GREIT02205 - Conditions and Tests: interest cover test: consequences of breaching the limit
Section 115 sets a limit of 1.25 on the ratio of rental profits
(before capital allowances) to interest. Definitions of the terms
can be found at
GREIT02200. If the limit is breached,
a tax charge by reference to the excess interest is imposed on C
(residual) (regulations 12 and 13 SI 2006/2864).
The excess interest is treated as income chargeable to tax
under Schedule D Case VI. The income arises to C (residual) (and
not to C (tax-exempt), which was the business that incurred the
excess interest) in the same accounting period as that for which
the limit was breached.
The income is chargeable at the main CT rate. No loss,
deficit, expense or allowances that might otherwise be offset
against an amount chargeable under Case VI, can be used to reduce
the amount of income brought into charge (regulations 12(4) and
13(4) SI 2006/2864). In common with other places in the UK-REIT
rules that prohibit reduction of income by losses, deficits etc,
the prohibition here extends to prevent the offset of management
expenses or charges that are normally given as a deduction from
total profits rather than as a deduction in reaching the profits
from any particular source of income or gains.
Example
The Schedule A profits of C (tax-exempt) are 95, after deduction
of 5 capital allowances. For the accounting period, interest
payable in respect of C (tax-exempt)'s business was 90.
The 'profits' of C (tax-exempt) (are as measured by section
120 FA 2006) are 95 – 90 = 5. The top line of the fraction
would be 100 = 5 + 5 + 90, and the ratio would be 100/90 = 1.11,
which breaches the 1.25 limit (a breach is when the fraction is
below 1.25).
To work out the income that is chargeable on C (residual),
the first step is to work out the amount of interest that would
just meet the 1.25 limit. A bit of algebra tells us that if 1.25 =
(P+FC)/FC then FC = 80% of P where P is profits before capital
allowances and financing costs have been deducted and FC is the
interest cost that just meets the limit. Therefore the interest
expense that just meets the limit in this example is 80.
The Case VI income of C (residual) would therefore be 10 (=
90 – 80).
Group REITs
A similar charge arises to the residual part of the principal company of a Group REIT if the group breaches the 1.25 limit as modified for Group REITs – see GREIT12150.
