On July 12, 2016, the European Council adopted a Directive laying down rules against tax avoidance practices used to shift profit among groups of affiliated companies. The Directive comprises the interest limitation rule (so-called “Zinsschranke”) that implies a limited deductibility of borrowing costs, depending on certain performance figures.
1. What is the interest limitation rule?
Borrowing costs shall only qualify as tax effective insofar, as the excess of borrowing cost doesn’t exceed 30 percent of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA).
2. Which borrowing costs are affected?
The interest limitation rule generally affects all borrowing costs, irrespective of whether the creditor is a third party (e.g. bank) or an affiliate.
3. How is the limitation of the deductibility of borrowing costs to be calculated?
The exceeding borrowing costs are defined in Art. 2 of the Directive as the surplus of a taxpayer’s tax effective borrowing costs over the tax effective interest revenues the taxpayer receives, whereby the Directive defines the term “borrowing costs” rather comprehensively.
The EBITDA is defined in Art. 4 of the Directive and is to be calculated by adding back to the income subject to CIT the tax-adjusted amounts for exceeding borrowing cost as well as the tax-adjusted amounts for depreciation and amortization.
Simplified calculation scheme:
- + income subject to CIT
- + exceeding borrowing costs
- + tax deductible depreciation
- = EBITDA based on EU Directive
- x 30 %
- = maximum tax effective interest deduction
4. What happens to non-deductible borrowing costs or unused interest capacity?
The Member States can individually decide upon whether the potential carry forwards concerning the interest limitation rule could be recognized as follows:
- The exceeding borrowing costs which cannot be deducted in the current tax period can be carried forward without time limitation;
- Possibly the exceeding borrowing costs, which cannot be deducted in the current tax period, can be carried back for a maximum of three years;
- Unused interest capacity which cannot be deducted in the current tax period can be carried forward for a maximum of five years.
It remains to be seen whether and if so, which of the above simplification rules will be implemented in Austria.
5. Are there any derogations from the interest limitation rule?
The Directive gives the Member States the following options for allowing derogations to the interest limitation rule:
- Right to deduct exceeding borrowing costs up to EUR 3 million;
- Right to fully deduct exceeding borrowing costs if the taxpayer is a standalone entity;
- Exception for loans financing long-term public infrastructure projects, and
- Exception for financial undertakings (e.g. banks, insurance undertakings).
The declared objective of the interest limitation rule is to prevent tax base erosion on the internal market and profit shifting abroad. Hence, a deduction of borrowing costs should also be allowed in case the EBITDA
rate is not met, but it nonetheless is ensured that borrowing costs are evenly spread within a group. There
are two options, which can be assumed by the Member States:
- The full deductibility of borrowing costs should be granted in case the equity ratio of the affiliated entity falls below the equity ratio of the group by only up to two percentage points. Each of the Member States will individually specify how to calculate the equity ratio.
- Additionally, the deduction of borrowing costs shall be possible if the affiliated entity accounts for borrowing cost below the group’s ratio of borrowing cost and the debt ratio of group as a whole is higher in relation to the EBITDA than the local entity’s ratio.
6. When is the interest limitation rule to be adopted?
The Directive is generally to be adopted into national law by individual national legislators until January 1, 2019.
An extended time limit until January 1, 2024 is provided for those Member States which have already implemented adequate regulations on national basis that are as effective as the interest limitation rule.
In Austria the existing restriction on the tax effective deduction of interest payments to group companies residing in low-tax countries according to Sec 12 para 1 no 10 Corporate Income Tax Act might be considered in this context. Should this rule be recognized by the EU committee as equally effective to the interest limitation rule, the adoption of the interest limitation rule in Austria could be postponed until January 1, 2024.
7. Does the interest limitation rule apply to already existing loans?
The Directive contains a grandfathering clause which gives the Member States the possibility to exclude loan agreements concluded before June 17, 2016 from the new regulation. However, the exception does not apply to subsequent modifications of loan agreements concluded before June 17, 2016.
The aforementioned provision is optional, thus, it is within the Austrian legislator’s discretion to exclude the loan agreements concluded before June 17, 2016 from the interest limitation rule. It remains to be seen whether the Austrian legislator implements such a provision to render the existing loans exempt.
8. What should be attended to within a company group with regard to the interest limitation rule?
TPA Tips for company groups:
- Borrowing costs of the group should be evenly distributed among individual group members.
- In case the refinancing or amendments of existing loan agreement are considered, it is advisable to examine any possible implications of the interest limitation rule beforehand.
- It should be checked on the level of the individual company whether interest expenses on capital borrowed to finance the construction or production of fixed or current assets (e.g. large-volume real estate projects) incurred. In such cases under certain criteria the interest incurring during the construction period can be capitalized as so-called construction period interest (“Bauzeitzinsen”). The interest limitation rule wouldn’t be applicable.
- Any further actions and improvements of interest deductibility (reorganizations, entering into tax groups, possibly application of the exceptions to the interest limitation rule) can be considered once specific information on the implementation of the interest limitation rule in Austria will be available.
In Austria the implementation of the interest limitation rule is equivalent to a paradigm shift. Thus, it can be expected that the adoption of the interest limitation rule will take place rather later than sooner. However, it is not certain yet and it remains to be seen, how the new regulations will be implemented, particularly with regard to the possible exceptions from the interest limitation rule. However, the Directive indicates clearly the direction the European tax policy and, consequently, in the Austrian tax policy will take.
- More tax news: News of the TPA Group
- If you have questions about the new EU interest limitation rule, do not hesitate to contact our tax experts!
- Tax facts at one glance: TPA’s Investing in Central and South Eastern Europe series