In accordance with the first EU’s Anti-Tax Avoidance Directive (‘ATAD’), Ireland was required to introduce interest limitation rules (“ILR”). These rules will apply for accounting periods commencing on or after 1 January 2022.
The aim of the ILR is to limit base erosion attempts by multinational enterprises and other companies through the use of excessive interest deductions and similar financing costs. The ILR does this by limiting the maximum tax deduction for net borrowing costs to 30% of a corporate taxpayer’s EBITDA (as defined under tax principles). The objective of these new rules is to ensure tax relief on financing costs is commensurate with the extent to which business activities are subject to corporation tax.
As noted, the restriction is applied by reference to “EBITDA”, which in turn 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” and this disregards any losses carried forward or back or group relief. “Relevant profits” are adjusted proportionally where there is income and gains which are subject to tax at different rates. Franked investment income is excluded from the tax-adjusted EBITDA figure.
The ILR applies to interest, and “interest equivalent” expenses, of all corporate taxpayers, subject to some exceptions where there is a limited risk of base erosion or profit shifting. A key definition in this regard is “interest equivalent”, as a restriction only applies if the interest equivalent expense exceeds interest equivalent income. Interest equivalent” has been defined quite broadly so as to include not just interest costs on all forms of debt, but also other economic equivalents including financial instruments, such as derivatives, amounts incurred in connection with raising finance, along with foreign exchange gains and losses on interest or similar amounts.
The key exceptions from ILR include:
Other worldwide relieving measures include:
- where the taxpayer’s ratio of equity to assets is greater than 98% of the worldwide group’s ratio, being scenarios where Irish equity funding is as high or higher than the group’s equity funding (with the group meaning the ultimate parent and all consolidating entities in the ultimate consolidated financial statements); and
- there is also scope for an increased deductibility threshold where the worldwide group’s exceeding borrowing costs as a percentage of EBITDA exceeds 30% - in this scenario, the taxpayer may use this higher percentage in its own calculations.
The legislation also helpfully provides for relieving measures for amounts disallowed as an interest deduction under the ILR. These amounts can be carried forward and taken as a deduction against taxable profits in future years.
In addition, where there is “interest spare capacity” or “limitation spare capacity”, this may be carried forward as a benefit to future years. “Interest spare capacity” arises where taxable interest equivalent exceeds deductible interest equivalent. “Limitation spare capacity” arises where exceeding borrowing costs is less than the allowable amount (i.e. 30% of tax-adjusted EBITDA or the group ratio percentage of tax-adjusted EBITDA). Both amounts together form “total spare capacity” and must be used within a period of 60 months from the end of the accounting period in which it arose. Thus, if companies are 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.
The new ILR provisions allow for its application using a single entity basis or by using a “group approach”, i.e. determining the interest restriction at the level of a local group of companies (i.e. an “interest group”). Membership of this group is to be determined on an elective basis. An “interest group” will 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. There may be benefits to opting into a group, such as pooling of interest and spare capacity, but this decision should be based on detailed tax analysis and modelling, as there is a minimum three-year period for staying within a group once the election is made.
Rather than replace Ireland’s existing comprehensive interest deductibility rules, the Department of Finance have chosen to operate the new ILR provisions alongside the existing regime. This will result in significant additional complexity for companies when considering the deductibility of their financing .
Given the widespread use of debt finance across a multitude of industries and sectors, particular in this era of historically low interest rates, the implications of the introduction of ILR will be significant, and taxpayers will need to understand the impact these new rules may have on their current structures and tax liabilities. In particular, this would include modelling out the deductibility of interest and related financing costs as an immediate action point.
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