Finance Bill 2021: Interest Limitation Rules enacted has been saved
Finance Bill 2021: Interest Limitation Rules enacted
As you are aware, on 21 October 2021 the Minister for Finance published Finance Bill 2021 following approval by Government earlier in the week. As expected, Finance Bill 2021 will complete Ireland’s integration of the EU Anti-Tax-Avoidance Directive (“ATAD”) with the inclusion of, among other things, Interest Limitation Rules (“ILR”). The ILR are set to apply to accounting periods beginning on or after 1 January 2022 (note therefore that depending on a taxpayer’s year-end there may therefore be a delay to the effective date of the rules relative to others).
As you may also be aware, the ILR is a fixed ratio rule that seeks to link a taxpayer’s allowable net interest deductions (i.e. deductible interest expenses in excess of taxable interest income) directly to its level of earnings, by limiting the maximum net deduction (“exceeding borrowing costs”) to 30% of earnings before deductions for net interest expense, depreciation and amortisation (“EBITDA”). Two Feedback Statements were previously released by the Irish Government (December 2020 and July 2021) wherein draft rules were set out for the operation of the ILR in Ireland, meaning that a good knowledge of the likely operation of the ILR already existed prior to the publication of the Finance Bill text.
The purpose of this alert is to highlight those aspects of the ILR as included in Finance Bill 2021 that are of particular interest to the leasing industry and were not previously included in the Feedback Statements mentioned above. Aircraft lessors (and also airlines involved in wet-leasing) should consider these developments carefully with a view to updating their models prepared to date, as some of these amendments have a material effect.
Definition of “interest equivalent”
A welcome inclusion to the leasing industry in particular is the expansion of the definition of “interest equivalent” to include, broadly, the interest rate implicit in an operating lease payment (which is broadly equivalent to the IFRS 16 “interest” portion of a lease payment) where the relevant entity carries on a trade of leasing as envisaged in S.403 TCA 1997. Thus, a portion of an operating lease payment receipt (essentially the difference between total expected lease payments receivable over the period of the lease less expected depreciation on the leased asset over that same period, expressed as a percentage of total lease payments over the lease) may be regarded as interest income when calculating the entity’s net interest expenses for the purposes of the ILR calculation. Based on initial revised modelling we have performed we have found that in many, if not most instances, this should result now in no interest restrictions for several aircraft lessors. However, the impact should be checked and confirmed on a case by case basis and should be calculated on a lease by lease basis taking into account any amendments that may have been made to the lease during the life to lease, including COVID driven amendments such as amendment of fixed rate leases to PBH lease arrangements.
As suggested by EU ATAD and previous Feedback Statements, Finance Bill 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 and interest equivalents as well as spare capacity. Per Finance Bill 2021, companies (that are within the charge to Irish corporation tax and which are part of the same “worldwide group”, or so within the charge to Irish tax and part of the same S.411 losses group) may elect to be included in an interest group as opposed to the Feedback Statement which provided that companies that met the criteria were automatically included in an interest group, unless they elected out. This amendment in the Finance Bill should have no particular adverse consequence.
A further amendment is that in calculating the EBITDA, exceeding borrowing costs, and other relevant amounts for the “interest group”, the Finance Bill no longer contains the requirement that transactions between members of the interest group should be disregarded. Instead, such amounts may comprise the results of all the members of the interest group simply added together, which should make the process more simple. It is our understanding that the intention is that the taxpayer may have a choice between this approach or to disregard transactions within the interest group, but the wording in the Finance Bill is perhaps not entirely clear as to whether such a choice in fact exists.
Another welcome change to the ILR included in Finance Bill 2021, but not previously included in the Feedback Statements, is the add-back of the non-finance element of finance lease payments in arriving at the tax adjusted EBITDA in addition to adding back capital allowance on leased assets. This has the effect of increasing the relevant company’s EBITDA further in cases where leased assets were financed by means of a finance lease in circumstances where capital allowances are not claimed on the finance leased asset.
De minimis exemption
The €3 million de minimis amount provided for in EU ATAD was previously treated in the first Feedback Statement as an “ILR free” amount always available to a taxpayer to deduct in a year. The 2nd Feedback Statement however presented the de minimis rule as a limit in certain instances i.e. if 30% of EBITDA was less than €3 million, the amount of €3 million was still available as an “allowable amount”. Under the Finance Bill, however, exceeding borrowing costs of €3 million and below escapes the application of the rule altogether, but €3,000,001 of exceeding borrowing costs would be subject to the full limitation (i.e. at least €3 million is no longer available as an “allowable amount”, only 30% of EBITDA is available as an “allowable amount”). Several submissions to the Department of Finance argued that the Feedback Statement 2 approach is not in line with the EU ATAD wording and that at least a €3 million interest deduction should always be allowed where exceeding borrowing costs exceeds such amount. However, the wording in Finance Bill 2021 now clarifies that the €3 million should be treated as a threshold amount and it is our understanding that this is in line with the Department of Finance’s interpretation of the ATAD. Therefore, modelling exercises performed to date should treat the €3 million exclusion accordingly.
The Deloitte team have been actively involved in written submissions to and consultations with the Department of Finance and Revenue on the introduction of the ATAD measures and are available to discuss any queries that you may have regarding the operation of the rules, or any further changes that may occur between now and the final Finance Act in this regard.
We encourage clients to examine the application of the provisions to their own circumstances in detail as we have found over the past c.12 months that it is early identification of these practical issues that have made a meaningful impact in the formulation of the rules as they currently stand, which you will agree is a positive outcome fully in line with applicable EU law.