UK: corporate tax reform and debt finance interest

Last month, after much work, the Mirrlees Review tax reform conclusions and recommendations were published: see here (summary, pdf). The Review concluded, amongst many other things, that the UK's current system of corporate taxation favoured debt finance over equity finance and that the systems lack of integration with other parts of the tax system led to distortions over choice of legal form. One reason why debt finance is attractive is that the interest on it is tax deductible.

The Mirrlees Review advocated the introduction of an Allowance for Corporate Equity which would provide a deduction for the cost of equity finance similar to that currently available for the interest on debt finance. Whether the Government adopts (or considers) this recommendation remains to be seen. Most recently, the deductibility of debt interest was a major item of discussion in the Government's Corporate Tax Reform strategy document (see here, pdf). In the document, which was published earlier this week, the Government states (paras. 3.7 and 3.8):

... OECD countries’ tax systems generally recognise the distinction between debt and equity and give deductions for interest as a business expense. This is also reflected in international accounting standards. The Government remains committed to interest being relieved as a normal business expense irrespective of where the proceeds of the loans are put to use. Any fundamental changes to these rules would have disruptive and potentially damaging effects on existing arrangements and could undermine the Government’s commitment to providing the stability and certainty needed to promote investment and growth.

The UK’s current interest rules, which do not significantly restrict relief for interest, are considered by businesses as a competitive advantage and it is the Government’s view that this advantage outweighs potential benefits from moving towards a more territorial system for interest. In coming to this conclusion, the Government has considered the difficulty of designing workable rules to restrict relief for interest, which are fair to all businesses without creating complexity and uncertainty.