Interest deductibility under BEPS: a new and more level playing field?

July 2016

The OECD BEPS project has rightly identified interest deductibility as a key issue in giving rise to intra-jurisdictional tax anomalies worldwide. But BEPS recommendations as of October 2015 - while welcome - still gave national governments considerable scope in terms of thresholds and exemptions for relief on interest costs. The adoption of the EU Anti Tax Avoidance Directive, however, promises a more even playing field, at least in Europe.

The OECD Base Erosion and Profits Shifting (BEPS) project is a direct response to the widely perceived injustices of multinationals (including Google, Starbucks and others) optimising their corporate structures in favour of low-tax jurisdictions. Fifteen key OECD BEPS initiatives (known as "Actions"), published in October 2015, address major controversies including treaty abuse, aggressive tax planning, transfer pricing (the setting of prices for goods or services sold between the subsidiaries of a group or multinational), and interest deductibility (the extent to which companies and groups are able to offset interest costs against profits).

Concurrently with this, the European Commission has been developing its own anti-tax avoidance package to ensure consistent and fair tax policy throughout the EU, and to facilitate the smooth implementation of BEPS initiatives by Member States. Part of this initiative includes the EU Anti-Tax Avoidance Directive (ATAD), the principle terms of which were agreed in July 2016 pending formal adoption at the next European Council meeting in December. Interest deductibility, recognised as central to the OECD BEPS project and addressed in its Action 4, is a central tenet of the ATAD.

The OECD BEPS recommendations on interest deductibility give individual jurisdictions considerable scope, recommending a threshold of between 10% and 30% before deduction of interest costs is disallowed, and leaving "de minimis" exemptions entirely at the discretion of individual countries. Pending adoption of any uniform standard across EU Member States, there had been concern that individual countries' adoption of Action 4 could put early adopters at a disadvantage in terms of tax competitiveness. Brexit notwithstanding, the UK 2016 Budget, for example, had introduced new regulation (effective from 1 April 2017) limiting interest deductibility to 30% of UK EBITDA, with a de minimis exemption of £2 million.

The EU Anti-Tax Avoidance Directive provides for the upper limit of the BEPS recommended thresholds, allowing the deduction of 30% of interest costs, as well as allowing a de minimis exemption of EUR 3 million. Except where Member States have adopted equivalent or more stringent regulation of their own, measures on interest deductibility must be incorporated into national legislation by 31 December 2018, effective from 1 January 2019. Those Member States that have legislation in place consistent with, or more stringent than the terms prescribed under the ATAD, may retain this until 1 January 2024 or until agreement of a minimum standard with the OECD, whichever occurs the sooner.

The adoption of the Anti-Tax Avoidance Directive appears to have been universally welcomed for introducing a degree of conformity (particularly for those seven Member States that are not members of the OECD) and for eliminating any disadvantage to those jurisdictions that have been quick to align domestic regulation with BEPS recommendations. The adoption of the maximum BEPS recommended threshold at 30%, and the de minimis exemption of EUR 3 million - both improvements on initial EU proposals for a 20% threshold and EUR 2 million exemption - are also a welcome concession for mid-market companies and groups.