On 28 January 2016, the EC released the Anti Tax Avoidance Directive. The Directive aims at transposing several OECD BEPS measures (published on 5 October 2015) into the national systems of the Member States, in a coherent and coordinated fashion.
The Directive proposes six legally-binding anti-abuse measures, which all Member States should apply against common forms of aggressive tax planning. The Directive includes the following rules: (i) interest limitation rule, (ii) exit taxation; (iii) switch-over clause; (iv) general anti-abuse rule; (v) CFC legislation and (vi) hybrid mismatches. We will look at one anti-abuse provision, which should have significant implications for Belgian companies: the interest limitation rule.
I. INTEREST LIMITATION RULES
The Directive allows the deduction of “net”[1] interest only up to a fixed ratio based on the taxpayer’s gross operating margin, i.e. 30 percent of the taxpayer's earnings before interest, tax, depreciation and amortisation (EBITDA) or up to an amount of EUR 1,000 000, whichever is higher.
The taxpayer may be given the right to fully deduct exceeding borrowing costs if it can demonstrate that the ratio of its equity over its total assets is equal to or higher than the equivalent ratio of the group.
The interest limitation rules do not apply to financial undertakings, i.e. banks, insurance companies, investment funds, etc.
II. IMPACT OF THE INTEREST LIMITATION RULE FOR BELGIAN COMPANIES
Belgium has very attractive rules with respect to the deductibility of interest expenses. As a general rule, at arm’s length interest expenses borne by a Belgian company, in the framework of the exercise of its business activity, are tax deductible. In 2012, a new thin capitalization rule has been introduced in the Belgian fiscal landscape. However, its scope is much more limited than traditional thin capitalization rules applicable in other EU jurisdictions:
the debt:equity ratio of 5/1 significantly exceeds the ratio applied in other countries;
it only catches intra-group loans and loans granted by low-taxed lenders (the “tainted debts”). Other debt than the tainted debts (e.g., bank debt) is thus disregarded for the purpose of determining whether the debt/equity ratio is exceeded.
it the debt/equity ratio is exceeded, the part of the interest that relates to the tainted debt in excess of the ratio is treated as a disallowed business expense. The “excessive” interest is not recharacterized into a dividend.
This flexible thin capitalization rule may explain why Belgian companies are often heavily financed through debt. It is true that the notional interest deduction (“NID”) stimulates companies to enhance their equity position. Indeed, the NID allows domestic companies to deduct on a yearly basis a fictional cost of equity from their taxable basis. The deduction is calculated as a percentage of equity, which is based on the return on 10-year linear government bonds. However, the NID has lost a great deal of its appeal over the last couple of years. First, the rate of the NID is limited: for the 2016 tax year, it should be approx. equal to 1,13% (1,63% for SME). Second, the possibility to carry forward excess notional interest has been abolished[2].
When looking at the Belgian tax system as a whole (steep statutory corporate tax rate of 33,99%, absence of tax consolidation), the absence of strict interest limitation rules is actually fully justified.
The interest limitation rule will have a substantial impact for debt-financed Belgian companies. Indeed, under the new rule, the deduction of net interest will in principle be disallowed, as soon as it exceeds 30% of EBITDA (and 1mio EUR).
It is striking to stress that this limitation applies to loans granted by related parties (e.g., shareholder loans) as well as third parties (e.g., banks). The tax position of the lender (low-taxed lender or lender fully subject to tax) is also irrelevant. Hence, it also applies for instance to bona fide loans between two Belgian companies.
When a Belgian company wishes to enter into a loan agreement with a (Belgian) bank or a (Belgian) group company in order to finance its (genuine) economic activities, it will therefore need to look at the potential tax implications of the new limitation rule.
As we can see, the new interest limitation rule may have (unexpected) adverse tax consequences. It is likely that this Directive will soon be adopted. Hence, it is strongly recommended to already assess the impact of this interest limitation rule in detail.
[1] The Directive provides that interest costs are always deductible to the extent that the taxpayer receives interest or other taxable revenues from financial assets.
[2] It should however be noted that recent case-law has allowed the use of the NID, even if the taxpayer did not have a great level of substance (i.e., limited infrastructure, activity limited to the management and holding of one single receivable). See http://www.lexgo.be/en/papers/tax-law/corporate-tax/the-notional-interest-deduction-is-alive-and-kicking-the-fortum-case,102023.html
