The objective of the ILR is to restrict deductions of interest which exceed 30% of EBITDA. The Feedback Statement outlined that there will be seven steps involved in the process of calculating excessive interest deductions and applying the restriction to a company’s taxable profits.
Acknowledging that interest is deducted in calculating the taxable profits at the outset and to avoid circularity, the ILR restriction is not embedded in the computation of taxable profits but rather sits alongside this calculation.
The proposed seven step approach is as follows:
- The operation of the rule requires companies to initially calculate their taxable profits in the normal way, taking deductions for interest in the normal manner. The company calculates “relevant profits” which we understand to be total profits taxable at both the 12.5% and 25% tax rates (likely to include chargeable gains).
- The company calculates its “interest equivalent income” and “interest equivalent expenses”. Interest equivalent expenses would include interest and other financing costs. Interest income for the payee should mirror what is an interest expense for the payor.
- The company calculates its “taxable interest equivalent”. This is the interest equivalent income from Step 2 that would be taxed in the hands of the recipient company. The definition of “relevant profits” is key to this calculation and has not yet been defined.
- The company calculates its “deductible interest equivalent”. This includes any amount that is taken into account (i.e. deducted) in calculating the relevant profits but not such an amount that reduces the relevant profits to below zero.
- The company calculates “exceeding borrowing costs”. This is the “deductible interest equivalent” from Step 4 that exceeds “taxable interest equivalent” from Step 3. The company also calculates EBITDA as relevant profits + exceeding borrowing costs + capital allowances.
- The company calculates 30% of EBITDA as computed under Step 5. If the exceeding borrowing costs are greater than 30% of EBITDA, a restriction is required. The restricted amount, called the “excess amount”, is subject to tax under Schedule D, Case IV. Assuming the exceeding borrowing costs had originally been deducted in a trade scenario, the excess amount is taxed at 12.5%. The manner in which a tax charge arises under Case IV involves halving the excess amount and taxing it at 25%.
- The excess amount is carried forward in the form of a tax credit to be used in a future period when the company’s exceeding borrowing costs do not exceed 30% of EBITDA. If the company has the capacity to use the carried forward balance, the company can take a credit for the tax paid in the previous period against its total corporation tax payable. Any balance unused continues to be carried forward and is supplemented by additional excess amounts arising in subsequent periods. Any unused interest capacity can also be carried forward but only for a maximum period of five years.
PwC understands why the rules have been proposed in this way - it is to fit the Directive into our existing schedular tax system. However, the complexity it entails will create challenges for taxpayers in applying the rule.
The complexity increases greatly where groups of companies are involved. Taxpayers in a “notional local group” can apply the ILR on a group basis instead of on an entity-by-entity basis. Who is in the notional local group will be important and PwC has requested maximum flexibility and pragmatism in determining which entities are in and out of the group. This Feedback Statement has not sought to focus on group situations (this will be addressed in the next Feedback Statement later this year).
Two possible “escapes” have been included in this round of discussions. The group ratio rules acknowledge that the 30% of EBITDA rule is a blunt tool and therefore the restriction can alternatively be calculated in accordance with:
- “The Equity Ratio Rule” which allows exceeding borrowing costs to be deducted in full insofar as a company’s ratio of equity:total assets does not fall below 2% of the equivalent ratio for the worldwide group; and
- “The Group Ratio rule” which replaces the 30% of EBITDA restriction with a percentage calculated as third-party exceeding borrowing costs/group EBITDA.
PwC advocates that both group ratio rules be introduced and taxpayers allowed to apply whichever rule is more beneficial given their circumstances.
A number of exemptions and exclusions are also proposed and may apply in certain instances where the risk of BEPS is low. These exemptions include:
- A de minimis exemption for interest expenses below €3m;
- An exemption for standalone entities given that they do not make payments of interest to associated entities;
- Exemption for legacy debt in place before 17 June 2016 and not modified since then;
- An exemption for interest income and expenses relating to long-term infrastructure projects;
- An exemption for financial undertakings. This is considered in further detail in our ILR banking sector insight available here.
PwC supports the introduction of all of these exemptions as they serve to lessen the administrative burden for taxpayers and limit the ILR restriction to high-risk BEPS arrangements. We have commented on each exemption in the submission document.
Key actions to take now
Although the public consultation process ended on March 8th, there are three key actions that you can take in preparing for ILR and having your say in the outcome of the legislation:
- Read the Feedback Statement and PwC submission for further commentary. The Feedback Statement is available here. It sets out the seven step approach and the further detail that impacts the calculations at each step. The PwC submission comments on the various steps and the key points yet to be addressed.
- Model the impact of the ILR using the seven step process. Can you calculate your expected exceeding borrowing costs and do you understand how the tax charge and credit system will work after reading the Feedback Statement? If not, reach out to your usual PwC contact who can help you in modelling the impact of the ILR on your business. PwC has also developed a visualisation tool which can demonstrate the impact that the ILR will have on your key tax numbers such as effective tax rate, carried forward balances, etc. We would be happy to demo this tool with you.
- Feedback your thoughts and concerns to PwC via your usual PwC contact. Although the public consultation is closed, discussions on the ILR will continue in the coming months with the Department of Finance and Revenue Commissioners. PwC will be a leading voice in these discussions. By feeding back your thoughts and insights to PwC, you are making sure that the rules will continue to be shaped with taxpayers in mind. We know that effective stakeholder engagement at this stage of the legislative process results in a better outcome for all parties.
We are here to help you
PwC can assist you with modelling the effects of the new ILRs on your company or group. We are also happy to feedback any comments from you into the wider stakeholder consultation process.
We have developed an ILR analysis tool that calculates the interest restriction, excess interest capacity and models the impact on the corporation tax position of the group in a visual and interactive manner. Contact your usual PwC contact today for more information.