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Changes to Ireland’s Interest Expense Deduction Rules

Changes to Ireland's Interest Expense Deduction Rules
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Changes to Ireland’s Interest Expense Deduction Rules

From next year, many companies in Ireland will be required to change the way they calculate interest deductions for tax purposes. Here, we provide a summary of these key measures and why Ireland must change its rules.

Background

The changes in question are included in the European Union’s first Anti-Tax Avoidance Directive (ATAD1), which formed part of the EU’s response to the OECD’s base erosion and profit shifting (BEPS) project — a multilateral effort to tackle cross-border corporate tax avoidance.

ATAD1

Interest expense deduction limitation rules are intended to prevent companies from setting up loan arrangements between companies within the same corporate group to reduce the taxable profit of an entity located in a higher tax territory.

ATAD1 attempts to prevent “excessive” interest deductions by restricting the amount of interest that taxpayers can deduct. Under the directive, member states can set this ratio up to a maximum of 30 percent of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA).

ATAD1 permits borrowing costs and EBITDA to be calculated at the level of the group. Disallowed interest may be carried forward or backwards and deducted in future or prior tax years, subject to certain limitations.

ATAD1 also provides for a de minimis threshold under which groups can fully deduct borrowing costs up to EUR3m, meaning that the changes are unlikely to affect the smallest companies.

Member states were required to implement these rules from January 1, 2019. However, ATAD1 also provided for a five-year extension for countries to adapt their rules, if their existing rules are deemed “equally effective” to those included in ATAD 1.

Ireland’s Rules

Ireland has yet to fully implement ATAD1. The Government considered its interest deduction limitation rules to be “equally effective” to those in ATAD. As such, Ireland had hoped to be allowed extra time — until 2024 — to implement the changes. However, the Commission has determined that Ireland's rules are not equally effective.

Irish rules currently utilize purpose-based tests (as opposed to the EU’s ratio-based approach outlined above). These seek to ensure that: borrowing is incurred wholly and exclusively for the purposes of the company’s trade; expenses must be revenue and not capital in character; and intra-group loan arrangements must be priced on “arm’s length” terms according to the OECD’s transfer pricing guidelines – in other words, the loan should be similar to financing arrangements between non-related entities prevailing in the broader marketplace.

Deductions are disallowed where borrowing is used with the sole purpose of reducing tax liabilities, and under the General Anti-Abuse Rule, where a tax advantage arises which represents an “abuse or misuse” of the relief.

The Government considered these and other aspects of the rules were already adequate to tackle BEPS.

Finance Bill 2021

New measures have now been included in Finance Bill 2021, introduced in parliament in October 2021. At the time of writing, the Bill was progressing through the lower house, the Dáil Éireann, with the new requirements set to be effective for accounting years beginning on or after January 1, 2022.

Irish Companies WP CTA 2

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