How will banks be affected by the new Interest Limitation Rules?

12 March, 2021

Interest Limitation Rules are due to come into effect in Ireland from 1 January 2022. The banking sector is set to be uniquely impacted due to the high level of regulation being imposed and the nature of interest income as operating income.

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There are three areas in the consultation which should be carefully monitored from a banking perspective: 

  • The definition of interest for the purposes of the ILR

  • The “financial undertaking” exemption

  • The application of group provisions 

Anti-Tax Avoidance Directive (ATAD)

The European Council adopted the ATAD in 2016. It contains five specific anti-avoidance measures that must be transposed into the national laws of each Member State. The ATAD is a targeted policy response to address Base Erosion and Profit Shifting (BEPS) within the EU. To date, Ireland has transposed four of the five anti-avoidance measures into national legislation. The fourth measure relating to anti-hybrid rules introduced in Finance Act 2019.

The fifth and final measure relating to the ILR was subject to a consultation phase which closed on 8 March 2021. The second feedback phase is due to conclude in the second quarter of 2021.

The definition of “interest”

Many banking groups are closely monitoring the definition of “interest” and “interest equivalent” for the purposes of applying the ILR. Given that most banking groups have net interest income - i.e. interest income is greater than interest expense, how broadly or narrowly “interest” and “interest equivalent” are defined will be a key factor in determining the impact for the sector.

Per the guidance released to date, “interest equivalent” comprises interest and amounts economically equivalent to interest including discounts and expenses incurred in connection with raising finance (including guarantee fees and arrangement fees). The inclusion of arrangement fees is helpful from a banking perspective, however it is yet to be confirmed if all profits derived from the dealing of financial instruments will be included, as is the case in other jurisdictions. Where the ILR provides for a distinction between standard money lending and dealing in other financial instruments, this has the potential to drive some market distortions in the banking sector. As a result a tax advantage may emerge whereby banks lean towards holding particular types of financial instruments or engaging in certain banking activities. This could potentially create an uneven playing field between banks with significant retail and lending operations, and those without. In our view, the definition of interest should be kept as broad as possible including interest on all forms of debt, other income economically equivalent to interest and income earned in connection with the raising of finance.

The “financial undertaking” exemption

The Directive gives Member States the option of providing an exemption for certain “financial undertakings''. Broadly, this exemption would apply to banks as well as insurance companies and other regulated financial institutions. The exemption would only apply to the regulated entity as defined, rather than the whole banking group. It is unclear as to whether there would be a degree of optionality over the application of this exemption. In our view, it is critical that maximum optionality is given to the taxpayer.  If this exemption was mandatory, it could negatively impact banking groups as capital regulations require significant amounts of debt to be held through non-regulated holding companies. These companies would not fall within the definition of “financial undertaking” and therefore could be subjected to the ILR restrictions. 

How the exemption will work and practice and the degree of optionality, if any, will be a key consideration for banking groups.

Group provisions

Article 4 of ATAD allows for certain grouping provisions to apply, such that a “notional local group” would be treated as a single taxpayer.  The consultation asks for feedback as to how the grouping provisions would impact financial undertakings, including how intragroup transactions should be treated.

In a banking context, challenges could arise in applying this “single taxpayer” approach, as a result of the financial undertaking exemption referred to above. The banking entity would be exempt but other entities within the same group would be subject to the ILR rules.  For some of these non-banking entities, their interest expense may exceed their interest income. 

In addition, the consultation asks for feedback as to whether intragroup transactions should be taken into account.  This could lead to issues where debt capital is raised through an unregulated holding company for regulatory purposes, and as a result of the intragroup transactions being excluded, interest income is not taken into account in assessing the holding company’s net interest position. Again, either having optionality over the application of the financial undertaking exemption or over the grouping provisions could offer a practical solution to banking groups. 

Our view is that where an exempt financial undertaking i.e. a bank elects to be part of a “notional group”, they should not be treated as a financial undertaking for ILR purposes unless all other entities within the notional local group are also financial undertakings. This would positively address the issue facing non-regulated group holding companies. 

It is worth noting that the issues raised above are subject to the consultation process and the ultimate approach that Revenue takes may differ.

To understand the impact of the ILR, banks should:

  1. Consider the specific aspects of the Feedback Statement most relevant as noted above.

  2. Analyse what the definition of “interest” will bring into and out of scope for their business

  3. Assess their net interest income/expense position, assuming they are not scoped out of the ILR and assess impact of any tax losses in the business, where relevant.

  4. Consider non-banking entities within the group and the potential impact of the grouping provisions and the potential carve out for “financial undertakings”.

We are here to help you

The ILR could potentially have significant ramifications for the banking sector. It will be necessary to analyse and map out the potential impact of these rules, particularly once further clarity is issued now that the consultation has closed and through the second consultation phase later in the year. In this regard, it is essential that entities operating in the banking sector closely monitor this process and any emerging guidance.

We are actively involved in that dialogue so please reach out to the PwC Ireland Banking tax team to discuss.


Contact us

John O'Leary

Partner, PwC Ireland (Republic of)

Nicola Sheridan

Director, PwC Ireland (Republic of)

Tel: +353 86 043 3017

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