Jump to content
House Price Crash Forum
Simon Taylor

Time To End Tax Relief On Debt?

Recommended Posts

Morning,

I've been reading the acres of press coverage about the gradual withdrawal of MITR from BTL. One thing which does surprise me is the lack of comment on the market distortion caused by allowing one set of market participants - BTL - a set of commercial advantages not available to another set - buyers of homes to live in. That it has been allowed to happen for a commodity which provides a basic human need - shelter - will be viewed historically as abhorrent.

Given that we now have over a decade of evidence to show the effects of such a policy, maybe it is time to consider phasing out all interest tax relief on debt interest? Companies were traditionally funded by equity capital and the cost of that capital - the dividend - is paid out of a company's profits after taxation. Why should the cost of debt capital be treated differently? It gives a company a massive incentive to fund a business with debt and a huge advantage to the banks providing that debt.

Creating a level playing field between debt and equity would create several positive changes to our economy:

1. A smaller banking sector

2. More widespread shareholder participation as companies have to work harder to raise equity.

3. More sustainable companies - have a look at a large proportion of the big corporate failures over the past decade and apart from the obvious victims of a changing world - Woolworths, HMV, and simple criminality - Enron - excessive and unserviceable debt has been the common cause.

Osbourne could truly be a radical, reforming chancellor if he put this in motion. He won't of course, the vociferous response of the banking lobby would make the hysterical shrieking of the BTL sector look like a Sunday school.

Share this post


Link to post
Share on other sites

A huge slice of the banking sector is built upon the "revenue" ie interest sucked out of the economy. Issuing that massive debt has sucked the oxygen out of capitalism. However it would be very brave political to attempt to unpick this mess, too many vested interests.

Share this post


Link to post
Share on other sites

The debt is often provided from overseas, so that the interest is deductible for UK corporation tax, but the interest recd ends up in some low tax jurisdiction.

If you want to read up on this, look at the IFS website or search for thin capitalisation.

Share this post


Link to post
Share on other sites

A huge slice of the banking sector is built upon the "revenue" ie interest sucked out of the economy. Issuing that massive debt has sucked the oxygen out of capitalism. However it would be very brave political to attempt to unpick this mess, too many vested interests.

The debt is often provided from overseas, so that the interest is deductible for UK corporation tax, but the interest recd ends up in some low tax jurisdiction.

If you want to read up on this, look at the IFS website or search for thin capitalisation.

Both comments add the argument for phasing out debt relief, no?

There will be powerful vested interests which oppose it, but isn't the wider population, and especially the younger element, also a powerful VI? They have electoral heft in their favour. As recent political moves on BTL have proved, electoral demographics carry some clout.

Share this post


Link to post
Share on other sites

look on any high street and the most upmarket premises in the prime locations tend to be those of the debt merchants- indebting people is a highly profitable business and those profits translate into political influence.

The problem is of course that at some point the debt grows so large that it threatens to destroy the very economy upon which it feeds leading to ever more desperate measures to make that debt 'affordable' via lower interest rates- but then these low rates eventually eat away the profits of the financial sector itself, which is where we are now- the system is trapped between the need to make debt profitable again while not blowing up the heavily indebted population of debt slaves by making their servicing costs unsustainable.

Share this post


Link to post
Share on other sites

Both comments add the argument for phasing out debt relief, no?

There will be powerful vested interests which oppose it, but isn't the wider population, and especially the younger element, also a powerful VI? They have electoral heft in their favour. As recent political moves on BTL have proved, electoral demographics carry some clout.

If the young and not so young just lived within their means and stopped borrowing the banks would have to wind their necks in. BTL got favourable treatment to encourage the sheeple to take on more than one load of mortgage debt, and maybe now that that has gone as far as it can go George has been told to crash the market so that the banks can get a slice of new debt on the books at lower prices but maybe higher interest rates. Either way it is just an attempt to keep the debt waggon rolling, even although some people might benefit from cheaper houses for a while. Best case would be a big collapse, debt revulsion among the main consumer age group and far less big banks IMO.

Share this post


Link to post
Share on other sites

look on any high street and the most upmarket premises in the prime locations tend to be those of the debt merchants- indebting people is a highly profitable business and those profits translate into political influence.

The problem is of course that at some point the debt grows so large that it threatens to destroy the very economy upon which it feeds leading to ever more desperate measures to make that debt 'affordable' via lower interest rates- but then these low rates eventually eat away the profits of the financial sector itself, which is where we are now- the system is trapped between the need to make debt profitable again while not blowing up the heavily indebted population of debt slaves by making their servicing costs unsustainable.

And the US hell bent on raising rates in a deflationary environment will just make the debt system eat itself faster, or will that somehow bring balance back to the system?

Edited by dances with sheeple

Share this post


Link to post
Share on other sites
Guest

I'm all for it but let's wait until the 118 brigade have incorporated first :D

:lol:

To invert this on its head, what if anything, is good about debt interest relief? Does it mean more companies get started? If companies are entirely dependent on this, how are they profitable? They are not incurring the true cost of business. If they are not incurring the actual costs of businesses, aren't they zombie companies? If they aren't incurring the true cost of business then nor do banks need to price or evaluate risk accordingly. Essentially you propagate an imbalance throughout the system. Why give a renter-saver an interest rate when you can set your business interest rate at something no business could actually pay without interest relief. This might explain the attraction of peer to peer business lending. The interest rates are pretty high and the banks must be even higher. Because nobody is really paying for it.

Individual creditors pay the cost of bankruptcy but debt interest relief hits everybody, even those not connected to the transaction.

Edited by phantominvestor

Share this post


Link to post
Share on other sites

Indeed. And debt is increasingly not being paid off, by corporations, governments and households.

Traditionally the model was borrow a capital sum and repay it over a fixed period paying back interest and principal. This has changed. Companies refinance the same amount of capital, households take interest only mortgages. As for governments, well....

The debt remains in perpetuity which may well be want was intended in the first place. Removing the tax relief will make this model less attractive.

Share this post


Link to post
Share on other sites

Tax relief on debt is the easiest way for multinational corporations to make sure they don't pay much corporation tax here in the UK.

http://www.theguardian.com/business/2015/dec/06/cadburys-owner-paid-no-uk-tax-last-year

An investigation by the Sunday Times found the company was wiping out Cadbury’s bills using interest payments on an unsecured debt, which is listed as a bond on the Channel Islands’ stock exchange.

Edited by Even Keel

Share this post


Link to post
Share on other sites

HM Treasury are currently conducting an open consultation on limiting tax reliefs on corporate debt (h/t Property118 of all places):

HM Treasury, Tax deductibility of corporate interest expense: consultation, October 2015

In recent years it has become clear that the international tax rules have not kept pace with globalisation and modern business practices which has led to some multinational enterprises exploiting the rules to pay little or no tax in many of the markets in which they operate. In 2013, the governments of the G20 and Organisation of Economic Co-operation and Development (OECD) launched the Base Erosion and Profit Shifting (BEPS) project to modernise and improve the international tax rules to drive out aggressive tax planning by multinational enterprises. Just two years later, the OECD has delivered reports on each element of the 15 point BEPS Action Plan, the outputs of which the Chancellor, and other G20 Finance Ministers, have now endorsed. The UK has already announced action on the 2014 outputs from the BEPS project to introduce country-by-country reporting and new rules to address hybrid mismatches.

At the summer Budget 2015 the government announced that it would be developing a new business tax roadmap for this Parliament. The government will as part of the development of that roadmap be considering the recommendations set out in the BEPS reports. One of the OECD recommendations concerns best practices on interest deductibility.

The use of interest expense has been identified as one of the key areas where there is a significant opportunity for BEPS by multinational companies. The OECD report under Action 4 of the BEPS project sets out recommendations for countering this. The government recognises this risk and so we are reviewing the rules on interest deductibility that apply within the UK in light of the recommendations set out in the OECD report. Consistent adoption and application of rules across all countries would have the benefit of certainty for business as well as ensuring a more level playing field.

[. . .]

Most OECD countries allow interest expense to be deducted in calculating taxable business profit while having rules to protect their tax base from excessive or tax-driven interest deductions. These rules may operate on either a general or transactional basis. Many countries, such as Australia, Germany, Italy, Japan, and Spain, already have rules that provide a structural restriction on tax relief for interest expense. Others, such as the US, have put forward proposals that would bring their current rules in line with the approach recommended in the OECD report. The UK’s worldwide debt cap is a general rule which provides a back stop for excessive interest deductions but its other rules are essentially transactional. Under its transfer pricing rules the UK restricts tax relief for interest to the arm’s length amount but this restriction takes no account of whether the income and assets supporting that interest are taxable. Despite a number of targeted rules to supplement the arm’s length test, significant planning opportunities can arise from both external and intra-group interest expenses.

[. . .]

5.0 Summary of the OECD’s best practice recommendations on interest expense

De minimis monetary threshold to remove low risk entities
Optional
+
Fixed ratio rule
Allows an entity to deduct net interest expense up to a net interest/EBITDA ratio within a corridor of 10%-30%
+
Group ratio rule
Allows an entity to deduct net interest expense up to its group’s net interest/EBITDA ratio, where this is higher than the fixed ratio
Option for a country to apply a different group ratio rule or no group ratio rule
+
Rules to address volatility
Including carry forward of disallowed interest / unused interest capacity and/or carry back of disallowed interest
Optional
+
Public-benefit project exclusion
Optional
+
Targeted rules to support general interest limitation rules and address specific risks
+
Specific rules to address issues raised by the banking and insurance sectors

6.0 UK implementation of the OECD best practice recommendations on interest expense

[. . .]

A balance will need to be struck between protecting the UK tax base and allowing businesses sufficient time to adapt to the new rules. If new rules are introduced in the UK it is unlikely this would be before 1 April 2017.

Question 1: What are your views on when a general interest restriction should be introduced in the UK?

[. . .]

Companies in large multinational groups pose the main base erosion and profit shifting risk. However, depending on their design, rules which only applied to multinational groups could discriminate in favour of domestic groups and stand-alone companies. This could harm the UK economy and may be contrary to EU law.

The OECD report includes the option for countries to consider introducing a group ratio rule in combination with the fixed ratio rule (see section 6.6 below). Depending on the design of such a rule, it could ensure that no restriction arises for domestic groups and stand-alone companies in respect of interest paid to third parties.

Question 2: Should an interest restriction only apply to multinational groups or should it also be applied to domestic groups and stand-alone companies?

[. . .]

Assuming the rule is to be applied at the UK sub-group level, the computational steps for the fixed ratio rule could be as follows:

(1) Calculate the sum of the tax EBITDAs of all companies (and UK Permanent establishments) in the UK sub-group.
(2) Multiply this sum by the fixed ratio percentage.
(3) The resulting figure gives a cap for allowable net interest expense for the UK sub-group.
(4) For the UK sub-group as a whole, any net interest expense in excess of the cap would be non-deductible (but the rules could provide for this amount to be carried forward and be relieved in future periods – see section on addressing volatility below).
(5) The rules could either determine mechanically how the non-deductible amount is to be allocated to individual companies or allow taxpayers an element of choice.

The table below illustrates a simple example of a fixed ratio rule based on EBITDA using fixed ratios of 30%, 20% and 10% and the resulting amount of interest relief being denied in the local group in each case:

10epr9t.jpg

The fixed ratio rule would apply to all interest, whether paid to related or unrelated parties.

[. . .]

The operation of the fixed ratio rule requires the fixed ratio to be set at a level which is appropriate to tackle base erosion and profit shifting. The OECD report recommends that countries should set the fixed ratio percentage in a corridor of 10% to 30%.

If a fixed ratio rule was implemented in the UK, the level of the fixed ratio would need to balance tackling BEPS effectively against allowing UK companies to deduct interest arising on third party debt that is used to finance assets and activities that are taxable in the UK. Where this balance would be struck may depend on which of the optional aspects of the OECD recommendations were implemented in the UK.

[. . .]

The OECD report includes an optional group ratio rule for countries to consider introducing in combination with the fixed ratio rule. The group ratio rule would replace the fixed ratio rule for determining the interest restriction with a ratio based on the position of the worldwide group. The group ratio rule would permit some groups that have a higher level of external gearing to deduct interest in excess of the amount allowed under the fixed ratio.

The ‘group ratio’ could be calculated as the ratio of net third-party interest expense to EBITDA in the GAAP accounts for the worldwide group as a whole. This could be aligned with the fixed ratio rule, using the same calculation of entity EBITDA based on tax numbers, and the same carry forward or carry back provisions.

A number of countries currently apply a fixed ratio rule in combination with a group ratio rule using an assets-based ratio. For example, Germany has an ‘equity escape’ rule whereby the fixed ratio rule based on net interest/EBITDA does not apply if a company can show that its tax-adjusted equity/total assets ratio is equal to or exceeds that of its group (within a small tolerance). Under the OECD’s recommendations, a country may also apply a group ratio rule based on asset values.

The OECD report notes that there will be cases where countries decide to apply a fixed ratio rule in isolation. As noted above, this could be one factor to consider when setting the fixed ratio within the OECD’s recommended corridor of 10% to 30%.

The inclusion of a group ratio rule may allow the interest restriction regime to be better targeted at BEPS (which is more likely to arise where the interest expense in the UK exceeds the group ratio). It would also allow groups which for commercial reasons are more highly leveraged, to obtain a higher amount of interest relief. However, by permitting more highly-leveraged groups to benefit from greater interest deductions, this increases the incentive to obtain funding through debt rather than equity. This may exacerbate the debt/equity asymmetry and encourage over-indebtedness amongst groups, thereby increasing the level of financial risk to which they are exposed.

[. . .]

The OECD report says a de minimis threshold can be applied to ensure that the rules are targeted where the greatest BEPS risk lies and to reduce compliance costs on business. Arguably the simplest way of applying the threshold would be to permit any group to deduct its net UK interest expense up to a fixed amount regardless of the calculated interest cap. It is estimated that setting such a de minimis at £1 million would exclude over 90% of companies in the UK. A group with a net UK interest expense below £1 million would be entitled to deduct all its interest expense. A group with a net UK interest expense above £1 million would be entitled to a net deduction for interest equal to the higher of £1 million and the cap calculated according to the interest restriction rules. The operation of the rule is illustrated in the table below using a threshold of £1 million.

11ca3ol.jpg

In addition, as the OECD report suggests that the greatest BEPS risk lies with large MNEs, groups which are classified as micro, small or medium-sized according to EU criteria (“SMEs”) could be exempted from the rules.

Question 9: What form of de minimis threshold would be most effective at minimising the compliance burden without introducing discrimination or undermining the effectiveness of any rules?

Question 10: What level should the de minimis threshold be set at, balancing fairness, BEPS risks and compliance burdens?

Question 11: Should SMEs as defined by the EU criteria be exempted from the rules, in addition or as an alternative to a de minimis threshold?

[. . .]

The OECD report includes a number of options for countries to deal with volatility in earnings, including averaging and the use of carry forward and carry back of disallowed interest and carry forward of unused interest capacity. The need for including these options depends to some extent on the percentage for the fixed ratio rule. Allowing carry forward of disallowed interest expense would seem to be the simplest approach to addressing volatility and is consistent with the operation of the UK tax system. There is a risk that the carry forward of unused interest capacity or the carry back of disallowed interest would otherwise permit excess capacity to build up in the economy over time, which might lead to tax-driven business combinations in order to utilise that capacity. Some countries with existing restrictions permit carry forward of both disallowed interest and unused capacity, in some cases with time limits, particularly in respect of unused capacity. Concerns may also arise when a company changes ownership or changes the nature of its economic activity. Some countries with existing restrictions place further conditions on the use of carry forwards in these circumstances, as does the UK in connection with other reliefs.

[. . .]

Where a PBP exclusion is claimed, income and interest expense attributable to the project would be omitted from fixed or group ratio rule calculations for the entity or group. Each use of the exclusion would be disclosed to other tax authorities with a legitimate interest (i.e. where foreseeably relevant) under tax information exchange agreements, whose interest restriction rules may also take account of the PBP exclusion claimed. If a group ratio rule is implemented, many of the public-private partnership projects which could benefit from the PBP exclusion may not need to use it. In the cases where the project vehicle is not consolidated into any other group it would be treated as a group for the purpose of the group ratio rule, permitting a deduction for the whole of its third party interest expense, subject to other tax rules.

[. . .]

The OECD report also says that countries should consider using targeted rules to prevent manipulation of the general rules and to address specific BEPS risks not covered by the general rules. Suitable targeted rules may enable the fixed ratio to be set at a higher level, subject to the overall 30% limit in the OECD recommendations.

[. . .]

The OECD report recognises that the recommended best practice approach is unlikely to address BEPS in the banking and insurance sectors for a number of reasons. In particular, banking and insurance groups are important sources of debt funding for groups in other sectors and as such many are net lenders by a significant margin. This means that the main operating companies in these groups, and the groups overall, will often have net interest income rather than net interest expense. The fact that interest income is a major part of a bank or insurance company’s income means that EBITDA would not be a suitable measure for economic activity across a group in these sectors.

The OECD report also suggests that the restrictions imposed by regulatory requirements lowers the BEPS risk in banking and insurance groups. However, not all companies within banking and insurance groups are regulated at the solus level, and there can be BEPS risks from borrowing involving non-regulated entities. The OECD will undertake further work on this area in 2016.

The UK recognises that it may not be appropriate to apply the general rules as proposed by the OECD to banking and insurance groups. The UK intends to work with the OECD and business to develop rules that could be introduced alongside the general rules or to modify the general rules to address the specific BEPS risk posed by the banking and insurance groups.

[. . .]

The OECD report says that a country may also apply transitional rules which exclude interest on certain existing loans from the scope of the rules, either for a fixed period or indefinitely. The OECD report recommends that these transitional rules are primarily restricted to interest on third party loans entered into before the rules were announced, and that interest on any loans entered into after the announcement of the new rules should not benefit from any transitional provisions.

Providing relief from the rules for existing loans would discriminate in favour of existing loans and may distort funding arrangements for business. However, it is acknowledged that there may be particular cases where transitional rules may be needed to prevent unfair outcomes or unintended consequences. Taking into account the other design options set out in the OECD best practice framework, the government would expect grandfathering of existing loans to be available only in exceptional circumstances.

[. . .]

The UK already has a number of rules limiting tax relief for interest under certain circumstances, including the Worldwide Debt Cap (WWDC), transfer pricing rules and certain anti-avoidance rules. It is envisaged that any new interest restriction would operate after the transfer pricing rules and anti-avoidance rules, including the anti-hybrid rules to be introduced following the OECD report on Action 2. Any rules which became redundant as a result of new rules could be repealed. It is envisaged that any new interest restriction would replace the WWDC, or the WWDC would need to be adapted to fit with the new approach.

Share this post


Link to post
Share on other sites

look on any high street and the most upmarket premises in the prime locations tend to be those of the debt merchants- indebting people is a highly profitable business and those profits translate into political influence.

The problem is of course that at some point the debt grows so large that it threatens to destroy the very economy upon which it feeds leading to ever more desperate measures to make that debt 'affordable' via lower interest rates- but then these low rates eventually eat away the profits of the financial sector itself, which is where we are now- the system is trapped between the need to make debt profitable again while not blowing up the heavily indebted population of debt slaves by making their servicing costs unsustainable.

Another dismal year for the hedgetarians. Makes me wonder how much trouble the financial sector is in already? Funny how these guys look more like overpaid mortals and less like investment geniuses now the QE's dried up. Everybody's a noise trader.

By
Rob Copeland
Jan. 1, 2016 6:25 p.m. ET

Hedge funds start the New Year with something to prove—again.

The money managers who charge some of the highest fees on Wall Street had a chance in 2015 to outperform a nearly flat stock market and end years of subpar performance.

Instead, hedge funds lost more than 3%, on average, according to early estimates from hedge-fund-research firm HFR Inc., while the S&P 500 returned 1.4%, including dividends. Managers stumbled for myriad factors, including bad wagers on energy and currencies and an overreliance on certain stocks.

“Everything went wrong,” said Alexander Roepers, founder of $1.5 billion hedge-fund firm Atlantic Investment Management. “There were very few places to hide.”

http://www.wsj.com/articles/rough-year-adds-more-stress-to-hedge-funds-1451690758

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now

  • Recently Browsing   0 members

    No registered users viewing this page.

  • The Prime Minister stated that there were three Brexit options available to the UK:   3 members have voted

    1. 1. Which of the Prime Minister's options would you choose?


      • Leave with the negotiated deal
      • Remain
      • Leave with no deal

    Please sign in or register to vote in this poll. View topic


×

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.