC.

With interest rates so high companies will need to take care with their QIPs calculations. They will need to balance carefully their cashflow management, potentially overpaying QIPs will create cashflow issues in the business, against the risk of an absolute interest cost if they underpay.

Late Payment Interest

HMRC accrue interest on all late paid quarterly payments. Interest rates on late QIPs currently at 6.25% (per annum) from 14 August 2023.

Penalties

HMRC does not typically apply penalties to late paid QIPs however there are provisions in the legislation which allow them to do so at their discretion. Should HMRC seek to apply penalties, these would normally be limited to two times the interest.

If you are unable to pay your tax on time for any reason, in addition to the potential interest cost, you should seek advice on how to manage the risks of deferring the tax payment.

3. Upstream loans section 455/459

The Loans to Participator Rules, often referred to by their tax legislation reference as ‘section 455’ tax, which apply to ‘Close Companies’ for tax purposes (these are broadly companies that are controlled by 5 or fewer ‘participators’) are extended by the rules regarding ‘indirect loans to participators’ in section 459. Section 459 can result in tax levied at 33.75% being applied to ‘upstream loans’ within a corporate structure. These upstream loans can typically arise from a historic management buyout (MBO) of one or more shareholders in a Family Owner Managed Business or in a Private Equity transaction, where cash in the business is used to fund the MBO leaving a payable balance due from parent to subsidiary.

An upstream loan can normally be cleared by a dividend, although a dividend to clear the upstream loan should be made within nine months following the year end in which the loan was made/the MBO took place to prevent the tax on loans to participators being charged. If any such tax is paid, this would be reclaimable once the upstream loan is repaid, cleared by distribution, or waived.

In practice, a group may only discover they have an upstream loan during a due diligence exercise. Whilst the tax itself is repayable, the repayment by HMRC is due only on the normal due date for the period in which the upstream loan is cleared (so normally nine months and one day after the period end) so in a company sale context can result in a retention amount until HMRC repays the tax.

Interest on late payment of tax on loans to participators applies as it does to other tax payments and with higher interest rates the potential interest can be significant.

Whether or not a loan is an ‘upstream loan’ for these purposes is fact specific and the facts need to be carefully reviewed. However, it is generally advisable to ensure that the analysis of whether such loans could be caught within s459, and if necessary, clearing outstanding balances is completed before entering a sale process.

4. Transfer pricing

Many large and listed companies will be well aware that for accounting periods beginning on or after 1 April 2023, entities in scope of the UK transfer pricing rules with consolidated turnover greater than €750million have more specific transfer pricing documentation requirements. 

However, in addition to the format changes required to documentation, with the hike in interest rates large companies will need to consider whether interest on intra-group loans still reflects an arm’s length interest charge.

Companies that are not large, such as Family Owner Managed Businesses or Private Equity companies, may not be required to adopt the mandated format for transfer pricing documentation, but will still need to ensure that their intra group interest charges are reviewed and increased if necessary to ensure they continue to reflect an arms-length position and stay up to date with current interest rates. Failing to do so could result in costly HMRC enquiries and potentially additional tax to pay.

5. Corporate Interest Restriction

For corporate businesses, the Corporate Interest Restriction (CIR) limits the amount of interest expense which a business can deduct when computing its taxable profits, often to around 30% of UK taxable profits. This restriction applies if the company or group’s total UK net tax interest and financing expenses are greater than the £2million de minimis amount. With higher interest costs, groups which were below the £2million interest threshold previously could find themselves breaching the limit unexpectedly.

This can mean a proportion of a group’s interest cost may not attract tax relief. The rules are complex and have specific compliance requirements.

Our article here has more detail on transfer pricing, CIR, refinancing and the taxation of interest generally.

6. Summary

The impact of higher interest rates can mean that businesses:

• have a higher rate of tax on profits than they expected; and/or
• are required to pay tax earlier than expected; and/or
• pay more tax because tax relief is not available or is delayed.
• become non-compliant with certain requirements linked to interest costs.

If companies don’t pay the right amount of tax when it is due, the additional cost with higher interest rates can be an unwelcome surprise. Businesses should ensure they understand how higher interest rates impact on their tax positions, especially in connection with the amount of tax that is due so they can include the cash impact in their budgets and cashflow planning or undertake restructuring to mitigate the additional costs.