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OECD outlines latest approach for restricting tax deductions for interest

An international economic development body has published proposed that changes be made to how interest payments are taxed to combat the artificial shifting of profits by multinational companies.

Tax deductions for interest payments could be restricted with a fixed ratio rule combined with a group-wide ratio rule, to restrict international tax avoidance involving interest expenses, the Organisation for Economic Co-operation and Development (OECD) has announced.

The OECD made the announcement in its latest update on the base erosion and profit shifting (BEPS) project.

BEPS aims to combat the artificial shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid. In July 2013 the OECD published an action plan, proposing 15 actions designed to combat BEPS. Action 4 of that plan was concerned with limiting base erosion via interest deductions. On 18 December a public discussion draft on Action 4 was issued, outlining different approaches that could be included in a best practice recommendation.

In relation to Action 4 the OECD announced that current discussions are focused on introducing a fixed ratio rule, combined with a group wide ratio rule and an optional de-minimis threshold to remove low risk entities from the ambit of the rule and reduce compliance costs.

Tax expert Eloise Walker of Pinsent Masons, the law firm behind Out-law.com said that "The availability of options and a range of ratios to choose from could go one of two ways – in allowing enough flexibility for each country to take its own path within the general consensus that excessive interest deductibility is now off the table, it may cause chaos and new avenues of mismatches as each country chooses something slightly different."

The OECD said that the use of a fixed ratio rule was widely supported in consultation.

"'Widely supported' is a bit of a misnomer," said Walker. "It's more a case of damage limitation and a desperate attempt by all to get something, anything, which is vaguely workable worked up in time."

The rule would be based on EBITDA (earnings before interest, tax, depreciation and amortization), which would ensure that an interest deduction could only be moved to another jurisdiction if the corresponding taxable income is also moved. The rule could also involve a benchmark fixed ratio, without a single worldwide ratio, but with a range of ratios and principles to assist countries in a setting a ratio within a specific range.

The update also announced that discussions are ongoing about including an optional carry forward provision of disallowed interest, in order to shelter organisations from the volatility that a fixed ratio rule could create.

Additional targeted rules to address specific risks regarding companies attempting to operate outside the general fixed ratio rule are also being discussed.

Walker said she was "disappointed that the proposals are not further along. It is looking like they are aiming for all papers to be published in the autumn with no third phase in December, so expect to see more around the CFA [Committee on Fiscal Affairs] meeting in September and G20 finance minister meeting scheduled for early October. But that doesn't give them long to get this all pulled together into a workable whole."

The update also covered ongoing discussions in relation to other actions in the BEPS project.

Editor’s note 15/06/2015: The first and second paragraphs of this story were changed to correct an error introduced in the editing process. 

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