Importance of notional interest deduction diminishes

The notional interest deduction, introduced in 2005, was intended to eliminate the fiscal distinction between equity and debt for companies and to strengthen the development of SMEs.

Today, 13 years after its introduction, the notional interest deduction has again changed, in a negative sense. The question may be asked whether this measure is still sufficiently tax-advantageous.

1. Basis of calculation

The notional interest deduction is applied as from tax year 2019 (linked to a taxable period starting at the earliest on 1 January 2018) to the growth of risk capital, i.e. the gross equity on the balance sheet. This growth will be calculated as one fifth of the positive difference between (a) the amount of risk capital at the end of the taxable period and (b) the annual amount of that risk capital at the end of the fifth preceding taxable period.

Example:

A company has a risk capital of 1 000 on 31 December 2018. On 31 December 2013 this amounted to 100. The calculation basis for application of the notional interest deduction amounts to 180 (900/5).

A newly founded company will be able to use full year-end risk capital as a basis for calculation for the first five years as the risk capital to be deducted is nil.

Where a company had negative risk capital at the end of the fifth previous taxable period, an improvement in such risk capital will also be regarded as a positive increase.

Example:

Risk capital 2013	-100.00
Risk capital 2018	400.00
Positive difference	500.00

The other rules on the determination of risk capital (i.e. the exclusion of certain own assets) have remained unchanged. The transitional arrangement (60.00% restriction on taxable profits in excess of one million euros) for the “surplus” of notional interest deduction accrued up to and including the tax year 2012 is also retained. However, the deduction of this “surplus” can now be further limited by the introduction of another tax measure, i.e. the “basket” restriction  (use of certain tax deductions up to 1 million euros, plus 70.00% of the remaining profit exceeding 1 million euros).

2. Tariff

The rate for tax year 2019 is set at 0.746%. The bonus of 0.5% for SMEs will be maintained (hence 1.246%). In view of the low interest rate, equity financing is still more or less as interesting as debt financing.

3. Double dip

A specific anti-abuse provision should eliminate double-dip structures. The following situation is clarified: an affiliated company takes out a loan of which the interest is tax-deductible and then uses this loan to increase the capital of an affiliated company. This contribution results in an increase in the equity capital of the latter company, to which it can apply the notional interest deduction. From now on, this contribution should be deducted when determining the qualifying risk capital.

4. Conclusion

The initial notional interest deduction, promoted internationally by the then government, has lost much of its glory. The heavy budgetary burden and its limited importance for SMEs has on several occasions raised questions about its continued existence. The phasing out of this tax measure seems to be the announcement of a final death.

Kim Bronselaer – Justine Bouckaert

Published in Business Vlaanderen,  Number 01 2018 – February – March 2018, publication in “Business Vlaanderen” as well as on the website of “Business Vlaanderen”.