Upcoming changes to Ireland's business interest deduction limitation rules could have a significant impact on businesses.
The EU Anti-Tax Avoidance Directive (ATAD)
The EU Anti-Tax Avoidance Directive (ATAD), part of the EU's response to the OECD's BEPS project, contains five legally-binding anti-abuse measures, which all EU member states are required to apply against common forms of aggressive tax planning. In addition to an interest limitation rule, the directive includes an exit tax, a general anti-abuse rule, controlled foreign company rules, and measures to tackle "hybrid mismatch arrangements".
In short, the interest limitation rule requires EU member states to put in place measures designed to limit the ability of companies to deduct substantial borrowing costs and reduce their taxable profits.
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. The directive allows member states to set this ratio up to a maximum of 30% of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA). Borrowing costs and the EBITDA may be calculated at the level of the group.
Under the ATAD, there is a de minimis threshold under which groups can fully deduct borrowing costs up to €3m.
The directive also allows member states to provide rules for the carrying forwards or backwards of unused deductions, subject to certain limitations.
Member states were required to transpose the interest limitation rules by January 1, 2019. However, countries with "equally effective" rules in place were allowed until January 1, 2024, to ensure these are aligned with the ATAD.
Ireland's interest limitation rules differ from the directive in that they utilise purpose-based tests, designed to limit certain borrowings (as opposed to the ratio-based approach described above). These are supplemented by anti-avoidance provisions relating to connected party transactions.
Nevertheless, despite these differences, Ireland's Government argues 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 takes a different view, however, and in 2019 it launched infringement proceedings against Ireland, requesting that it transpose the directive sooner or face possible legal action.
According to a Tax Policy paper published in September 2020, the Irish government remains of the view that national rules are equally effective, although, given the European Commission's challenge, it has decided to bring forward the transposition process. However, the Government is against rushing such complex new measures into law at a time when businesses are being impacted by measures to restrict COVID-19 and are experiencing an uncertain trading environment due to Brexit. The Government is also aware that the ATAD rules focus on all borrowings, rather than those singled out by Ireland's existing framework. As such, they are likely to affect most businesses.
With these factors in mind, the Government wants to engage with businesses and advisors in the drafting process to avoid unintended legal consequences. It expects to launch a consultation by the end of 2020 with a view to including new draft rules in Finance Bill 2021. These changes would then go into effect on January 1, 2022.