Section 97 of the Finance Act 2010: Restriction on Deduction for Interest on Excessive Debt

Section 97 of the Finance Act 2010 introduced significant changes to the UK’s corporation tax rules, specifically targeting perceived tax avoidance related to excessive debt financing within multinational groups. This section inserted a new Part 10A into the Corporation Tax Act 2009, establishing rules to restrict deductions for interest expenses where a UK company is deemed to be part of an arrangement that allows it to secure a tax advantage through excessive debt.

The core principle of Section 97 is to prevent UK companies from artificially inflating their debt levels, typically borrowing from related parties within the same group. By maximizing interest payments on these loans, the UK company could reduce its taxable profits in the UK, effectively shifting profits to jurisdictions with lower tax rates. This practice is viewed as base erosion and profit shifting (BEPS), which Section 97 aimed to combat.

The legislation operates by disallowing the deduction of interest expense if certain conditions are met. Specifically, the rules apply when:

• There is a connection between the borrowing company and the lender, typically through common ownership or control, making them related parties.
• The amount of debt is considered excessive, judged by comparing it to what would be considered arm’s length borrowing – what an independent third party would have lent the company under similar circumstances.
• The main purpose or one of the main purposes of the debt arrangement is to obtain a tax advantage. This tax advantage could be for the company itself or another entity within the group.

Determining whether debt is “excessive” is a key aspect of applying Section 97. HMRC guidance provides various factors to consider, including the company’s financial position, its earnings, its existing debt levels, and the terms of the loan. Essentially, HMRC will assess whether the debt is commercially justifiable or is primarily driven by tax considerations. Evidence suggesting the loan would not have been granted by an independent lender at the same terms would strongly indicate excessive debt.

The identification of a “tax advantage” is also crucial. This is broadly defined and includes any reduction in corporation tax liability, either in the UK or overseas, that would not have arisen without the excessive debt. This could include deductions for interest, capital allowances, or other tax reliefs. The intention behind the arrangement is a critical factor; the presence of a genuine commercial rationale for the debt can mitigate the risk of disallowance, even if a tax advantage also arises.

If HMRC determines that Section 97 applies, the interest expense that is attributable to the excessive debt is disallowed. This means the company cannot deduct this portion of the interest from its taxable profits, effectively increasing its tax liability. The legislation includes provisions allowing companies to appeal HMRC’s decision.

While Section 97 sought to address abusive tax practices, its broad scope and subjective criteria created uncertainty for businesses. Compliance required careful analysis of debt arrangements, involving significant documentation and justification of borrowing levels. Subsequent legislation and ongoing guidance from HMRC have aimed to clarify the application of Section 97 and provide greater certainty for taxpayers. It’s important to note that these rules were later superseded by the Corporate Interest Restriction (CIR) rules in the Finance Act 2017, which introduced a more comprehensive and objective approach to limiting interest deductions based on a fixed ratio of earnings.