Ireland Prepares To Implement Key Anti-Tax Avoidance Reforms
In July, the Irish Government began taxpayer consultations on proposed new anti-tax avoidance rules stemming from the OECD’s BEPS project.
These reforms will introduce new restrictions on companies' deductions for interest expenses and tackle certain “hybrid mismatch” arrangements (explained in more detail below).
Together, these changes form part of the EU’s Anti-Tax Avoidance Directives (ATAD1 and ATAD2).
ATAD1 contains five legally binding anti-abuse measures that EU member states must apply against common forms of aggressive tax planning. ATAD2 extends the scope of the anti-hybrid rules in ATAD1.
Interest Limitation Rules
Interest limitation rules are designed to prevent firms from using borrowing costs to create excessive interest deductions and unfairly reduce their corporate tax liability. They do so by limiting such deductions to a certain percentage of a company’s profits. ATAD1 allows EU member states to set this ratio up to a maximum of 30 percent of the taxpayer's earnings before interest, tax, depreciation and amortization (EBITDA). The rules permit borrowing costs and EBITDA to be calculated at group level.
While Ireland already has interest limitation rules, these are deemed by the EU to not meet the standard required by ATAD1, because they rely on purpose-based tests rather than ATAD’s ratio approach.
Ireland has attempted to argue that its rules are “equally effective” to those included in ATAD1 and that no changes are needed. However, the European Commission disagrees, and the Government has decided to concede on this point, after the Commission launched infringement proceedings against it in 2019.
The Government had earlier consulted taxpayers on these new measures in 2018 but decided to launch a second consultation due to the reform's complexity. The new draft proposals included in the recent consultation, which concluded on August 3, 2021, are based on previous responses and observations received from taxpayers.
Member states were required to fully transpose ATAD1 in time for January 1, 2019. Ireland intends that the new legislation will be implemented by January 1, 2022.
Hybrid mismatch arrangements seek to exploit disparities in the tax treatment of certain financial instruments, payments or entities in two (or more) jurisdictions to reduce a taxpayer’s exposure to tax.
A hybrid mismatch outcome arises due to differences in the tax characterisation, or to the hybrid nature, of the instrument or entity. Use of these arrangements can often result in a double tax deduction or double non-taxation, such that no tax liability arises in any jurisdictions concerned.
ATAD2 broadens the scope of the anti-hybrid rules that were introduced in ATAD1 to ensure that hybrid mismatches of all types cannot be used to avoid tax in the EU, even where the arrangements involve non-EU countries. ATAD2 also deals with “reverse hybrid” mismatch arrangements which are the main focus of the new consultation. These involve a hybrid entity that is fiscally transparent for domestic tax purposes but not for foreign tax purposes in a given jurisdiction. ATAD2 must be transposed into national law for January 1, 2022.
These rules are technical and complex and are likely to affect larger corporate groups with international arrangements rather than domestically focussed small firms. Nevertheless, a January implementation date leaves little time for companies to ensure they are compliant with the reforms, especially if the rules are tweaked before the legislation is enacted.