Leading analyst Geof Collyer, of Deutsche Bank, has highlighted a key area of the budget for pub groups.
He pointed to the details set out by the Chancellor in regards to base erosion and profit shifting, which he said could catch leveraged groups in the travel and leisure sector.
He identified Enterprise Inns and JD Wetherspoon as two examples of how pub groups could be affected.
He said:
“The UK Budget and Business Tax Road Map publications provided a more detailed outline on BEPS. In The Budget Big Red Book, para 1.209 stated that “…[HMG] is…implementing the G20 and OECD recommendations…Where large multinationals are over-leveraging in the UK to fund activities elsewhere in their worldwide group…will act to prevent aggressive tax planning…so that multinational businesses can no longer arrange their interest expenses to shelter profits…” Para 1.210 went on to state that “…[HMG] will cap the amount of relief for interest to 30% of taxable earnings [EBITDA] in the UK or based on the net interest to earnings ratio for the worldwide group….” On the face of it, the law of unintended consequences could catch leveraged groups in the Travel & Leisure sector – all of which are not multinational enterprises – in the net.
The 2016 Business Tax Road Map – pub groups could be exempt
The key para (2.34) in this report states: “…Recognising that some groups may have high external gearing for genuine commercial purposes, the UK will also be implementing a group ratio rule based on the net interest to EBITDA ratio…[that] should enable businesses operating in the UK to continue to obtain deductions for interest expenses commensurate with their activities…” We do not have details of this as yet, but this could imply that UK corporates with external debts (non multinationals) would be exempt.
Fairer to apply the new rule to all financial costs, on- and off-balance sheet?
It seems strange to allow unlimited off-balance sheet debt (lease rent) to be offset against tax and not on-balance sheet debt, especially since the off-balance sheet debt will soon be brought on-balance sheet under IFRS anyway. Surely it would be more appropriate to apply the 30% rule to EBITDAR, not EBITDA, or maybe even a fixed charge cover limit - which would be fairer?
Example (based on FY17E): ETI vs. JDW
ETI and JDW have the same fixed charge cover at ~1.7x. JDW has 3.7x net debt/EBITDA and 5.5x lease-adjusted net debt/EBITDAR. ETI has 7.5x net debt/EBITDA and 7.6x lease-adjusted net debt/EBITDAR.
ETI’s net interest cost is £148m or ~50% of EBITDA (see table below right). Assuming 30% would be allowable against tax under the BEPS rule, this would imply an extra £12m of tax, equivalent to ~12% EPS downgrade. Net interest (£148m) & rent (~£24m) are ~53% of EBITDAR (EBITDA pre rent). Using this metric for the 30% rule would imply an EPS downgrade of ~15%.
JDW’s net interest cost is ~£28m, or ~16% of EBITDA. The BEPS 30% rule would not apply, and there would be no EPS downgrade. However, we forecast net interest (£28m) plus lease rent (£75m) at ~42% of EBITDAR. If only 30% of this combined finance cost was allowable, this would add ~£7m to the tax bill, implying an equivalent ~13% downgrade to our EPS forecast. Under the 30% of EBITDA BEPS rule, ETI is penalized and JDW isn’t, but their indebtedness is broadly the same – based on the fixed charge cover ratio.”
