Modifications to Ireland’s Interest Expense Deduction Rules
In 2022, many companies throughout Ireland will be required to change the way in which they calculate interest deduction for tax deductions. With that, let’s have a look at the key measures and why Ireland’s rules must change.
The changes are included in the EU’s first Anti-Tax Avoidance Directive also known as the ATAD1. This formed part of the EU’s response to the profit shifting (BEPS) project and the OECD’s base erosion and is a multilateral effort to combat cross-border corporate tax avoidance.
In short, Interest expense deduction limitation rules are intended to prevent companies from setting up loan arrangements between companies within the same corporate group whose aim is to reduce the taxable profit of an entity located in a higher tax location.
The aim of the ATAD1 is to prevent “excessive” interest deductions by restricting the amount of interest taxpayers can deduct. Under this directive, EU member states can set this ratio up to a maximum of 30% of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA).
ATAD1 permits borrowing costs and EBITDA to be calculated at the level of the group. It’s worth noting that disallowed interest may be carried forward or backwards and deducted in future or prior tax years, all subject of course to certain limitations.
Under the ATAD1 a de minimis threshold is provided for, which groups can fully deduct borrowing costs up to €3m. This means that changes are unlikely to affect the smallest companies.
EU member states are required to implement these rules as of January 1, 2019. However, the ATAD1 provided a five-year extension for countries to adapt their rules only if their pre-existing rules are deemed “equally effective” to those included in ATAD1.
Rules in Ireland.
Currently, Ireland has yet to fully implement ATAD1 as the government considered its current interest deduction limitation rules to fall under the “equally effective” banner to those in the ATAD1. Thus, Ireland had hoped to be allowed the extra time (until 2024) to implement the changes. However, it has been determined by the Commission that Ireland’s rules are not equally effective.
Irish rules presently utilize purpose-based tests as opposed to the EU’s ratio-based approach. These look to ensure that:
- Borrowing is incurred wholly and exclusively for the purposes of the company’s trade;
- Expenses must be revenue and not capital in character;
- Intra-group loan arrangements must be priced on “arm’s length” terms according to the OECD’s transfer pricing guidelines. This means the loan should be similar to financing arrangements between non-related entities.
Deductions are disallowed in the event borrowing is used with the sole purpose of reducing tax liabilities. Furthermore, under the General Anti-Abuse Rule, where a tax advantage arises which is an “abuse or misuse” of the relief.
The Government considered these and other aspects of the rules were already sufficient in tackling BEPS.
Finance Bill 2021
There were new measures included in Finance Bill 2021 which was introduced to parliament in October 2021. The bill is progressing through Dáil Eireann, with the new requirements set to be effective for accounting years beginning on or after January 1, 2022.