27 June 2018

The new interest deduction restriction

The interest that a company pays on loans is in principle deductible as a professional expense, provided that a number of thresholds are met.  One of these thresholds is the so-called “thin capitalisation regulation”, which limits the deduction of interest for companies that are over-indebted in relation to their equity (undercapitalisation).

1. Current undercapitalisation

Undercapitalisation occurs when there is a mismatch between a company’s equity and borrowed capital (the so-called debt equity ratio).  The debts of the company may not exceed a maximum of 5 times the sum of the taxed reserves at the beginning of the taxable period and the paid-up capital at the end of this period.

If the threshold is exceeded, the interest paid on the part of the loans exceeding the threshold will not be deductible as a professional expense.

This restriction only applies to loans granted between partners belonging to the same group and/or tax haven lenders. Loans taken out with credit institutions are not subject to this deduction restriction.

The legislator’s objective is to combat “profit shifting”.  Profit-making companies could transfer their profits to an associated loss-making company by paying it abnormally high interest: the profit-making company reduces its taxable base because it has more costs, while the interest received is hardly taxed by the associated loss-making company because it is used to offset existing scale losses.

2. European intervention:  ATA Directive

In the context of the international fight against tax abuse and tax evasion, Europe has already taken numerous measures in the international fight against tax abuse and tax evasion, which are included in the ATA (Anti Tax Avoidance) Directive, among others.  One of these measures is a new interest deduction restriction, which provides that interest can only be deducted as professional expenses within certain limits.

This new deduction restriction has been transposed into Belgian law and will result in the replacement of the current thin capitalisation regulation.  The new regulation applies as from assessment year 2021.

3. New interest deduction restriction

The new regulation is much more complex than the current thin capitalisation regulation.  The main lines of the new interest deduction restriction can be summarised as follows:

  • first of all, the “financing of cost surplus” must be determined.  This is the positive difference between the interest paid and the interest received by a company (i.e. net interest cost).

The interest and similar income to be taken into account to determine the net cost surplus will be laid down in a royal decree.

Contrary to what applies under the current thin capitalisation regulation, interest on loans taken out with financial institutions would also be eligible for determining the net profit surplus;

  • the financing of cost surplus will not be deductible as a professional expense, to the extent that the net interest cost exceeds the higher of the following two amounts:  (i) EUR 3,000,000.00 or (ii) 30.00% of the fiscal EBITDA.  The interest will therefore always be deductible as professional expense if the net interest cost is less than EUR 3,000,000.00, regardless of the level of the fiscal EBITDA.

The fiscal EBITDA is calculated as follows:

Tax result of the period

+ depreciation and amortization

+ net profit share deductible as professional expense

– certain untaxed profit components (FDI, patent revenues, etc.)

Interest that cannot be deducted in a particular tax year can be carried forward indefinitely to the following tax years.

4. Conclusion

For many SMEs, the new interest deduction restriction will have little or no impact, since the net interest will always be deductible if it is less than EUR 3 000 000.  Companies that rely heavily on debt financing – intra-group or via a financial institution – may have to adjust their financing model in order to avoid that the interest paid is not deductible in part.  Your tax return is guaranteed to be even more complex.

Nicolas Lauwers
De Langhe Attorneys

Published in VOKA – “Ondernemers Oost-Vlaanderen”, edition 6, June 2018

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