How does your corporate group finance its activities because it’s going to change!

Europe has spoken: In its view Ireland’s law allowing corporate tax deductions for interest on borrowings is not okay.

Let’s get one thing clear: Right now, our law on this issue is excruciatingly complex given the level of legal hoops companies have to jump through to achieve tax deductions for interest on their borrowings. Nonetheless the European Commission said recently that it had decided to send a “letter of formal notice” to Ireland requesting it to implement the interest limitation measure in the EU’s Anti-Tax Avoidance Directive (ATAD). It continued that if Ireland didn’t “act within the next two months, the Commission may send a reasoned opinion” to our government. Austria got a similar letter.

This limitation rule was supposed to be in law by 31 December 2018 and take effect from 1 January 2019. So why didn’t we just do that? Simple: The ATAD allows countries to put off the inevitable until whichever came first: the start of 2024 or the point when the OECD made these rules a “minimum standard”. This legal delay applied to countries that had “targeted” rules for preventing Base Erosion and Profit Shifting (BEPS), which, and here’s the kicker, were “equally effective to the interest limitation rule” set out in Directive.

The OECD hasn’t yet shifted its “nice to have” to “minimum standard” stance so we were going with a 2024 kick off arguing our rules were “equally effective” to those in the directive. The meaning of “equally effective” isn’t elaborated upon so arguably took its ordinary meaning: For example, is Chuck Norris kicking you “equally effective” to Mike Tyson punching you, I would argue yes, and so went the debate on our interest rules regarding BEPS risks.

Earlier this year the Department of Finance said that engagement was ongoing with the Commission, but that work had “commenced to examine options for transposing the ATAD interest limitation rule before 2023 and possibly as soon as Finance Bill 2019”. And now we have the EU’s “au contraire” letter so au revoir 2024?

Under the ATAD, deductions for “excess borrowing costs” (we’ll get to that in a second) are limited to 30% of a company’s earnings before interest, tax, depreciation and amortisation (EBITDA). Bottom line, restrictions may apply to an interest expense whether the related borrowing funds day to day operations, corporate acquisitions or intragroup lending and more.

The restriction is on “excess borrowing costs” which the directive explains as the amount by which “deductible borrowing costs” exceeds interest and similar income. So interest-in less interest-out may be okay, other income-in less interest-out, not so much. “Deductible borrowing costs” are broadly defined and include interest on debt, payments under profit participating loans, the interest element of finance lease payments, notional interest amounts under hedging arrangements related to borrowings, certain foreign exchange gains and losses on borrowings and the list goes on and on. So at first blush you mightn’t think your group has an issue but the devil is in the detail.

The ATAD explains that member states may allow standalone entities (i.e. those not in a corporate group) to fully deduct borrowing costs. Additionally, member states may allow taxpayers deduct excess borrowing costs up to a €3 million threshold determined for the entire group. It’s also possible for a lower (or no) threshold to apply. This “may allow” stuff means that we will have to see how the directive is enacted into our law because the detail requires a Finance Act move.

Also, member states can introduce additional exclusions: (i) an “equity/total assets” ratio test, whereby a company may deduct borrowing costs in excess of 30% of EBITDA if it can show that the ratio of its equity to total assets is equal to or higher than the equivalent ratio of the group where certain Ts & Cs are met or (ii) a “group EBITDA” test under which a company may deduct its excess borrowing costs by reference to the group ratio of excess borrowing costs over EBITDA.

The ATAD also allows member states to not apply the restriction to loans concluded before 17 June 2016 (and not modified thereafter). We brought about a similar exclusion when we introduced transfer pricing into our law back in 2010 so we have form in this area.

The directive also allows countries exclude third-party loans used to fund a long-term public infrastructure project where the project provides, upgrades, operates and/or maintains a large scale asset that’s considered in the general public interest of the respective country. Certain financial undertakings can be excluded from the interest expense limitation rule which in general comprise regulated entities e.g. banks etc. so these may not go far enough for most companies.

Significant change was brought about to our tax law regarding securitisation and other vehicles not so long ago. This new-fangled restriction, when it applies, may bring about another layer of complexity to such vehicles which are generally funded by profit participating debt (specifically included in the ATAD’s meaning of borrowing costs). Care needs to be taken to how this sector is affected within these rules given its importance to financial services generally.

We will have to wait for the legislation to see how this, and the exceptions outlined above, will be dealt with in law. We need to remain competitive and heed Bruce Lee’s dictum to adapt what is useful (all exceptions above), reject what is useless, and add what is specifically our own (e.g. the option of a worldwide group).

The concept behind this restriction is one of anti-avoidance. As part of writing the recently launched Capital Gains Tax book I read the Dail debates leading to its enactment and the then Finance Minister said about one provision that the genuine case was caught because of the inclination “to contrive cases to frustrate the intentions of Parliament. So long as it is so I fear we must, in the words of St. Paul, see the innocent suffer for the guilty”. This restriction is similar given that day to day activity could be financed by debt with its related borrowing costs limited for tax purposes.

As one of the main characters in the Transformers movies explained “Fate rarely calls upon us at a moment of our choosing”. We chose 2024 and the EU said “non mes amis” so the need to review your company’s financing arrangements may go to a “looks like we got ourselves a situation” sooner rather than later depending on the response to the EU.

Tom Maguire is a tax partner with Deloitte and his column on tax matters appear in the Sunday Business Post. The above column was first published on 25th Aug 2019. 

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