OECD proposed restrictions on tax deductions for interest a "glimmer of hope for infrastructure", says expert

Out-Law News | 05 Oct 2015 | 5:18 pm | 3 min. read

The Organisation for Economic Co-operation and Development (OECD) has recommended that countries amend their tax laws to restrict the availability of tax relief for interest deductions. 

However, a potential exemption for 'public benefit projects' could offer a "glimmer of hope" for infrastructure projects, said Heather Self, a tax expert at Pinsent Masons, the law firm behind Out-law.com.

She was commenting as the Organisation for Economic Co-operation and Development (OECD) published its final report on limiting base erosion involving interest and other financial payments. In the report the OECD recommended that countries should introduce into their tax systems an interest / EBITDA limitation on tax deductibility, with countries free to pick a percentage level within a range. The suggested range is from 10% to 30%. EBITDA means a company's earnings before interest, taxes, depreciation and amortisation.

The restriction would apply to all interest, including amounts paid to third parties, with no 'arm’s length' escape route. However, the OECD said that countries could choose to have an additional allowance where interest does not exceed the group ratio. This would mean that a subsidiary with 40% EBITDA interest would not have a disallowance if the group ratio was also at least 40%. The OECD said that this is to recognise that "some groups are highly leveraged with third party debt for non-tax reasons".

Countries will also be able to introduce a 'public benefit exemption', to allow public infrastructure projects which are considered to have low tax risk to be exempt from the new rules.

The OECD said the new rules on interest deductibility would not "restrict the ability of multinational groups to raise third party debt centrally in the country and entity which is most efficient taking into account non-tax factors such as credit rating, currency and access to capital markets, and then on-lend the borrowed funds within the group to where it is used to fund the group’s economic activities."

Self said that companies operating in the UK will now be "waiting anxiously" to see how the UK responds to the OECD recommendations. It is understood that the UK government will publish a consultation document over the next few weeks on how it should implement the recommendations into UK law.

She said: "the key issue for infrastructure companies will be to ensure that the UK implements the public benefit exemption in a way that excludes major PFI projects from the restriction on interest deductibility".

“The potential restriction of interest deductions has been a particular concern for the UK, given the importance of the infrastructure pipeline. The final report is more flexible than had been feared, and in particular there is scope for a particular country to relax the rules in order to ensure that public benefit projects are not affected. This will be a crucial area for further discussion with HM Treasury,” Heather Self said.

The OECD is considering restrictions on interest deductibility as part of its 15 point action plan to counteract base erosion and profit shifting (BEPS). BEPS refers to the 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. Following international recognition that the international tax system needs to be reformed to prevent BEPS, the G20 asked the OECD to recommend possible solutions. In July 2013, the OECD published a 15 point Action Plan and the first formal proposals dealing with seven of the 15 specific actions were published in September 2014.

The OECD proposed a restriction on interest deductions as deductible payments such as interest can give rise to 'double non-taxation'. Excessive intra group interest deductions can be used by multinational groups to reduce taxable profits in operating companies, even in cases where the group as a whole has little or no external debt. The OECD is also concerned that groups can use debt finance to produce tax exempt or deferred income, thereby claiming a deduction for interest expense while the related income is brought into tax later or not at all.

The OECD published a discussion draft in December 2014 setting out some initial proposals on interest limitation rules. This suggested that tax deductions for interest payments could be restricted on a group wide basis, by reference to a fixed ratio, or by a combination of these two solutions. There were concerns from many commentators that group-wide interest limitation rules could result in effective double taxation for some wholly commercial group structures.

Countries including Germany, Greece, Italy, Norway, Portugal and Spain already have a limit of 30% of taxable EBITDA and France has a limit of 25%. The UK currently has a range of anti avoidance provisions that can restrict interest deductibility in specific situations, but no general ratio rule.

At the same time as publishing the interest report, the OECD published twelve other final reports on other aspects of its BEPS project.