ATAD transcription into National Law
Corporate issues to be highlighted in some countries
One of the main issues is the interest limitation deduction and the way it will be implemented by each State. It could give some countries a competitive advantage or disadvantage. In Luxembourg, we would prefer a German-like approach on tax pools. The abolition of art. 22bis (2) nr 1 LIR contained in the Luxembourg draft law implementing ATAD is a concern. While ATEL understands and supports the intention to discourage groups of companies from engaging in BEPS through excessive interest payments and to counter abusive practices, it fears that the current wording of the Draft Law goes beyond what is necessary to achieve these goals. ATEL would suggest avoiding situation where the Law is likely to affect legitimate operations that are undertaken without the intention of achieving a tax advantage and may, therefore, have a negative impact on the decision whether to locate or expand treasury activities in Luxembourg.
ATEL has noticed to the Finance Minister its views and recommendations, to best protect the interests of its members. The first issue to consider is the application of interest limitation rule to fiscal unities. In ATAD, Article 4, paragraph 1, 2nd & 3rd sentences, Member States may apply the interest limitation rule at the level of a tax group, by treating as a taxpayer for these purposes “any entity which is permitted or required to apply the rules on behalf of a group, as defined according to national tax law”; “in such circumstances, exceeding borrowing costs and the EBITDA may be calculated at the level of the group and comprise the results of all its members”.
In Luxembourg, and potentially in some other countries, this option of treating the interest deduction calculation for the group (and not individually) has not been planned, so far. For a group of companies which fulfills the conditions to be treated as a fiscal unity, it implies that the limitation to deductibility of interest would apply to each entity separately and, from the group’s point of view, cumulatively.
It could be an issue in countries where many companies have fiscal unities, as this system enables groups to organize their activities in separate companies for a variety of commercial, legal, regulatory and financial reasons, while fulfilling their income tax obligations almost as if they were organized as a single company.
The obligation to apply the interest limitation rules to each entity on a standalone basis could create situations where companies tasked with borrowing on the market to finance affiliates partly through equity financing will be unable to deduct a significant part of their borrowing costs, even though affiliates may have net interest income which is taxable. In some case, companies are more likely to occasionally have non-deductible exceeding borrowing costs, if only because separate companies’ performances tend to fluctuate more than the aggregate performance of the group, and such companies will also be less likely to benefit promptly from the effect of a compensating carry forward. Eventually, the standalone treatment will lead to the equivalent of double taxation of the same group of companies. We should not forget that a country like Germany has been applying its interest limitation rules on a fiscal unity basis for more than a decade and we understand that France and the Netherlands, among others, also intend to apply their new interest limitation rules to fiscal unities. The inability to apply the interest limitation rules at the fiscal unity level could lead to a costly re-organization of activities.
Furthermore, the interest definition is also an item to be better defined. In line with the definition provided by ATAD, laws must define “borrowing costs” as interest expenses on all forms of debt, as well as other costs economically equivalent to interest and expenses incurred in connection with the raising of finance, and it provides a non-comprehensive list of examples of expenses which constitute borrowing costs. “Exceeding borrowing costs”, which is the item to which the deduction limitation applies, means the amount by which the deductible borrowing costs of a taxpayer exceed taxable interest income and other economically equivalent taxable income realized by the taxpayer.
ATAD does not propose a clear definition of “interest income” on which States could refer to. This leaves legal uncertainty about certain non-recurring expenses (or income), e.g. losses (gains) on the redemption/repayment of a debt instrument, provisions for risks (even if in relation to a debt instrument) and foreign exchange losses (gains) on instruments to hedge a currency exposure (even if connected with the raising of finance). It is crucial to clarify whether the terms “interest expense” are to be interpreted in a wide or narrow manner and confirm that a symmetrical approach is taken when defining interest expense and interest income (i.e., where a specific item is considered as borrowing cost for the debtor, it would be considered as interest income for the creditor).
Adopting the symmetrical approach (in line with Action 4 OECD BEPS report) also provides clarity to another common business fact pattern. Many corporates borrow funds in a currency that is not their functional currency and they use hedge agreements or forward contracts in relation to such debt to hedge foreign exchange effects. Upon repayment of such debt, the company is – on the one side - subject to foreign exchange exposure and realizes – on the other side – either income or expense under the forward or hedge agreement, resulting in a commercial and accounting net result of nil. Chapter 2 of the Action 4 report (page 30, paragraph 37) explicitly states that “foreign exchange gains and losses on instruments to hedge or take on the currency exposure connected with the raising of finance are not generally economically equivalent to interest. A country may however wish to treat some or all foreign exchange gains and losses on these instruments as economically equivalent to interest.
Corporate Treasurers in Luxembourg consider that it is important to make sure the transposition of this Directive into National Law will not penalize corporations and recommends adopting, when possible, a more advantageous option for MNC’s. It also insists on definitions to more precisely delimit what must be included into calculation or not (without being too large because it could be at the expenses of deduction of interests).
As we can see the “translation” of a Directive into local law is not always easy and could result into very different situations. In some cases, when options are offered, it can give an opportunity to be on the “softer” side and to better preserve interest of treasurers. At the end of the day, it can make a country more attractive than another, on some tax issues. We should not forget that ATAD must be transposed into National Law by end of December 2018 and will be applicable starting on first of January 2019. It is tomorrow I’m afraid…