GREIT12155 - Group conditions and rules: Financial Statements: financing costs (External)

The amount of Financing Costs (External) is derived from the financial statement for G (property rental business). The aim is to capture the amount of interest etc paid to third parties so far as the loans giving rise to the interest relate to the property rental business of the group. How the group chooses to fund itself internally is immaterial for the purposes of working out this number (although of course whether internal funding is by debt or equity does make a difference for the calculation of the income of the tax-exempt business).

Regulation 6 SI 2006/2865 sets out the steps for working out Financing Costs (External).

Step 1

The first step is to determine the amount of outside financing costs for the group in respect of its property rental business. This is the costs of financing raised by group entities from non- group entities, so far as it has been applied to the property rental business of group members.

If a group entity (other than the principal company) that has raised outside finance is not wholly owned by group entities, the financing costs relating to that group entity are reduced by reference to the interest in the company held by non-group entities.

‘Group entity’ means a company that is a member of the group, or an entity that is treated in the same way as a member of the group for the purposes of the Financial Statements regulations. This includes joint venture companies where there is a ‘look-through’ election in place, OEICs where the group has a significant influence (that is, owners more than 20% of the shares) and other non-corporate entities where tax-exempt group has an interest of greater than 20%.

In the example in GREIT12150, the outside fianancing costs of the group in respect of its property rental business are 1,000 @ 4% and 300 @ 5% = 40 + 15 = 55.

Step 2

This step is to determine the percentage which relates to the ‘UK business’ of G (property rental business) and how much to other activities carried on by the group.

Financing Costs (External) is that percentage of the outside financing costs that were worked out in Step 1.

The regulations do not prescribe how the proportion that applies to the property rental business or the UK business of G (property rental business) is calculated. If an external loan is clearly linked to a particular property, for example because a bond issue has been made to finance a particular acquisition, then that will be an important factor. If there are no clear links, then an apportionment based on the fair value of the assets involved in the different activities can be used.

In the example in GREIT12150, the ‘property rental business’ in step 1 above is the same as the ‘UK business’ of G (property rental business). There is therefore no nedd to take step 2, as Financing Costs (External) are the same as the outside fianancing costs, 55.