Swedish Committee on Corporate Taxation proposes new corporate tax system
Deloitte Tax Alert
The Swedish Committee on Corporate Taxation issued a document on 12 June 2014 that includes recommendations for a new corporate taxation system. The main task of the Committee given by the Government was to propose a system that would result in greater neutrality between the taxation of equity and debt, and that would counteract the use of tax planning opportunities involving interest expense. The Committee has presented two alternative proposals, as well as additional changes to the tax legislation. There is a main proposal that the Committee favors and an alternative. According to the Committee the proposed changes should apply as from 1 January 2016.
The main proposal contains two parts:
1. Limitation on deduction of interest expense and other financial costs – Deductions for interest expense and other financial costs would be limited by allowing deductions only for financial costs for which there is corresponding financial income. No other financial costs would be deductible. The proposal, therefore, would abolish deductions for net financial costs. The current restrictions on the deduction of interest on intragroup debt also would be abolished.
The Committee proposes a new definition of financial costs for tax purposes. Financial costs would include (in addition to interest expense) inter alia the effect of exchange rate differences, taxable profits and losses on financial instruments, taxable dividends and the interest component of certain rental payments. Income corresponding to financial costs would be deemed to constitute financial income.
The main proposal also includes that companies with net financial income will be allowed to offset this income against net financial costs reported by companies in the same group, provided the companies meet the requirements to exchange group contributions under the Swedish tax consolidation regime.
2. Financing allowance – The current nominal corporate income tax rate of 22% would remain unchanged, but to compensate for the disallowance of a deduction for net financial costs, a standard deduction would be introduced for all financial costs (a “financing allowance”) at a rate of 25% of the company’s entire taxable profit. This financing allowance would be allowed regardless of whether a company has financial costs. The financial effect for companies would be equivalent to reducing the corporate tax rate by 5.5 percentage points (from 22% to 16.5%).
The alternative proposal also has two components:
1. Reduced corporate income tax rate – The corporate income tax rate would be reduced from 22% to 18.5%. The currently applicable restrictions on the deduction of interest on intragroup debt would remain, but additional restrictions on the deduction of all financial costs connected to a company’s EBIT (earnings before interest and taxes) would apply.
2. EBIT-limited deduction of interest expense and other financial costs – Unlike the main proposal, the alternative proposal does not provide that the deduction for financial costs exceeding a company’s financial income (net financial costs) would be entirely abolished. Instead, a deduction for the net financial costs would be allowed in an amount equal to 20% of the company’s EBIT. Net financial costs for which a deduction is denied could be carried forward to be used during a period of six fiscal years after the fiscal year in which the cost arose (subject to certain limitations).
Standard income for financial institutions
For financial institutions, such as banks, financial expenditure generally does not exceed financial income, i.e. financial institutions generally have net financial income. Consequently, the deduction limitations under both the main and the alternative proposal likely would not have the intended effect for these types of companies, even though financial institutions would benefit from the proposed financing allowance (under the main proposal) or tax rate reduction (under the alternative proposal). To compensate for this, it is proposed (under both the main and the alternative proposal) that financial institutions should be required to report taxable standard income that corresponds to a percentage of a basis that is calculated in essentially the same manner as the basis for the “stability fee.” This implies that the basis would be calculated as the sum of the company’s liabilities and provisions, less untaxed reserves, at year-end, according to the adopted balance sheet. Liabilities to other financial institutions within the same group, and for subordinated debt that may be included in the capital base under the Swedish capital adequacy rules, would be able to be deducted from the basis. The standard income percentage is set at 0.24% under the main proposal and 0.12% under the alternative proposal.
The term “financial institution” would encompass credit institutions and foreign credit institutions, as defined in the Banking and Financing Business Act.
As part of the financing of the reform, it is further proposed that deductions would be discontinued for interest expense on certain subordinated loans issued by credit institutions.
Other proposed changes
Reduction of loss carryforwards – Since any loss carryforwards remaining at the time the new rules enter into effect (i.e. 1 January 2016) would have been incurred during a period where it was possible to create deficits by utilizing interest deductions, the Committee has proposed that loss carryforwards remaining as of 1 January 2016 would be reduced by 50%. Following the enactment, the rules governing loss carryforwards would be applied as normal.
Standard income on contingency reserve provisions – It is proposed that non-life insurance companies would be required to report taxable standard income on provisions for contingency reserves. Standard income would be calculated by multiplying the sum of all contingency reserve provisions at the beginning of the financial year with the government borrowing rate as of 30 November of the previous year. Consequently, provisions for contingency reserves would be treated in a similar way as tax allocation reserves for tax purposes.
Raised standard income on tax allocation reserves – It is proposed that the calculation of the taxable standard income with respect to tax allocation reserves would be raised by 15 percentage points, from 72% of the government borrowing rate, to 87% of the government borrowing rate.
Transitional rules – The Committee has proposed rules to prevent allocations to tax reserves and provisions for contingency reserves that currently can be made at a corporate tax rate of 22% and later dissolved at a lower effective tax rate. In addition, a rule is proposed that would prevent tax benefits from arising from group contributions between companies that are subject to different effective tax rates during the transitional period.
Group contributions (transfer of value) – The Committee proposes codifying case law regarding the requirement for a transfer of value when making tax- deductible group contributions. It also proposes that a transfer of value would be required to take place no later than the date the company files its income tax return.
Capital contributions and loss carryforwards – The Committee proposes a change to the rule providing that capital contributions that lead to a change in ownership in certain cases should not affect the survival of tax loss carryforwards. The proposal implies that the burden of proof would be reduced and that the calculation of the cost of acquisition for the purpose of determining the survival of loss carryforwards should be carried out in a different way.