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Finance Act 2021 and it's impact on the banking and payments sector
Finance Act 2021 completed Ireland’s transposition of the EU Anti-Tax Avoidance Directive (“ATAD”) with the inclusion of Interest Limitation Rules (“ILR”). The ILR apply to accounting periods beginning on or after 1 January 2022 meaning that companies with non-calendar year financial reporting periods will benefit from a delay in implementation relative to those with calendar year ends.
At a fundamental level, the ILR is a fixed ratio rule that seeks to link a taxpayer’s net interest deductions (i.e. deductible interest expenses in excess of taxable interest income) directly to its level of tax-adjusted earnings, by limiting the maximum net deduction (“exceeding borrowing costs”) to 30% of earnings before deductions for net interest expense, depreciation, and amortisation (“EBITDA”). An increased measure of relief may be available where it can be established that the net interest deductions/level of indebtedness at the relevant Irish entities reflects the group as a whole.
The purpose of this alert is to highlight those aspects of the ILR as included in Finance Act 2021 that are of particular interest to the Banking & Payments Sector. Where applicable, the calculation of any restriction on tax relief as a result of the ILR may be time intensive and complex and we strongly encourage those in the Banking & Payments Sector to examine in detail the application of the provisions to your own circumstances as early as possible to identify the potential impact on the corporation tax liability for accounting periods commencing on or after 1 January 2022. It is worth noting that even where it is not expected that a denial of relief will apply, an increased compliance burden arises as a result of the changes which, inter alia, require reporting of “interest equivalent” and “EBITDA” data which would not historically have been required. Indeed, additionally financial accounts analysis will be required which, for the initial period at least, may require significant manual intervention.
Regulatory changes including the creation of holding companies and bond-issuance vehicles to facilitate resolution strategies together with the impending requirement for certain non-EU headquartered groups to establish intermediate parent undertakings create complexities in relation to ILR especially in the context of companies which are not trading entities and which are subject to corporation tax at 25% rather than 12½%.
Definition of “interest equivalent”
A key definition in the rules is that of “Interest equivalent”. Interest equivalent is widely defined and the definition encompasses interest and amounts economically equivalent to interest including (but not limited to) discounts (in certain circumstances), amounts under derivative instruments or hedging arrangements and amounts arising in connection with the raising of finance (such as guarantee, arrangement and commitment fees). While it might be expected that items regarded as “finance costs” for IFRS would automatically be classified as interest equivalent, this will not always be the case. Additionally, the particular treatment of individual components of derivatives supporting foreign exchange hedging will require individual attention.
As suggested by EU ATAD and previous Feedback Statements, Finance Act 2021 includes the concept of applying the rules on a group basis – so called “interest groups.” When companies are within an interest group, ILR calculations are done at a group level, allowing the group members to pool individual entities’ interest equivalents as well as spare capacity. Per Finance Act 2021, companies (that are within the charge to Irish corporation tax and which are part of the same “worldwide group”, or those within the charge to Irish tax and part of the same S.411 losses group) may elect to be included in an interest group.
The compilation of the results of an interest group will be important in understanding the effect of the rules. It is our understanding that the intention is that the taxpayer may have a choice between an aggregation approach or to apply a consolidation type approach involving the disregarding of transactions within the interest group but this is not clear based on the statutory language and the impending Revenue guidance will be important in establishing what methods will be accepted without challenge.
It is to be expected that no ILR disallowance will arise in respect of most banking groups which will generally have a surplus of taxable interest revenues (as opposed to net interest deductions). However, individual entities within such banking groups may incur exceeding borrowing costs (for example, a Group Parent or Holding companies with a Section 247 Interest Charge or Groups with leasing entities etc.) and it will be necessary to make “interest group” elections which may increase the reporting and compliance burden for the Group.
De minimis exemption
The ILR shall apply to a relevant entity (meaning either a company or an interest group) where the exceeding borrowing costs exceed the de minimis amount. The de minimis amount is defined as €3m in respect of an accounting period of 12 months and is reduced pro rata in respect of shorter accounting periods. Therefore, where the exceeding borrowing costs of a relevant entity are below €3m, the interest limitation rules will not generally apply for that accounting period.
We understand Irish Revenue are on track to provide the draft Tax & Duty Manual relating to these rules for practitioner review by the start of April. Please note the Deloitte team are actively involved in written submissions to and consultations with the Department of Finance and Revenue on the introduction of these ATAD measures and are available to discuss any queries that you may have regarding the operation of the rules. To minimise recurring compliance work, it is to be recommended that an early stage mapping of financial accounting and tax rules be undertaken to automate the process insofar as possible.
Tom Maguire discusses shell entities in the EU in his latest Business Post column