Eager to cut the budget deficit, the Di Rupo government has proposed several new tax measures, including new restrictions on the notional interest deduction (NID) and more stringent thin capitalization rules. In this newsflash, we discuss the impact of these changes on the PPP sector. Although PPPs will not be directly affected by the changes to the thin cap rules, the same cannot be said for the new restrictions on the NID. Thus, in the coming years, a reassessment of PPP financing and structuring possibilities will undoubtedly be necessary.
New restrictions on the NID
The NID rules, which entered into force in tax year 2007, allow Belgian corporate taxpayers (and foreign corporate taxpayers with a permanent establishment in Belgium) to benefit from a tax deduction corresponding to a percentage of (fictitious) interest on their adjusted net equity, i.e. the company’s net equity, as stated on its opening balance sheet for the tax period, less certain disqualified amounts. The adjusted net equity is subsequently multiplied by a fixed interest rate, based on the average interest rate on ten-year Belgian government bonds (OLOs). This rate was initially capped at 6.5% but was subsequently reduced for tax years 2011 and 2012. The result of this equation constitutes the NID for the year. Any unused portion of the NID can be carried forward for seven tax years.
The Omnibus Act of 28 December 2011 (the "Omnibus Act") implemented some of the tax measures proposed in the 2012 budget agreement and, with respect to the NID, further lowered the maximum interest rate to 3%, or 3.5% for SMEs (where, based on the OLOs, the interest rate would have been 4.2% approximately). The new cap will apply as from tax year 2013.
The 2012 budget agreement proposed other amendments to the NID rules. It is likely that these changes will be enacted shortly, as the cabinet formally announced an agreement to this effect in the Omnibus Bill of April 2012 (the "Omnibus Bill"). At the time of writing, no official version of the Omnibus Bill was publicly available. However, the Bill is thought to repeal the current possibility to carry forward any unused portion of the NID for seven years. Under the new rules, it will still be possible to carry forward the unused portion of the NID built up under the previous rules (the "NID stock") before the Bill was introduced, but certain restrictions will apply: (i) the NID stock carry-forward must be the last deduction taken on the corporate tax return to determine the tax base (in other words, all other deductions must be taken first, meaning the possibility to deduct the NID stock carry-forward will be severely reduced) and (ii) the maximum NID stock carry-forward that can be taken per tax year is limited to 60% of the tax base, not taking into account the first one million euros. Any NID stock carry-forward which is left over after the application of these limitations can be further carried forward, regardless of expiry of the currently applicable seven-year time limit. These new rules will most likely enter into force as from tax year 2013.
New thin cap rules
Thin capitalization ("thin cap") rules limit the deduction of interest on loans when a certain debt-to-equity ratio is exceeded. Prior to the enactment of the Pluriannual Estimates Act of 29 March 2012 (the "Act"), Belgium not only applied a rather generous seven-to-one debt-to-equity ratio but also restricted the application of the thin cap rules to interest paid on loans (other than bonds and similar publicly issued debt securities) to a resident or non-resident beneficiary that was either not subject to income tax or subject to tax treatment substantially more advantageous than would normally be the case in Belgium.
The Act amends the thin cap rules in two ways. Firstly, the Act reduces the debt-to-equity ratio from seven-to-one to five-to-one. As was the case previously, equity is still defined as the total of taxed reserves at the start of the tax period and paid-in capital at the end of this period. Secondly, however, the Act extends the scope of application of the thin cap rules. Now, the rules are applicable not only to payments to tax-exempt entities or entities located in tax havens (as was previously the case) but also to all intra-group loans, with the exception of bonds and similar publicly issued debt securities and loans extended by banks and other financial institutions. The concept of a "group" is defined with reference to the company law concept of an affiliated company, laid down in Article 11 of the Company Code.
As PPP deals rely heavily on debt financing, virtually every PPP would fail to meet the lower debt-to-equity ratio under the new thin cap rules. Therefore, the Act expressly states that the new rules will not apply to "companies whose main activity is PPP (....) in accordance with the public procurement legislation". This mean not only that the deduction of interest on loans obtained in the framework of a PPP cannot be disallowed on the basis of the new thin cap rules but also that such loans need not be taken into account when determining the debt-to-equity ratio for the purpose of (possibly) disallowing the deduction of interest on loans contracted for reasons other than PPP.
After extensive lobbying, the Di Rupo government agreed to postpone the implementation of the new thin cap rules until 1 July 2012, at the latest, although it is possible that additional changes will be adopted in the meantime. To the best of our understanding, these changes will not affect the carve-out for PPPs, but rather will focus on the adverse tax consequences of the new thin cap rules for corporate headquarters, group finance companies, and treasury and other cash-pooling centers active in Belgium, all of which fall within the scope of application of the new rules.
Due to these recent legislative changes, debt will continue to be the preferred means of PPP financing. Nonetheless, the ongoing discussions on how to treat group finance companies and other cash-pooling centers in this new legislative setting, combined with the recent adoption of a new, more extensive, general anti-abuse provision, will undoubtedly require a reassessment of the PPP financing and structuring possibilities.