Interest limitation rule: a uniform standard

Anti-Tax Avoidance Directve and Interest Limitation Rule (earnings stripping rule)

The proposal introduces targeted amendments to the interest limitation rule (earnings stripping rule) set out in the Anti-Tax Avoidance Directive (EU) 2016/1164 (ATAD). In particular, it proposed mandatory provisions that reduce the discretion available to Member States. The main changes are as follows:

30% of EBITDA threshold is mandatory;
exceeding borrowing costs on low risk third party loans are excluded from the rule;
safe harbour mandatory and increased to EUR 5 million and indexed;
group escape rule and carry-forward mandatory; and
exemptions for public benefit and defence projects.

EBITDA 30% threshold and low risk third party loans

The threshold of 30% of EBITDA for the deductibility of exceeding borrowing costs is made mandatory. Accordingly, Member States will not be allowed to apply lower threshold, meaning that level of deductibility is fixed at 30% of EBITDA will be a uniform standard across the EU.

Exceeding borrowing costs incurred on low risk third party loans are excluded from the scope of the rule. A low-risk third-party loan is the loan that meets two cumulative conditions: a loan that is not granted by an associated enterprise or by an entity of the same consolidated group and that is used to finance exclusively the borrower’s own activities, with the exclusion of any on-lending or equity funding within the group.

The safe harbour of EUR 5 million

The safe harbour, under which net interest expense remains deductible up to a fixed amount, is made mandatory. It is also increased to EUR 5 million and indexed annually. The calculation of EBITDA is adjusted accordingly, in particular so that amounts deducted under the proposed R&D facilities are added back, in the same manner as exceeding borrowing costs, depreciation and amortisation. For more on R&D see here R&D expenditure: common EU framework - Forvis Mazars

In addition, if a taxpayer demonstrates that its EBITDA has decreased by at least 50% in a given tax period compared with the immediately preceding period, the limitation does not apply for that period.

The group escape rule and carry-forward

The group escape rule, which allows a taxpayer to deduct exceeding borrowing costs above the general limit where its level of leverage is in line with that of its group, is proposed to be mandatory. However, Member States retain the choice between the two existing mechanisms from Article 4(5) of ATAD: the equity escape (balance sheet based) and the group ratio rule (earnings based).

The carry-forward of exceeding borrowing costs and of unused interest capacity is also proposed to be mandatory. In addition Member States may allow a carry-back for a maximum of three years. These changes recognise that the timing of interest expense and taxable income is not in the same tax period which is relevant for capital intensive sectors and start-ups.

Public benefit and defence projects

The scope of optional exclusion for long-term public infrastructure is extended to large scale assets considered to be in the general public interest by a Member State. This may include project relating to climate, digitalisation, social and economic resilience, energy security and social housing. The condition is that the operator, borrowing costs, assets and the income are all situated in the EU.

An additional and temporary mandatory exclusion is introduced for exceeding borrowing costs on loans used to finance defence products or other products for defence purposes. This exclusion will apply only to loans concluded in the first five tax periods following the application of the rule.

Finally, the optional exclusion for standalone entities is removed and the definition of financial undertakings is updated to reflect changes in EU financial regulations.

Relevance for the Netherlands tax law

The Netherlands currently applies the earnings stripping rule (earningsstrippingmaatregel) more strictly than the EU minimum requires. The deductibility of net borrowing costs is limited to 20% of EBITDA, and the safe harbour is set at EUR 1 million.

The proposed mandatory standard would therefore require two notable changes: the threshold would rise from 20% to 30% of EBITDA, and the safe harbour would increase from EUR 1 million to EUR 5 million, with annual indexation. Both represent a relaxation of current rules by expanding the scope for interest deductibility with corresponding implications for the domestic tax base.

In addition, the Netherlands tax provisions do not currently provide for a group escape rule which will also be a significant change once the proposal is adopted. Also, the new mandatory exclusions for low risk third party loans, long term public benefit projects (especially targeting housing corporations) and defence project related financing would also require changes to the Netherlands tax law.