The new interest limitation rule-
Pitfall or opportunity for financing in Luxembourg?
Four months have passed since the new interest limitation rule has been introduced so it’s a good time to look at the main pitfalls and potential opportunities.
What has changed for interest deductions?
Before 2019, the tax deduction of interest expenses incurred by a Luxembourg company was assessed based on the arm’s length principle and whether or not the expenses were linked to tax exempt income. This is still the case, but another layer has been added: the deductibility of borrowing costs is limited to 30% of taxable EBITDA or EUR 3m, whichever is higher. The threshold refers to a tax-specific EBITDA that is different from the usual financial understanding of this term. The new rule, which is based on the EU Anti-Tax Avoidance Directive (“ATAD”), applies equally to intra-group and third-party debt.
Who is affected? What are some of the pitfalls?
Taxpayers need to assess the impact of the new interest limitation to avoid surprises. If interest expenses are no longer fully deductible, that may have cash tax implications.
The impact of the new deductibility restriction should, in principle, be very limited for companies granting loans to other group companies. However, such financing activities may still be adversely affected due to uncertainties in the interpretation of what constitutes borrowing costs and interest income or equivalent revenues. In practice, that can be very relevant for certain non-recurring income (e.g., a gain on the repayment of a debt instrument).
In view of the remaining uncertainties on some of the definitions, the impact of the interest limitation also needs to be carefully considered in the context of certain transactions e.g. in connection with losses (gains) on instruments used to hedge a currency exposure.
Cash tax implications may, in particular, arise when a taxpayer incurs annual interest expenses exceeding EUR 3m on debt that is used to finance e.g. intellectual property or operating activities
What are the opportunities that lie in the new rule?
Comparing the implementation of the ATAD within the EU shows significant differences with regard to the options taken by the various Member States.
Some countries have introduced (de minimis) caps which are even lower than what is foreseen by the ATAD (e.g., Finland, the Netherlands, Romania, Sweden).
The Luxembourg law contains a grandfathering clause in relation to loans concluded before 17 June 2016. Such a rule does not exist under the laws of e.g. the Netherlands.
Please note: to benefit from the Luxembourg grandfathering clause, taxpayers need to consider whether the underlying existing debt was modified in a way that could jeopardize the application of grandfathering. Also, the exact effect of grandfathering on the deductible expenses needs to be assessed on a case-by-case basis.
Luxembourg companies forming a fiscal unity will, based on the draft budget law 2019, be given the choice to apply the interest limitation rule to each company individually or to the fiscal unity as a whole. Again, this makes use of the full range of flexibility offered by the ATAD.
Other options implemented by Luxembourg include an equity escape clause, the carry forward of exceeding borrowing costs and unused interest capacity as well as the exclusion of financial undertakings and stand-alone entities.
The differences in Luxembourg’s implementation of the rule compared to other Member States can help Luxembourg to remain attractive for financing, even in an increasingly complex environment. If they haven’t yet done so, taxpayers should analyze their finance structure in Luxembourg and throughout Europe now to avoid denial of interest deductions and potential (economic) double taxation. Such situations may often be avoided by upfront careful consideration.