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Traditionally, businesses have relied heavily on debt to finance their operations. This is primarily because interest expenses on debt are tax-deductible, making debt a tax-efficient source of finance. However, the changing tax landscape and the associated risks have made debt financing a challenging proposition for businesses.
This is where the NID comes into play. It aims to reduce the discrepancy in the tax treatment between debt and equity financing. By doing so, it enhances the tax benefits of financing business operations through equity, thereby offering a tax-efficient alternative to debt financing.
At its core, the NID works by aligning the tax treatment of the cost of equity with that of the cost of debt. It allows businesses to deduct notional interest on their risk capital. Risk capital is defined to include share or partnership capital of a company or partnership respectively, any share premium, any positive retained earnings, loans or other debt borrowed by the undertaking which do not bear interest.
This means that just like interest on debt, businesses can now deduct a notional interest on their equity, thereby making equity a more attractive source of finance.
The calculation of the NID involves determining the notional interest rate and applying it to the risk capital. The notional interest rate is established by reference to the current yield to maturity on Government Stocks which have a remaining term of approximately 20 years, plus a premium of 5%.
However, it’s important to note that the NID is capped at a maximum of 90% of the chargeable income. This means that businesses cannot use the NID to completely eliminate their tax liability.
At Grant Thornton, we understand the complexities of tax regulations and financial strategies. As your partner, we can help you navigate the intricacies of NID and other tax incentives. Trust Grant Thornton to be your strategic ally in maximizing tax efficiency, enhancing financial stability, and achieving long-term success.
