4 August 2016 National Housing Federation submission to the second consultation on the tax deductibility of corporate interest expense Submission by email: BEPSinterestconsultation@hmtreasury.gsi.gov.uk The National Housing Federation is pleased to respond to HM Treasury s second consultation on the detailed policy design and implementation of tax deductibility of corporate interest expense. As well as responding to this second consultation we would like to request a meeting to ensure that our members are not detrimentally impacted by these proposals. Our response includes this letter where we set out our key concerns to the proposals and our response below, on an exceptions basis only, to questions within the consultation document as they relate to our members. The Federation is the representative body for housing associations in England. Our members provide two and a half million homes for more than five million people. In our response to the previous consultation, tax deductibility of corporate interest expense (January 2016), we explained that if the proposals were enacted in the form then set out, there would be severe consequences for the development of affordable homes in this country. We are encouraged that HM Treasury has gone some way to address our concerns by introducing proposals to exempt charitable organisations from these restrictions. Charities - 100% owned subsidiary exemption This consultation document proposes a charitable exemption at paragraph 8.55 (question 36 below also refers) that allows interest payable by non-charitable subsidiaries of charities to be excluded from the rules where the interest is payable to a charitable parent. While this exclusion, as drafted, will help a few housing associations with their current finance arrangements, we would request that the definition of charity is defined such that it also explicitly covers non-profit private registered providers of social housing. The position of non-profit private registered providers of social housing is closely analogous to that of charities. These bodies are established on a non-profit basis for public benefit and are registered with the Homes and Communities Agency (HCA) as a funding and regulatory body. For the purposes of any specific exemptions/carve outs for charities we would request that they should be treated on the same basis as charities and references to charities should be construed accordingly. Potentially the carve-out could be badged as specific rules for charities and certain other public-benefit bodies. The purpose of this change is to put all non-profit registered providers of social housing (generally termed as housing associations) on the same footing whether or not they are charities in the strict sense (although many of them are). They are established for public benefit and do not distribute profit. The operations and financial arrangements of noncharitable housing associations are similar to those of charitable housing associations and,
in particular, the nature of the relationship with any trading subsidiary is effectively identical. While we support the approach of having a specific carve-out for interest payable to charities and other non-profit private registered providers of social housing as an initial step to limit the impact of these rules on housing associations, we are concerned that other interest payments made by housing associations will still be caught by the rules and, therefore, result in many housing association groups struggling to meet the Government s aspirations to build new houses. As we set out in our response to the previous consultation on this subject, housing associations delivered one in three of all new homes last year and are planning to significantly increase the number of homes in future years. We therefore believe that an exemption should be developed for all finance advanced to all fully owned (100%) subsidiaries of charities and other non-profit private registered providers of social housing. Many housing association groups choose to finance their activities through separate, noncharitable treasury companies (Treasury Cos). This is often for a number of financial, risk mitigation and compliance reasons including: Many housing association groups fund themselves through bond issuance and the borrowing terms may require the debt to be held in a non-charitable entity. Bonds issued from a special purpose vehicle can be less restrictive on housing association businesses compared to selling bonds through the main propertyholding charitable housing association, as registered with the HCA, the social housing regulator. Bonds issued via an unregistered SPV can be on-lent unfettered to other group entities. This is contrast to restrictions on registered housing associations on them on-lending to non-charitable, unregistered group entities. The loan covenants of legacy debt held by the existing housing association often restrict housing associations from increasing borrowings or restructuring finance. Without an exemption being developed for all 100% owned subsidiaries of charitable or quasi-charitable housing association groups (see our response to question 22 in our responses to the questions below), these Treasury Cos would be impacted by the wider proposals and housing associations ability to meet the Government s housing ambitions would be frustrated. Non-charitable trader impact A significant number of housing association groups that hold Treasury Cos also transfer third party debt through the Treasury Co to a non-charitable trader (NCT) subsidiary (see diagram below).
In this scenario it is our understanding that the NCT could face a restriction. The NCT is not funded directly from a third party, but via an intermediary related party (Treasury Co) and so these loans will not strictly meet the definition of a third party loan. Therefore, this would limit the benefit that the NCT could obtain through applying the Group-wide Ratio rule in place of the Fixed Ratio rule. As a result of this, the group headed by the NCT will need to ensure that net interest expense forms 30% or less of its tax earnings before interest, taxes, depreciation, and amortisation (EBITDA), potentially reducing the resources available to develop the new affordable homes this country needs. To limit the impact on the supply of new homes we propose a solution to this issue. The definition of a third party should be expanded to include conduit/back-to-back financing arrangements so that third party loans that are on-lent by a Treasury Co (that itself does not use the funds) are also treated as third party loans and not related party loans. This would mean that the loan between the Treasury Co and NCT would be considered third party rather than related party and, as such, the Group-Wide ratio rule could be utilised to prevent a disallowance arising in place of the Fixed Ratio rule. While the above proposed response to this issue is primary there is a further solution, which redefines the charitable group, that we could further explore at a meeting. At this meeting we would also be keen to discuss how the charitable exemption definition could be expanded to include 100% owned subsidiaries of charitable or quasi charitable housing association groups so that associations public benefit activities remain unaffected by these proposals, as intended. Yours sincerely John Butler Finance Policy Officer 020 7067 1177 john.butler@housing.org.uk
1. Does the use of IFRS concepts cause practical difficulties for groups accounting under other accounting frameworks (e.g. UK GAAP or US GAAP)? Could the use of a range of acceptable accounting frameworks to define the group give rise to difficulties in identifying the members of the group? What would be the main consequences of relaxing the definition in this way? As with all unlisted UK entities, all but one English housing association account under UK GAAP Financial Reporting Standard 102 (FRS 102) as well as the Housing Statement of Recommended Practice (Housing SORP). If the interest restriction regime only operates under the IFRS framework this could lead to every unlisted entity in the UK having to prepare two sets of accounts, one for audited financial statements and another only for taxation purposes. The significant amount of work that will be required to comply with these proposals will lead to increased burden for many small organisations and businesses. In addition, there are some significant differences between the requirements of UK GAAP and IFRS, including how social housing grant is disclosed and, potentially, the accounting for financial instruments. Our view therefore is that there must be scope for other accounting frameworks to be used to report/calculate this requirement. 2. Is it reasonable to take the proposed approach to the periods for making interest restriction calculations? What changes or alternatives to that approach, if any, should be adopted? N/A 3. Do you agree that these are the right amounts to be included with the scope of taxinterest? Are there any other amounts that should be included within the scope of tax interest, or any amounts which should be excluded? If so, please explain the reasons why? Many housing associations own interest rate swaps used to manage the variation in interest rates when holding variable interest rate loans. Under FRS 102, these and a number of other types of financial instruments are disclosed at fair value and movements in fair value are subject to mark-to-market adjustments in the income statement. These could lead to excessive interest cost charges if these movements are included in the calculation of taxinterest. Upon adopting FRS 102, entities were required to make a decision as to whether or not to elect into the disregard regulations for tax purposes, enabling these fair value movements to be excluded for tax purposes, and instead be taxed under old UK GAAP principles. Since the significant majority of housing associations meet the definition of large for the purpose of making this election, the deadline has already passed for making this election. Housing associations are asset rich organisations and many are quite considerable enterprises with
very significant scales of operations. Based on the global accounts produced for the year ended 31 March 2015 produced by the Homes and Communities Agency (the English social housing regulator) which profiles the accounts of housing association owning 1,000 or more homes, some 10% of these housing associations will classify as large, with either turnover exceeding 200m or balance sheet assets exceeding 2bn. Some housing associations, based on the information available at the time, have made the decision not to elect into the disregard regulations and instead tax the fair value adjustments in line with the accounting treatment. Had these housing associations been aware that such fair value movements may potentially fall within the measure of tax interest at the time that they considered whether or not to elect into the disregard regulations, then their decision would probably have been different. They were previously indifferent about making the election since they were not tax paying in any event. Furthermore, given that it appears that the same fair value movements will not be taken into account in the corresponding measure of group interest, this can result in the group ratio rule failing to provide full relief for finance costs arising in respect of third party debt. We would suggest permitting groups to be able to use tax EBITDA and tax interest in place of an accounting measure of EBITDA and interest when calculating the group ratio to prevent mismatches arising. In addition, we are concerned that in the event of a housing association breaking a fix-rate loan agreement, the organisation breaking it may be penalised from a tax perspective. There are a number of reasons why these loan agreements might be terminated prematurely for example, organisations seeking to merge typically restructure loan arrangements. This proposal could restrict tax relief on break costs if housing associations want to seek to refinance loans using bond funding. 4. Do you agree with the proposed treatment of exchange gains and losses? Do you foresee any unintended consequences from this approach? If so, please explain, and suggest an alternative? N/A 5. Do you agree with the proposed treatment of impairment losses? Do you foresee any unintended consequences from this approach? If so, please explain, and suggest an alternative? N/A 6. Do you agree with the proposed treatment of related transactions? Do you foresee any unintended consequences from this approach? If so, please explain, and suggest an alternative? Please refer to our answer to question three.
7. Are there any other amounts that should be included with the definition of tax EBITDA, or any more items which should be excluded? If so, please explain the reasons why? Housing associations adopting good asset management strategies commonly make a number of fixed asset property disposal each year. With housing association tenants soon to be eligible for the right to buy, sales of property fixed assets are likely to increase going forward. Therefore, our view is that the full surplus from the disposal of each property should be taken into account when computing the group s tax EBITDA annually and not just the proportion that is recognised in the income statement under the rules for disposing of part of a business. We believe that the definition of tax EBITDA should be clarified to state that it will take account of the full amount of the group s profits before any relief is given for Gift Aid. We are of the view that if Gift Aid were deducted from earnings in a borrowing entity, it could unfavourably skew their interest/ebitda ratio and not reflect the true ability of the borrower to support debt. 8. Do you agree with the proposed treatment for tax depreciation and tax amortisation? N/A 9. Do you agree that the proposed treatment of different types of loss relief will be fair and effective while minimising the need to analyse and trace loss amounts? If not, please suggest an alternative, providing an explanation of why you find it preferable? N/A 10. Do you agree with the proposed treatment of chargeable gains and allowable capital losses? If not, please suggest an alternative, providing an explanation of why you find it preferable? We agree that chargeable gains should be included in tax EBITDA. This is key, since many housing associations are likely to see this balance become increasingly more relevant as they continue to manage their assets and response to government initiatives including the Government s decision to cut social housing by 1% a year from 1 April 2016 to 31 March 2020. 11. Given the proposed reform of losses, does carrying forward restricted interest to be treated as an interest expense of a later period give companies sufficient flexibility? It would be preferable to allow carry back as well.
12. Does the three year limit on the carry forward of spare capacity provide sufficient flexibility for addressing short term fluctuations in levels of tax interest and tax EBITDA? The three-year limit on carry forward of spare capacity appears to be an arbitrary time limit that does not fit well with housing associations long-term investment strategies. Housing association investment in housing property are for the long term to cater for the continuing needs of those unable access a market solution to adequate housing. This is reflected by the fact that housing association loans are typically advanced for terms of up to 30 years. In addition, housing associations have been increasingly investing in the commercial property market and developed homes for outright sale as a means of generating surpluses to cross-subsidise the cost of affordable housing. The volatile nature of the commercial market can lead to large short-term movements in surpluses and therefore a long-term view of these investments is required. For example, the value of some of these commercial property investments is still less than before the 2008 financial crisis. It is our view that the carry forward of spare interest capacity should therefore be indefinite. 13. Are there common circumstances where the proposals will substantially fail to deal with problems around timing differences? Please refer to our answer to question 12. 14. Does the proposed modification of the Debt Cap rule balance the objectives of maintaining effective Exchequer protection in this area, aligning the mechanics with the interest restriction rules and ensuring that the relevant figures are readily available from the group s consolidated financial statements? While the majority of housing associations engage in UK-only work, a number have overseas activities. These foreign businesses provide further funding to their core English-based social housing operations. The proposal to limit the net interest amounts that groups can claim to only the interest that arises from their UK operations will restrict this cross subsidy and reduce the financial resources available for the development of new homes. We therefore recommend that the net interest of overseas operations be incorporated in the calculation of the group net interest expense. 15. Which of these two approaches do you consider to be the most appropriate way to address the risks arising from very high group ratios or negative group EBITDA, and why? How should the percentage cap be set under the second approach? Are there other approaches which would better address this situation? Option two would be preferable and in our view - the percentage ratio should be in excess of 100% (even if still capped) to reflect the high levels of debt housing associations require to fund this country s affordable housing units. 16. Are there specific cases where the removal of the broadly comparable limb contained in the current Debt Cap regime would give rise to particularly difficult
outcomes? If so, please suggest how this extension should be modified to allow the calculation of the group ratio? Please refer to our answer to question one. FRS 102 and the Housing SORP must be allowed to be used to apply these proposals. 17. Are there any further items of profit or loss which should be included within the definition of total qualifying group interest? No other items recommended. 18. Are there any other amounts that should be included with the definition of adjusted group interest, or any more items which should be excluded? If so, please explain the reasons why? No other items recommended. 19. Are there any other amounts that should be included with the definition of qualifying group interest, or any more items which should be excluded? If so, please explain the reasons why? A number of housing associations provide PFI schemes to public sector bodies. The most common form entails a housing association or consortium of housing associations engaging with a local authority to either develop new social housing properties for the local authority or to improve the authorities existing homes, The PFI structure is used to limit the level of risk to the local authority while the housing association provides the upfront funding necessary to enable the developments/improvements to take place. Where interest is charged by the investors in a PFI on mezzanine finance they have provided, it would be inequitable to exclude it on the basis that it has been advanced from a related party. This mezzanine finance will have been provided to reduce the risk and cost of funds on the senior debt. We are aware of examples where one housing association participates in a housing PFI with another housing association which has regenerated a local authority housing estate funded in this way. 20. Do you agree that the proposed definition of related party will be effective in preventing equity investors inflating the group ratio by investing using debt instruments? Please identify situations where this definition would prevent the Group Ratio Rule from taking into account interest payable to lenders that invest for a fixed return and without seeking influence over the borrower? As we set out in our covering letter at the start of this document, we are conscious that many housing association groups hold their debt in a separate non-charitable treasury company (Treasury Co). This is often for a number of financial, risk mitigation and compliance reasons. Without an exemption being developed for any debt advanced to all 100% owned subsidiaries of charities, these Treasury Cos would be impacted inadvertently by the wider proposals and this would undermine the ability of housing associations to build new homes.
Further details on how the group ratio rule could fail to take into account of the way housing association groups are typically funded by Treasury Cos is outlined in the covering letter. The covering letter includes some suggestions on how this may be addressed. I request that we have a meeting to discuss this in further detail to ensure that the rules will be appropriately adapted to prevent this situation being caught by the rules? 21. Are there any other amounts that should be included with the definition of group EBITDA, or any more items which should be excluded? If so, please explain the reasons why? It is common practice for housing associations to dispose of a number of properties each year. With housing association tenants soon to be eligible for the right to buy, sales of property fixed assets are likely to increase going forwards. Therefore, our view is that the full surplus from the disposal of each property should be taken into account when computing the amount of each group s group EBITDA annually and not just the proportion that is recognised in the income statement under the rules for disposing of part of a business. We believe that the definition of group EBITDA should be clarified to state that it will take account of the full amount of the group s profits before any relief is given for Gift Aid. We are of the view that if Gift Aid were deducted from earnings in a borrowing entity, it could unfavourably skew their interest/ EBITDA ratio and not reflect the true ability of the borrower to support debt. 22. Bearing in mind the Fixed Ratio Rule permitting net interest deductions of up to 30% of tax-ebitda, the Group Ratio Rule, the 2 million de minimis amount, rules permitting the carry forward of restricted interest and excess capacity, and the inclusion in tax-interest of income accounted for as finance income, please describe the key features of situations involving the financing of public benefit infrastructure where a specific exclusion will be necessary to prevent interest restrictions arising in cases where there is no BEPS Our principal suggestion regarding any exclusion is that it is expanded to expressly include all housing association groups. As outlined in our cover letter at the start of this document we propose that the definition of charity is extended to also include certain other publicbenefit bodies. This could be addressed by allowing the definition of charity to also include non-profit private registered providers of social housing (quasi charitable). In terms of the specific design of the public-benefit bodies exclusion, the applicability of the qualifying criteria should be assessed by reference to the position of the sub-group as a whole (including sister companies), as opposed to the test being applied on an entity-byentity basis.
In our view, this clarification is important given that the activities of all of the entities in each housing association group collectively contribute to the provision of a public benefit, albeit, in some cases, each stand-alone entity only contributes part of the overall activities of the housing association. Our concern is that if a more granular application of the public-benefit bodies exclusion is applied, then individual entities may not be able to independently satisfy all of the qualifying criteria. Interest arising on sub-group loans needs to be exempt from the definition of interest in order for all of the public-benefit exemption conditions to be satisfied in the case of housing associations. 23. Are there any situations involving the financing of public benefit infrastructure where interest restrictions could arise in the absence of BEPS despite a PBPE with the above conditions? If so, please provide details and suggest how the proposals could be changed to prevent undue restrictions occurring Please refer to our response to question 22 above and our covering letter. 24. Are there any situations where interest restrictions would arise connected with public benefit infrastructure despite the provisions outlined in this document, and where those restrictions could have wider economic consequences? If so, please provide details, including an explanation of why the consequences could not be avoided, such as by restructuring existing financing arrangements. Please suggest how the rules could be adapted to avoid those consequences while still providing an effective counteraction to BEPS involving interest Housing associations would not fall under the public benefit infrastructure definition as drafted and would be required to apply the new interest deductibility restrictions proposed. As we set out in our previous response to this consultation, housing associations would therefore reduce the amount they invest in developing new homes. We have outlined in our cover letter some proposals that would help avoid our members facing an interest restriction, without compromising the effectiveness of this BEPS initiative. Housing association groups often choose to finance their activities through separate, noncharitable treasury companies (Treasury Cos) for a number of reasons, including those set out in the covering letter at the start of this document. Any attempt to restructure the debt into the main charity would be fraught the difficulties outline and countless others. 25. 35. N/A 36. Does this approach adequately address the situation where charities hold subsidiaries to undertake trading activities? If not, how could the rules be adapted to better address this situation? While we support this approach as an initial step to mitigating the impact on charitable housing associations the other proposals in the consultation document would lead to many housing association groups struggling to meet the Government s own housing development
aspirations. As we set out in our response to the previous consultation on this subject, housing associations delivered one in three of all new homes last year and are planning to significantly increase the number of homes in the future. Therefore, we believe that an exemption should be developed for all interest arising in fully owned (100%) subsidiaries of charities or non-profit private registered providers of social housing (even where noncharitable themselves). 37. 39. N/A 40. Do you agree with the proposed treatment of derivative contracts for calculating taxinterest? Do you foresee any unintended with this approach? If so, please explain, and suggest an alternative. Please refer to our response to question three. 41. Do you agree with the proposed treatment of derivative contracts for calculating tax- EBITDA? Do you foresee any unintended consequences from this approach? If so, please explain, and suggest an alternative. Please refer to our response to question three. 42. Do you agree with the proposed treatment of fair value movements on hedging relationships? Would this cause particular difficulties for groups, that would warrant particular rules to replace the fair value movements on hedging relationships with amounts recognised on an appropriate accruals basis (for example, in line with regulations 7, 8 and 9 of the Disregard Regulations S.I. 2004 / 3256)? We agree that it would be appropriate for the rules to be explicitly adapted to replace the fair value movements on hedging relationships with amounts recognised on an appropriate accruals basis. As noted in our response to question three, the majority of our members did not elect to adopt the rules as they were not relevant to housing associations at the time so such a specific amendment would be welcomed. 43. Does this approach adequately address the position for both the lessor and lessee across the range of different leasing arrangements? If not, how could the rules be adapted to better address these situations? N/A 44. Does this approach adequately address the position for investments in non-group entities? If not, how could the rules be adapted to better address these situations? Housing associations increasingly make use of joint ventures (JV) to develop new properties approximately 850 JVs are used by the top 250 housing associations, which develop the vast majority new affordable homes. While we welcome the incorporation of JV s interest into the measure of group-interest, based on the examples in Appendix D, we are concerned with the inability to include these amounts in the group ratio calculation if it results in a ratio that is above the fully JV excluded ratio. This could lead to some JV partners of housing associations reducing the
amount they lend to fund new affordable housing developments at the very time when more unaffordable housing is needed. 45. Does this approach adequately address the situation where public bodies hold subsidiaries to undertake trading activities? If not, how could the rules be adapted to better address this situation? It is currently unclear whether it is intended that housing associations will meet the definition of a Public Body. Given the specific charitable exemption that is proposed at paragraph 8.55 (and discussed at question 36) that would have the effect of excluding interest payments to the charitable parent from the rules, then the approach proposed at question 45 should not be necessary for the majority of our members. It would be helpful to clarify our understanding in this regard at a meeting. 46. Does the phasing in of the rules as outlined above create any particular difficulties for businesses? We strongly urge that sufficient time is taken to introduce any proposals to ensure its application is both equitable and proportionate. To rush through this interest restriction will inevitably result in unintended consequences. Not only will this stifle economic activity, it will needlessly waste housing association time and divert housing association limited resources away from building new homes in order to understand complex tax rules and reduce their impact. Therefore, we do not believe implementation of a general interest restriction for 1 April 2017 is feasible this would not allow for sufficient time to develop the system, engage in meaningful consultation on final proposals, and pilot the scheme.