14 Jul 21
Interest Limitation Rules (ILR)
In June 2016, the European Council adopted the EU Anti-Tax Avoidance Directive (ATAD), introducing five legally-binding anti-abuse measures which all Member States were to apply against aggressive tax planning.
The measures focused on the following five areas:
Controlled Foreign Company Rule: to deter profit shifting across countries
Switchover Rule: to prevent double non-taxation of certain income
Exit Taxation: to prevent companies from avoiding tax when re-locating assets
Interest Limitation: to discourage artificial debt arrangements designed to minimise taxes
General anti-abuse rules: to counteract aggressive tax planning outside of scope of other rules.
Interest Limitation Rules (ILR) seek to restrict tax-deductible interest expenses to 30% of EBITDA in a given period. ILR is set to be transposed into Irish law in the Finance Bill 2021 and is likely to take effect from 1 January 2022. In July 2021 the Department of Finance published a second Feedback Statement on the pending legislation.
ATAD provides for a number of exemptions from the scope of ILR:
A de minimis exemption for interest expenses below €3m
Standalone entities given that they do not make payments of interest to associated entities
Legacy debt in place before 17 June 2016, to the extent that it has not been modified
Loans used to fund long term public infrastructure projects
Certain “financial undertakings” (such as pension schemes, banks, funds, insurance undertakings)
The Department of Finance is expected to adopt these exemptions, the scope and form of which are under consideration.
For taxpayers who are members of a consolidated group for financial accounting purposes, ATAD provides for relief from ILR for borrowing costs with third parties, allowing for deductions for third party debt based on an equity ratio rule or a group ratio rule.
The Equity Ratio Rule allows a taxpayer to fully deduct its ‘exceeding borrowing costs’ if it can demonstrate that the ratio of its equity to total assets is less than or equal to the equivalent ratio of the group.
The Group Ratio Rule replaces the 30% of EBITDA restriction with a percentage calculated as third-party exceeding borrowing costs/group EBITDA.
Proposed Nine-Step Approach to ILR
Step 1: Identify the relevant entity, either a company or interest group (equivalent to an Irish tax loss group)
Step 2: Calculate the relevant entity’s relevant profit or loss on a value basis before interest limitation
Step 3: Identify the relevant entity’s taxable interest equivalent on a value basis
Step 4: Identify the relevant entity’s deductible interest equivalent on a value basis
Step 5: Based on previous steps, calculate exceeding borrowing costs or interest spare capacity and EBITDA
Step 6: Apply the equity ratio rule (Step 8 is not relevant if the equity ratio rule applies)
Step 7: Calculate the allowable amount and compare it to exceeding borrowing costs. Where the exceeding borrowing costs are greater, the excess will be a disallowable amount. Limitation spare capacity will arise where the exceeding borrowing costs are less than EBITDA multiplied by the EBITDA limit.
Step 8: Reduce the deductible interest equivalent by the disallowable amount and calculate the taxable profit accordingly.
Step 9: Carry forward any disallowable amount as a deemed borrowing cost, or the sum of interest spare capacity and limitation spare capacity as total spare capacity.