Release of second Feedback statement on Ireland’s Interest Limitation Rules has been saved
Release of second Feedback statement on Ireland’s Interest Limitation Rules
On 2 July 2021, the Department of Finance issued “ATAD Implementation Article 4 Interest Limitation Feedback statement July 2021”, which builds on previous work undertaken in the Feedback statement of December 2020 (to access our comments on this, please click here). The July Feedback statement expands on a number of the proposals previously outlined while amending a number of key areas of note.
ATAD Article 4 (“EU ATAD”) requires the introduction of a fixed ratio rule that links a company’s allowable net interest deductions (i.e. deductible interest expenses in excess of taxable interest income) directly to its level of economic activity, based on taxable earnings before deducting net interest expense, depreciation and amortisation (EBITDA). Article 4 requires domestic provisions implemented in Member States to place a limit on deductible interest equal to 30% of EBITDA. The limitation on interest deduction may be subject to certain exemptions and group ratios, the latter of which may allow higher interest deductions to an individual company by reference to the position of the wider group.
The Feedback statement of 2 July 2021 outlines a range of policy and technical considerations, including proposed definitions and a suggested mechanism for the operation of the Interest Limitation Rule (ILR) in Ireland. The consultation period closed on 16 August 2021, to be followed by a period of discussion between the Department of Finance and stakeholders who have submitted their responses to the Feedback statement. Domestic legislation is expected to be introduced in Finance Bill 2021 to implement these interest restriction rules.
While the previous Feedback statement focussed primarily on the calculation and application of the ILR to a single company, several key aspects were notably absent including the identification of “relevant profits”, the group escape clauses provided for in ATAD and also the treatment of local notional groups. These key aspects and others have now been addressed in the Feedback statement.
Impact for Irish companies and taxpayers
While existing Irish tax law is generally restrictive in terms of relief for interest incurred on borrowings, the introduction of the ILR provided for in ATAD is the first time that Irish companies will have to contend with a restriction calculated as a percentage of tax EBITDA. The intention based on the Feedback statements issued to date (both in December 2020 and July 2021) would act to layer the ILR on top of existing interest relief rules. Accordingly, Irish taxpayers currently obtaining tax relief on borrowings will now be required to consider the application of the ILR as part of their compliance and tax return preparation processes.
The ILR has the potential to impact a wide range of taxpayers and is unlikely to be exclusively of concern to large multinational companies. Some key messages included as part of our response document include:
We appreciate that by its nature the Feedback statement does not contain the full proposed legislation and therefore some of the comments included in this document may already be addressed in the wider proposed law. However, we would emphasise the following points:
- As a general matter, the interest limitation rules need to take account of international best practice on the adoption of the OECD BEPS Action 4 report.
- We would recommend that clarity be provided as early as possible on the policy options which may be taken or rejected by the Department of Finance to permit specific industries sufficient time to consider the ramifications for their businesses; for example, the implications for restricted interest deductibility for non-bank financial entities.
- It is important that measures taken in the enacting of the interest restriction rules do not go beyond what is necessary to implement the Directive in that this has the capability to interfere with our competitiveness vis a vis other countries. Their enactment should avoid complexity and additional administrative burdens as much as possible. We have highlighted in our response certain proposals in the consultation document which suggest broadening the scope and implementation of the interest limitation rule beyond what is required in the ATAD. In our view, it is critical that such measures and proposals are realigned to what is required by the directive and does not go further.
- The removal of the previously suggested Case IV charging mechanism in the prior Feedback statement of December 2020 is welcome in light of the unintended consequences identified with respect to same. While we welcome the alternative mechanism involving a value basing of relevant profits to address differences in rates of corporation tax, we have outlined a number of considerations which arise on foot of proposal now contained in the Feedback statement e.g. we would argue it appropriate that the “ITDA” element of the “EBITDA” formula be value based to correspond with such treatment in “E”.
- The calculation of the various components of the interest limitation rule including the calculation of the Equity ratio and Group ratio rules should be as clear as possible and should not require taxpayers to “unpick” consolidated accounts insofar as is necessary.
- The reporting mechanism for the interest restriction rules should ideally build on existing corporation tax return obligations. While the calculation and application of the interest restriction rules will undoubtedly result in an additional compliance obligation, it is vital to ensure that the new rules do not impose an additional burden that taxpayers may find unworkable.
Feedback statement details
The Feedback statement contains 23 questions ranging in focus from broad policy considerations to technical and practical considerations associated with the application of the ILR. The Feedback statement also outlines a nine step method for the application of the ILR as follows:
- Identification of the relevant entity or interest group;
- Calculation of the relevant profit or loss before interest limitation;
- Identify taxable interest equivalent;
- Identify deductible interest equivalent;
- Calculate exceeding borrowing costs/interest spare capacity and EBITDA;
- Apply the Equity Ratio Rule;
- Calculate the allowable and disallowable amount;
- Reduce the deductible interest equivalent by the disallowable amount and calculate the taxable profit accordingly;
- Carry forward any disallowable amount as a deemed borrowing cost for use in later periods (or total spare capacity where applicable).
Relevant entity and interest groups
A relevant entity per the Feedback statement means a company or an interest group as defined. Based on the Feedback statement issued, an interest group refers to companies that are deemed to be members of a group for corporation tax loss purposes. EU ATAD recognises that in implementing the ILR, certain Member States (including Ireland) do not operate tax consolidation regimes; to accommodate this, Member States may opt to apply the ILR at the level of a group defined for national tax law. The Feedback statement makes provision for the application of the ILR and the allocation of disallowable amounts across such a group. The Feedback statement would suggest that a single entity within the interest group should take on the role of “reporting company” in filing details of the ILR and any disallowable amounts with the Irish Revenue for each group member. The paper also indicates that a company may elect not to be a member of an interest group, and such election shall apply for a period of three years and be made in such form as the Revenue make available.
The proposed drafting with respect to companies joining and leaving an interest group would appear to implicitly provide that any deemed borrowing costs carried as an attribute by a member of an interest group at a time when they leave that group should remain attributed to that company at the date of exit.
While the actual reporting and election mechanisms have not yet been indicated in the Feedback statement, we would expect such detail to be forthcoming in Finance Bill 2021.
Identification of relevant profits/losses
The relevant EBITDA for the purposes of applying the 30% restriction is calculated by identifying the relevant profits of the entity in question, and adjusting for an amount referable to deductible interest equivalent and any allowances in respect of capital expenditure. As the quantum of EBITDA is central to the operation of the ILR, and the “relevant profits” form a basis for such a calculation, it is imperative that such profits be well defined in law and are easily identifiable.
The July Feedback statement provides that such profits are those on which corporation tax falls finally to be borne prior to the use of any relief for losses carried from prior years. A relevant loss is to be calculated in the same manner as a relevant profit, and crucially, the calculation of the relevant profits is subject to value basing – to address challenges encountered by the 12.5% vs 25% rates of tax (on trading and passive income, respectively).
Taxable and deductible interest equivalents
“Interest equivalent” is defined in the drafting of the Feedback statement as meaning not only interest but amounts “economically equivalent to interest” and amounts in connection with raising finance. In our view, the definition of interest equivalent is a critical definition for the purposes of the ILR and should therefore be made as clear as possible. It may be necessary to defer to guidance on what is meant by “economically equivalent to interest” in due course.
Group ratio rules
EU ATAD provides that where the taxpayer is a member of a consolidated group for financial accounting purposes, they may be given the right to either
a. Fully deduct exceeding borrowing costs where the ratio of its equity over total assets is equal to or higher than the equivalent group ratio (the “Equity ratio rule”); or
b. Deduct exceeding borrowing costs based on a group ratio (i.e. instead of the 30% EBITDA limit) determined by dividing the exceeding borrowing costs of the group vis a vis third parties over the EBITDA of the group (“the Group ratio rule”).
Both group rules would appear to be provided for in the Feedback statement issued but are considered at differing stages of the ILR calculation. While the Equity ratio rule operates to disapply the ILR, the Group ratio rule serves to allow an EBITDA threshold above the normal 30% ordinarily allowed. Accordingly, it follows that the two group rules cannot be availed of in tandem.
While some technical clarifications may be required prior to the application of the Equity ratio rule (as detailed in our response to the public consultation in part 3.6.2), the application of the rule is welcome and in line with that provided for in EU ATAD. Similarly, the application of the Group ratio rule is welcome but may require further amendment to allow for technical uncertainties to be fully addressed (refer to part 3.7.1 of our response for details in respect of same).
Reduction in deductible interest equivalent
A key amendment contained in the July 2021 Feedback statement as compared to the December 2020 feedback statement is the mechanism by which the ILR actually takes effect to reduce a relevant entity’s tax relief on interest expenses. The December 2020 Feedback statement previously identified complexities with denying interest relief ordinarily granted by way of tax deduction or as a charge on income due. Such complexity arose due to the differing rates of corporation tax on income which may be partially sheltered by such interest. Accordingly, a suggested solution was the imposition of a 25% corporation tax charge on “imputed income”. Such an approach, while addressing the complexities posed by the differing rates of corporation tax in Ireland (i.e. 12.5% on trading income vs 25% on passive income), ultimately was found to pose other challenges. The July 2021 Feedback statement would now appear to have removed the previously mooted “imputed income” method, instead looking to reduce deductible interest equivalent (on a value basis) by the disallowable amount.
Treatment of spare capacity
The Feedback statement recognises two distinct types of capacity which may arise in the course of applying the ILR, namely:
i. Interest spare capacity, being an excess of taxable interest equivalent over deductible interest equivalent; and
ii. Limitation spare capacity, being the amount by which exceeding borrowing costs is less than the allowable amount (i.e. 30% of EBITDA or the group ratio % of EBITDA).
While the two categories of capacity stem from differing areas of the ILR provisions, the Feedback statement recognises them as comprising “total spare capacity”, and in line with EU ATAD such capacity may be carried forward for a period of 60 months from the end of the accounting period in which it arose. Where total spare capacity is carried forward to later accounting periods, it may be allowed as relief against a disallowable amount in future periods.
Carried forward disallowable amounts
Disallowable amounts may be carried forward indefinitely to succeeding accounting periods and are to be treated as “deemed borrowing costs” of that later period. Such a carry forward provision is in line with EU ATAD and is welcome for taxpayers to ensure that the operation of the ILR constitutes a deferral of tax relief on interest expenses incurred and not a permanent disallowance. While our comments in part 3.9.2 of our response note some technical clarifications required prior to the enactment of Finance Bill 2021, the carry forward provisions would appear to distinguish between (a) deductible interest incurred which would, but for the ILR, reduce an amount of tax payable and (b) deductible interest incurred which, but for the application of the ILR, result in a loss. The rationale for such an approach would appear to us to ensure that the disallowable amount carried forward for use in future years is not given more flexibility than it would have otherwise be granted, and to ensure that the existing loss relief rules remain robust.
Exemptions and exclusions
EU ATAD provides for a number of exclusions and exemptions in the application of any domestic interest restriction rules:
- De minimis amount: EU ATAD allows for Member States to include a de minimis threshold of any amount up to €3million. The Feedback statement provides for the de minimis threshold in the calculation of the “allowable amount”.
- Financial undertakings: EU ATAD allows for Member States to exclude certain specific financial undertakings from the scope of the ILR. While the definition contained in the Feedback statement is in line with EU ATAD, the financial undertaking exemption as envisaged above would apply only to certain entities within financial services groups and may be of limited benefit to reducing the compliance burden necessitated by the ILR provisions. We note that major European economies such as Germany, France, the Netherlands and the UK have not included this exemption in their equivalent provisions. We would argue that financial undertakings should be allowed to form an “interest group” where the financial undertaking exemption is brought about. Investment undertakings (as defined in TCA97 s739B TCA) should be included as part of an interest group, whether they are constituted in corporate form (e.g. ICAV) or in authorised unit trust form. In addition, companies held by securitisation companies as described in TCA97 s110 should also be allowed participate in an interest group. TCA97 s411 excludes companies whose share capital is owned by a company “if a profit on the sale of the shares would be treated as a trading receipt of its trade” and in certain instances those companies would not be within an interest group on the basis of TCA97 s411. This should be catered for as part of the interest group provisions.
- Legacy debt exclusion: EU ATAD provides that Member States may exclude loans that were concluded before 17 June 2016 (the date of agreement of ATAD) from the scope of the ILR. While the Feedback statement and nine step approach to the ILR would allow for the legacy debt exclusion to be taken into account, we would note that further clarity may be required in Finance Bill 2021 to avoid uncertainty.
- Long term public infrastructure projects exclusion: EU ATAD provides that Member States may exclude both the income and associated expenses of certain ‘long-term public infrastructure projects’ from the scope of the interest exemption, on the grounds that they present little or no BEPS risks. While the Feedback statement provides little in the way of additional detail as to what would qualify as a “public infrastructure project”, our view (as in the December 2020 consultation) is that on legislating for this exclusion, the Government needs to adopt a wide definition such that projects passing a public benefit test should qualify.
- Standalone entity: EU ATAD allows for a taxpayer to fully deduct exceeding borrowing costs where the taxpayer is a “standalone entity”, referring to a taxpayer that is not part of a consolidated group for financial accounting purposes with no associated enterprise or permanent establishment. While the inclusion of the standalone entity exemption in the Feedback statement is in line with EU ATAD, we would have concerns that the proposed definition of “associated enterprise” would mean that a company owned by 4 or fewer individuals could not avail of the exemption, and could result in undue burdens for SMEs generally.
Group of one
One notable addition in the July 2021 Feedback statement has been the concept of a “group of one”. The Feedback statement notes the challenges posed by single small owner operated companies who strictly would not fall within the definition of standalone entity and would therefore be subject to the ILR despite incurring genuine interest expenses (including costs on third party borrowings). While a de minimis threshold would ensure that many small, low risk entities are not within the scope of the ATAD ILR, it will not exempt those with ‘exceeding borrowing costs’ in excess of €3 million. To address this, the Feedback statement introduces the concept of a “single company worldwide group” or “group of one” referring to a company that is not a member of a worldwide group and is not a standalone entity.
In the absence of additional legislation, it would appear that the main purpose of this definition is to extend the “equity rule” and the “group ratio rule” to such “groups of one”. This is a welcome policy, but we would note that further clarification may be required to ensure that SMEs are not subject to additional administrative complexities in calculating and applying the equity ratio rule and group ratio rule (please refer to part 3.7.1 of our response for further details on same).
Reporting and compliance
The Feedback statement provides for the making of a return either by a relevant entity or an interest group, detailing key components of the ILR including any allowable/disallowable amounts, spare capacity and carried forward borrowing costs and spare capacity. The exact format for such reporting and deadline for same remains unclear; we would be of the view (as noted in our response) that any implementation of the ILR into domestic Irish tax law should endeavour to minimise additional compliance burdens on taxpayers. Further details on filing and compliance obligations are likely to emerge in due course as we move towards the Finance Bill process.
Overall comments and next steps
The Department of Finance consultation period closed on 16th August. Following a review of the submissions made, the expectation is that the Department will likely open a dialogue with interested stakeholders to express their views contained in submissions. These discussions are likely to be followed by a period of legislative drafting, culminating in the initiation of Finance Bill 2021. While a definitive date for the initiation of the Bill is not yet known, experience from prior years would suggest that an October 2021 timeline would not be unreasonable.
It is important that measures taken in the enacting of the interest restriction rules do not go beyond what is necessary to implement the Directive in that this has the capability to interfere with our competitiveness vis a vis other countries. Their enactment should avoid complexity and additional administrative burdens as much as possible. We have highlighted in our response certain proposals in the consultation document which suggest broadening the scope and implementation of the interest limitation rule beyond what is required in the ATAD.
Should you have any queries as to the imminent introduction of the ILR and the potential impact for your business, please do not hesitate to reach out to your Deloitte contact who will be happy to assist you.
Article 4 Interest Limitation - Public Consultation Response
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