Tax authorities release guidance on interest limitation rules

 

Tax authorities release guidance on interest limitation rules

 

The Luxembourg tax authorities issued guidance (Circular n°168bis/1, in French only) on 8 January 2021 clarifying certain aspects of the interest expense deduction limitation rules in article 168bis of the Income Tax Law (ITL).

The interest limitation rules were introduced following the transposition of the EU Anti-Tax Avoidance Directive (ATAD1) into Luxembourg domestic tax law. They are applicable as from fiscal years starting on or after 1 January 2019.

Broadly speaking, any excess borrowing costs (EBC) are generally restricted to 30% of the taxpayer's tax-based earnings before interest, tax, depreciation, and amortization (EBITDA). The rules apply to the borrower regardless of the jurisdiction of the lender (located in Luxembourg, in an EU member state, or in a third country) and of its link with the latter (related entity or third party).

The circular only focuses on the rules applicable at the level of a concerned taxpayer (article 168bis ITL)—Luxembourg companies as well as permanent establishments of nonresident companies—but does not provide any additional guidance on how to apply the rules in the context of a fiscal tax consolidation (article 164bis (9) ITL).

Furthermore, Article 168bis (7) ITL excludes from the scope of the interest limitation rules EBC incurred on loans used to fund EU long-term public infrastructure projects, subject to certain conditions.

Borrowing costs and interest revenue

Borrowing costs

The circular mentions that only borrowing costs incurred exclusively by the taxpayer (article 45 ITL) or directly for the purpose of acquiring, securing, and retaining revenue (article 105 ITL) are in principle tax deductible and can be subject to the interest expense deduction limitation rules, to the extent that their total or partial deduction is not denied.

The circular indicates that:

  • Hidden dividend distributions cannot be characterized as operating expenses or costs of obtaining funding;
  • The rules on hybrid mismatches (article 168ter ITL), as well as the provisions of articles 45 (2) and 166 (5) (1) ITL, apply before article 168bis ITL; and
  • Transfer pricing rules (articles 56 and 56bis ITL) should apply first. Article 168bis ITL should apply on the tax-adjusted (up or down) amount of interest where an adjustment is required.

The circular provides further analysis on the non-exhaustive list of borrowing costs included in article 168bis (1) 2) ITL. The list includes more particularly the following:

  • Issuance of, and redemption premium on, financial instruments.
  • Derivatives, including contracts commonly known as forwards, futures, options, and swaps. Interest expenses that are calculated on the basis of a notional amount are also covered.
  • Capitalized interest included in the balance sheet value of a related asset, or the amortization of capitalized interest.
  • The circular also clarifies that foreign exchange gains and losses that are included in taxable income and that relate to interest on loans and financing-related instruments are included in the definition of borrowing costs.

The circular also refers to the personal exclusions allowing the full deduction of borrowing costs if the taxpayer is a financial enterprise or a stand-alone entity:

  • For purposes of the financial enterprise exclusion, the definition of “financial enterprise” covers entities regulated by an EU directive or regulation.
  • For purposes of the stand-alone entity exclusion, the circular mentions the three parts of the definition of a “stand-alone entity,” including the absence of associated enterprises. 

Interest revenue and other economically equivalent revenue

The circular confirms the application of a horizontal symmetric approach whereby the concept of “borrowing costs” and “interest revenue and other economically equivalent income” should be defined or interpreted similarly whether it is arising from a debt receivable or a debt payable.

We also note that the circular proposes to consider the tax treatment in the hands of the creditor and the debtor for the purpose of qualifying an income or an expense in a domestic context.

How to calculate the interest expense deduction limitation

The rule limits the deduction of EBC incurred to an amount equivalent to 30% of the taxpayer's tax EBITDA. 

The circular clarifies that the rule applies to each financial year as defined in the ITL, i.e., if a tax year contains less than 12 months, it is treated as an entire financial year.



 

Source: Deloitte Luembourg Tax News

 

 

 

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