The Finnish Government has released a draft regarding a bill to limit the deductibility of interest expenses in business taxation. The goal of this proposed regulation is to secure Finland's tax base and to balance competition between domestic and foreign groups of companies.
At the moment, interest expenses are widely deductible in business taxation and deductibility can be restricted only by applying the transfer pricing regulation or the general provision for tax avoidance. Applying the new proposed limitation will not require any intention of tax avoidance or deviation from arm's length principle, but it will be applicable as a general rule.
Main aspects of the new regulation
According to the draft, limitations would be applicable to corporations, partnerships, corresponding foreign entities and their permanent establishments and in cases where the foreign entities have some other income subject to taxation under the Finnish Business Tax Act (360/1968). The limitations would be applied only if the interest expenses exceed the interest income received by the company, i.e. if the company has net interest expenses.
An interest would become non-deductible if the net interest expenses exceed 30 % of the company's EBITDA (earnings before interest, taxes, depreciations and amortizations). In the proposed regulation, group contributions would be included in EBITDA. However, interest expenses would remain deductible to the extent that the net interest expenses exceed interest expenses paid to related parties. The related parties are defined similarly as in the Finnish transfer pricing regulation. This means that parties are deemed to be related, if the other party has directly or indirectly control over the other.
The interest could be regarded to be paid to related parties also by indirect payments in situations such as back-to-back arrangements or when a related party has secured a third party loan with a collateral. Applying limitations in these indirect situations would require a connection between the interest paid to the third party by the debtor and the collateral given to the third party by the related party.
According to the draft, a general safe haven of always deductible EUR 500,000 would apply, but this amount would include all interest expenses, whether paid to related parties or not.
The proposed regulation would allow an indefinite carry forward of non-deductible interest expenses. The use of this interest carried forward would require unused EBITDA in the fiscal year of use. Change of ownership would not affect the possibility to carry non-deductible interest expenses forward. In a merger, interest expenses carried forward would pass to the acquiring company, and in a division, they would pass in so far as they have obviously resulted from the transfering business or for the part that equals to the transfer of net assets. Carry forward could not be passed in a transfer of business.
The proposed regulation would be carried out by adding a new section 18a to the Business Tax Act (360/1968). The regulation would also be applicable to income from other income source, taxed according to the provisions of the Income Tax Act (1535/1992). This would require an amendment of section 58 of the Income Tax Act where a new subsection would be added. Also, an amendment to section 65 of the Tax Procedure Act (1558/1995) is proposed in order to provide a possibility to appeal against decisions concerning non-deductible interest.
Example of application
To clarify this new regulation, the following example may be presented:
Company A has interest expenses worth EUR 1,000,000. This exceeds the amount of the general safe haven of EUR 500,000, so a further analysis is needed.
EUR 500,000 of the interest expenses are paid to a related company B, and in addition, a related company C has provided a collateral for a bank loan which produces EUR 200,000 of the interest expenses.
Company A has EBITDA of EUR 2,000,000. The maximum deductible interest equals to 30 % x EUR 2,000,000 = EUR 600,000. However, Company A has interest expenses worth EUR 1,000,000 – EUR 600,000 = EUR 400,000 more than the EBITDA barrier allows. Out of all interest expenses, EUR 500,000 + EUR 200,000 = EUR 700,000 are interest expenses paid to the related parties.
As interest expenses exceeding those paid to the related parties remain deductible, EUR 1,000,000 – EUR 700,000 = EUR 300,000 remain deductible regardless of the limitations. EUR 100,000 will become non-deductible and may be carried forward indefinitely.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
