Article 4 of the ATAD requires EU Member States to put in place anti-avoidance tax rules that set a limit on the amount of interest a company can deduct for corporation tax purposes. Therefore, limiting the ability of companies to deduct substantial borrowing costs and reduce their taxable profits.
The international tax landscape has changed dramatically in recent years, with businesses continually adapting and evolving. The EU ATAD contains five legally binding anti-abuse measures, which all EU Member States are required to apply against common forms of aggressive tax planning. These five measures are; controlled foreign company rules, a general anti-abuse rule, measures to tackle hybrid mismatch arrangements, an exit tax, and now the final measure an interest limitation rule (“ILR”).
When should ILR be enacted by?
Member States were required to transpose the interest limitation rules (“ILR”) by 1 January 2019. However, countries with "equally effective" rules in place are allowed until 1 January 2024. Ireland's interest limitation rules differ in structure from the Directive in that they utilise purpose-based tests, designed to limit certain borrowings, as opposed to the ratio-based approach the ATAD takes. Nevertheless, despite these differences, Ireland's Government argued that the country's rules remain “equally effective”, allowing it to postpone transposition of the interest limitation element of the ATAD until 2024. The European Commission took a different view, however, and in July 2018, served a formal notice on Ireland asking that interest limitation rules be transposed into law sooner than the planned date in 2024. This measure will be transposed into Irish law in Finance Bill 2021 and come in effect on 1 January 2022.
The Implementation of Interest Limitation Rules (ILR)
Article 4 of ATAD requires EU Member States to introduce a fixed ratio rule that links a company’s allowable net interest deductions directly to its level of economic activity, based on taxable earnings before deducting net interest expense, depreciation and amortisation (EBITDA).
ILR will introduce a fixed based ratio rule to limit a company’s allowable tax deduction for net interest cost in a tax period to 30% of EBIDTA. The existing Irish interest deductibility rules will remain in effect after 1 January 2022 and taxpayers will need to compute tax liabilities by reference to the new ILR and the old deductibility rules.
To limit excessive interest deductions, the ATAD takes a ratio-based approach. This stipulates that only a certain percentage of "exceeding borrowing costs" are deductible in the tax period in which they are incurred. “Exceeding borrowing costs” are defined as the amount by which the deductible borrowing costs of a taxpayer exceeds taxable interest receipts.
The objective of the ILR is to restrict deductions of interest which exceed 30% of EBITDA. Being considered by the Department of Finance is a possible seven step approach to applying the ILR on a single company basis.
The ILR restriction is not embedded in the computation of taxable profits but rather sits alongside this calculation. The operation of the rule requires companies to initially calculate their taxable profits in the normal way, taking deductions for interest in the normal manner.
The rules have been proposed in this way to fit the Directive into our existing schedular tax system. However, the complexity it entails will create challenges for taxpayers in applying the rule. The implementation of the ILR will likely impact differently on the range of Irish businesses, including, foreign direct investment, domestic businesses and Irish indigenous businesses with a global presence.
The ATAD provides for a number of exemptions when calculating the ILR, as follows: -
- A de minimis exemption for net interest expense of up to €3 million per ‘taxpayer’ per period;
- An exemption for ‘standalone entities’;
- Interest on loans entered into before 17 June 2016 (to the extent the loans are not modified);
- Interest on loans used to fund ‘long-term public infrastructure projects’; and
- ‘Financial undertakings’ may be excluded from the rules.
All of these exemptions serve to lessen the administrative burden for taxpayers and limit the ILR restriction to high-risk BEPS arrangements.
However, as many domestic and multinational companies claim interest relief, all companies will need to pay close attention to the new rules which will represent significant changes to Ireland’s rules, and will have ramifications for many companies. Even though the Directive allows for certain financial undertakings to be excluded, for example banking and insurance sectors, all financial services industries will need to analyse the new rules. Many banks often have legal entities which would not form part of the exemption.
Government’s feedback statement
In December 2020 the Department of Finance issued their Feedback Statement seeking stakeholder input on a range of initial proposals regarding Ireland’s adoption of the ILR under the ATAD. The Feedback Statement outlines a range of policy and technical considerations, including proposed definitions and a suggested mechanism for the operation of the ILR in Ireland. The deadline for responses was in March 2021, however due to the level of complexity, a further Feedback Statement is expected to issue in summer 2021 for further stakeholder input.
The Department of Finance have noted that the views of stakeholders are important in ensuring that Ireland’s ILR, while meeting the ATAD standard, is clear, operable and consistent with the long-standing focus on taxation of activities with substance in Ireland.
The Feedback Statement confirms that policymakers intend to largely overlay the new ILR provision on top of existing comprehensive rules that restrict the deductibility of interest expenses which provide strong protections for the Irish corporate tax base.
Stakeholders welcomed the opportunity to engage with the Department of Finance on the implementation of this measure, which will be a very complex process and will impact most businesses in Ireland. The opportunity to provide recommendations and observations on the proposed legislative approach for the implementation of the Interest Limitation Rule (ILR) is valued by stakeholders.
Some observations were that the Irish corporate tax system has some unique features compared to other EU countries, including having two corporate tax rates, together with interest deduction rules that are increasingly more complex. The proposed implementation of the ILR will add further complications. There is a major concern that the intention to layer the ILR on top of existing rules is likely to result in Ireland having one of the most complex interest deductibility regimes within the EU. The general consensus from stakeholder feedback is that the proposed regime is overly complex which should be avoided, and the provisions adopted should seek to minimise the administrative burden on taxpayers while reducing the cost of compliance.
We wait to see if the Department of Finance will provide initial comments in respect of the feedback received to date before issuing their second Feedback Statement in the coming weeks. In view of the technical nature of this measure and its impact on most businesses, there is an overwhelming request for early engagement to ensure the best possible outcome for businesses across Ireland.
If you have any questions in relation to the above, or if you would like to discuss this topic further, please contact a member of the Mazars corporate tax team.