Finance Bill 2021 sees Ireland formalise its transposition of Article 4 of the EU Anti-Tax-Avoidance Directive (ATAD) into Irish tax legislation through the introduction of interest limitation rules (ILR). The ATAD ILR aims to limit base erosion by restriction of interest deductions.
It will operate by placing a ratio-driven cap on the deduction allowable for net borrowing costs to 30% of earnings before interest tax, depreciation and amortisation (EBITDA) as measured under tax principles. These rules will apply for accounting periods commencing on or after 1 January 2022. 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.
Calculation of EBITDA
The restriction is applied by reference to “EBITDA”, which in itself is reliant on the definition of “relevant profits”. The legislation provides that “relevant profits” is the amount on which corporation tax finally falls to be borne, disregarding any losses carried forward or back. “Relevant profits” are modified where they include income or gains taxable at different rates. Franked investment income (FII) is excluded from the tax-adjusted EBITDA amount.
ILR will apply to both “interest equivalent” which has been broadly defined to include interest and amounts economically equivalent to interest (such as discounts and the finance element of finance lease payments, along with foreign exchange gains and losses on interest or similar amounts, amongst others). It should be noted that the ILR will apply to net borrowing costs; consequently, a company’s interest income will reduce its net borrowing costs.
Applying the restriction and “spare capacity”
In consideration of the applicability of the provisions, a nine-step approach guides the taxpayer with a step-by-step approach to apply the provisions. Interest is deducted in calculating the taxable profits at the outset and to avoid circularity, the ILR restriction is not embedded in the computation of taxable profits but rather sits alongside this calculation. Where net borrowing costs exceed 30% of EBITDA, the excess is disallowed as a tax deduction. A welcome inclusion is relief for amounts disallowed as an interest deduction in later periods. These amounts can be carried forward indefinitely and are to be treated as “deemed borrowing costs” of that later period.
The draft legislation also provides for relief by allowing a carry forward of “interest spare capacity” and “limitation spare capacity”. “Interest spare capacity”, being an excess of taxable interest equivalent over deductible interest equivalent; and, “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 percentage of EBITDA). Both form “total spare capacity” which must be used within 60 months of the period-end in which they arose. Should an entity be restricted in terms of interest deductibility in future years but had spare capacity in earlier years (after ILR was introduced), the interest restriction may be reduced as a result of this carry forward of spare capacity provision.
Local “interest groups”
The draft bill provides for the application of the rules on a single entity basis or by a “group approach”. by calculation of the restrictions applicable at a local group level (i.e. an “interest group”). Membership of such a group would be on an elective basis. An “interest group” would include all companies within the charge to corporation tax in Ireland that are members of a financial consolidation group as well as any non-consolidated companies that are members of a corporate tax loss group. Interest group membership offers several benefits such as pooling of interest and spare capacity. However, the election to enter into an interest group should be only be done after careful consideration as interest group membership applies for a minimum of three years.
Legacy debt provisions: ATAD permits a number of exemptions from ILR which the Irish draft legislation provides for a number of exemptions. One of such exemptions relates to loans signed predating 17 June 2016 (before the terms of the ILR were agreed). However, such legacy debt provisions have been constructed narrowly, placing strict conditions on pre-existing loan facilities. Where modifications are made to legacy loans, such grandfathering exemptions may be lost. It should be noted that the draft provided that any modifications to legacy debt will only result in a limitation on the “interest equivalent in respect of legacy debt” to the extent that they increase the interest payable on such legacy debt (with the interest limitation rules applying only to the increase itself). Consequently, any modifications to the terms of legacy debt should be considered carefully in terms of their net effect in light of the new rules.
€3M de minimis interest threshold: Also provided for is a de minimis exemption for interest expenses up to €3m; The de minimis threshold applies to the “interest group” as a whole. As the risk of base erosion in such a situation is considered low. The manner in which the de minimis threshold is applied accommodates taxpayers that have profits taxable at different rates.
Standalone entities: There is also an exemption from the rules for certain “standalone entities,” i.e., an entity that is not part of a consolidated group for financial accounting purposes and has no associated enterprise or permanent establishment.
Exemption for infrastructure projects: A welcome inclusion is an exemption for long-term “infrastructure projects” from the scope of the interest exemption. Such projects would present little or no base erosion and profit shifting risks. This applies to a wide range of assets in areas such as energy infrastructure, transport infrastructure, environmental infrastructure and health infrastructure with no requirement for state or public ownership. This supports the governments' Project Ireland 2040 plan and offers support to build the State’s renewable energy generation capacity.
However, the Finance Bill does not provide for a financial undertakings exemption which is permitted under ATAD.
Worldwide reliving measure: The draft provisions provide for two reliefs from the ILR linked to a worldwide accounting group of the entity. The first is based on the ratio of equity-to-assets to that of the worldwide accounting group (using their accounting results). Under this relief, where the taxpayer’s ratio of equity-to-assets is 98% or more of the worldwide group’s ratio, ILR is disapplied.
The second relief, the group ratio rule, provides for a potential increased deductibility threshold, where the worldwide group’s exceeding borrowing costs as a percentage of its EBITDA exceeds 30% then the entity is permitted to use this higher percentage in its own calculations.
While the new legislation offered an opportunity to consolidate and simplify existing legalisation relating to interest deductions. Such opportunity has alluded the government and the new ILR are supplemental and will operate alongside Ireland’s existing rules on restriction on the deductibility of interest. Consequently, tax liabilities will need to be computed by reference to the new ILR and the old deductibility rules. This will add a further layer of complexity and administrative burden for taxpayers.
Given the widespread use of debt financing across a variety of sectors and industries, the implications of the introduction of ILR will be significant. The legislation provides that the new rules will apply for accounting periods commencing on or after 1 January 2022. Taxpayers will need to understand the impact on their current structures, if any, adapt a position on whether to form an interest group and assess any reliefs or exemptions available to them.
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.