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Financing your corporate activity may be changing sooner than expected – EU style

Tom Maguire

My previous column dealt with the EU Commission’s proposal on how EU decision-making on certain tax issues could be “streamlined” by removing the need for unanimous agreement by all countries. Instead, these matters would be decided by a weighted system ("qualified majority voting") where measures could be carried if supported by a minimum number of EU countries. So unanimity of consensus for tax was in the EU’s cross-hairs. My reaction “non merci” because tax sovereignty or “our tax revenue is not the EU’s tax revenue” matters.

Since that column, it’s been reported that a spokesperson for our Minister for Finance explained “Taxation is a sovereign member state competence”. She continued that such decisions at EU Council on tax matters “require unanimity” and then “Ireland does not support any change being made on how tax issues are agreed at EU level.” I don’t think we could have been clearer unless we added “so there!”

Staying with the EU. Since that column the public consultation period with the Department of Finance on the tax treatment of the somewhat X-files area of "hybrids" and corporate interest deductions closed. All this came about because of the EU’s Anti-Tax Avoidance Directive (ATAD), which we signed up to. As a segue into this from the abovementioned unanimous voting point the June 2016 press release announcing the ATAD’s agreement explained that “In negotiating the Directive the Minister for Finance, Michael Noonan T.D. sought to ensure that Ireland’s sovereignty on tax rates was fully protected”. We are consistent.

The consultation’s hybrids bit dealt with instruments and entities that our law sees one way while other countries might see them another with differing tax consequences applying in those countries. This consultation looks at the resulting mismatch. This means that if your corporate group carries on activities cross border then this law will be required reading when passed in Finance Act 2019. It’s not all about exotic financial instruments because it can affect common commercial transactions such as branches in other countries depending on how the law ends up.

Interest deductions do what they say on their tin. This relates to interest on borrowings and other financing of a corporate group’s activities and so covers a multitude of taxpayers and transactions. One of my first accounting lecturers had a mantra “cash is the lifeblood of business” and you borrow cash to finance your business. The directive wants to change (read reduce) the tax effects of that borrowing.

The way that it works is that net borrowing costs will only be tax deductible up to 30 per cent of a taxpayer’s (read corporate group’s) earnings before interest, tax, depreciation and amortisation (EBITDA). In short, the interest companies pay might not all be tax deductible. Gasp!

Apart from that, a standalone company may be given the right to fully deduct net borrowing costs if it is, in short, not part of a group. Alternatively, a taxpayer may be given the right to deduct net borrowing costs below a €3 million threshold. These options are up to individual countries to allow; my reaction, we should allow this.

Another option is that the ATAD allows Member States to have two different group exclusion provisions based on either an “equity/total assets” ratio or a group EBITDA test. This is effectively a balance sheet or P&L approach. Your group might be “asset heavy” (depending on the industry) such that one option may be more beneficial over the other. Therefore, many commentators (I’m one!) argue this is not a one size fits all point but rather tax law should allow taxpayers to choose the most appropriate option for them.

That just acknowledges that corporate groups that build bridges (real not metaphorical ones!) are not the same as those writing algorithms for the next must have app. All these options will determine how competitive we are when compared to our European counterparts. Best in compliance class could put us back of the investment class.

Here’s the kicker, the ATAD says Member States can have a transitional period if their own “targeted rules” on interest deductions (countermeasures) for preventing Base Erosion and Profit Shifting (BEPS) are “equally effective” to those contained in the ATAD. Those countries can still apply their targeted rules until the end of the first fiscal year following the agreement between the OECD Members on a minimum standard for interest deductions, or, at the latest, until 1 January 2024.

The public consultation document mentioned earlier explains (as did the Department’s previously published roadmap) that we would be bringing about such a rule but “…The timing of that legislation will be determined following further engagement with the European Commission. Ireland remains of the view that our national targeted rules for preventing BEPS risks are equally effective to the interest limitation rule set out in Article 4 of the Directive and will continue to engage with the European Commission in this regard. … In view of the complexity of our existing interest limitation rules, it is anticipated that transposition could potentially advance, at the earliest, to Finance Bill 2019.” So we could have an interest restriction possibly five years ahead of schedule if the OECD does not bring about a minimum standard anytime soon.

Are our interest rules complex? As Daniel Craig whispered as James Bond in “Casino Royale” (2006) after he executed his second kill giving him “00” status: “Yes [dramatic pause] considerably”. But that’s a huge understatement because they are galactically complex.

A company can borrow money to acquire another company or lend to another company and claim a tax deduction on that borrowing’s interest. Simple right? When that deduction first became law almost 40 years ago, the related legislation was about three quarters of a page long, now it’s almost 9 pages long. The relief has remained practically the same; it’s just that the targeted countermeasures have ballooned the law. But that’s only one type of interest deduction, there are special rules for financing a company’s trade, financing rental properties, overseas borrowing and the list goes on.

So we should continue to argue for a 2024 change date; but whenever we have to adopt this new-fangled interest restriction should we be simplifying our related tax code as the quid pro quo? “Yes, considerably”.

Simplicity eats complexity for breakfast and our competitors will be looking at chinks in our armour when all EU countries have to bring about similar law. A corporate group’s lifeblood is not the place for weakness.

Tom Maguire is a tax partner with Deloitte and his fortnightly columns on tax matters appear in the Sunday Independent. The above article was first published on 27th January 2019.

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