Government’s Bill on the new Interest Deduction Limitation Rules effective in 2019
The Government’s Bill for Interest Deduction Limitation Rules in line with the Anti Tax Avoidance Directive (ATAD) was published on 27 September 2018. The Bill means significant tightening of the interest deduction restrictions compared to the current rules, and in some aspects restricts the deductibility of interest expenses more than ATAD requires. However, the Bill is not as strict as the draft published earlier this year.
Summary of the key changes to the current rules
- The new rules will apply also to interest paid to unrelated parties with a new safe harbor rule of EUR 3 million. In addition, the rules will cover all Finnish corporate entities including the real estate sector.
- The national definition of interest will not be totally rewritten, but the new Limitation Rules will cover expenses in connection with the raising of finance, guarantee fees for financing arrangements, arrangement fees and similar costs related to the borrowing of funds.
- The current balance sheet test (“escape clause”) will remain, but the Finnish company and the group should prepare the accounts with the same standard for this purpose.
- The certain long-term public infrastructure projects will be exempted from the rules (at this stage e.g. not including so called mutual “Mankala” energy companies).
- The definition of exempted financial institutions will cover also e.g. insurance companies, UCITS and AIFs.
Interest Deduction Limitation Rules in more detail
The current interest deduction restrictions apply only to corporations and partnerships in their business source of income. The new restrictions will apply to interests also in other income baskets. This will bring passive investments and real estate holdings under the restrictions.
The deductibility of the interest expenses would not be restricted provided the net interest expense is maximum 500,000 euro. In this respect the new provision will be similar to the current provision, but tighter that required by the ATAD.
The new rules will apply to interest paid to both related and unrelated parties. However, the restrictions on the deductibility of interests paid to unrelated parties will be more lenient as the taxpayer is allowed to deduct the net interest expenses paid to unrelated parties up to EUR 3 million threshold.
In line with the ATAD, the new interest deduction restrictions will apply to interest, other compensation for debt corresponding to interest as well as other payments arisen in connection with the raising of finance. Guarantee fees, arrangements fees and similar costs have been mentioned as examples. However, the deductibility of, for example, fees paid to advisors would not be restricted. The definition of interest would cover both interest expense and interest income. This is relevant since the restrictions are applied to net interest expense.
The maximum deductible net interest expense would be calculated similarly to the current rules and amount to 25 % of the taxable EBITD, which is the taxable profit to which the interest expenses, tax deductible depreciations and the received group contribution are added and from which the given group contribution is subtracted.
The current balance sheet test would remain with amendments. Consequently, the interest deduction restrictions will not apply in case the taxpayer demonstrates that its ratio of equity over the total assets on its balance sheet is equal or higher than the ratio of equity over total assets on balance sheet of the whole consolidated group. The consolidated balance sheet has to cover the whole group and be prepared in the EU, EEA or tax treaty country in accordance with the international accounting standards or rules that correspond to the accounting rules of an EU or EEA country. In case the consolidated balance sheet is prepared using different accounting standard that the balance sheet of the Finnish taxpayer, the taxpayer has to convert the consolidated balance sheet to follow the rules that have been followed in the preparation of the Finnish taxpayer’s balance sheet.
The non-deducted net interest expense is carried forward and deductible during the following years under the 25 % taxable EBITD restriction. The change of control in the company does not have an effect on the deductibility. These provisions and the provisions on the merger’s and demerger’s effect on the carry forward of the non-deducted net interest are similar to the current interest deduction carry forward rules.
The restrictions will not apply to stand alone entities as defined in the new rule and based on 25 % ownership. Also taxpayers that qualify as financial undertakings will be outside the scope of the restrictions. In addition certain long-term public infrastructure projects related to housing are not under the restrictions.
The new restrictions will apply to 2019 and following tax years, i.e. accounting periods that end on or after 1.1.2019. However, the restrictions will not apply to loans from unrelated parties and raised on 16 June 2016 or earlier.
The next steps
- Instead of centralized financing the group entities may need to consider having external financing in separate entities within the group.
- Especially the real estate sector should evaluate the totally new situation when the Limitation Rules will start to apply in 2019.
- The applicability of the escape clause should be re-evaluated, including the level of the test based on the developed new case law.
- “Mankala” energy companies may need to be restructured, if not later exempted.
- Foreign financial institutions (including insurance companies and various funds) should evaluate whether they are exempted.
We are happy to tell you more about the Bill and its possible effects on your Finnish tax burden.