On 28 July 2016, the Organisation for Economic Co-operation and Development (OECD) published a discussion paper on its proposed approach to interest deductibility in the banking and insurance sectors.
In October 2015, the OECD published its final reports as part of the ongoing BEPS (base erosion and profit shifting) project. BEPS Action 4 addressed interest deductibility and the final proposal made by the OECD was for countries to limit an entity’s net interest deductions to a fixed ratio of the taxable income generated by the entity’s economic activities. At the time, however, the OECD recognised that further work would be needed in some areas, including the banking and insurance sectors.
Following on from the OECD’s final proposals, the UK government quickly announced its intention to implement the OECD’s recommendations on interest deductibility. In May 2016 a consultation was launched on a set of new rules on corporate interest deductibility, to take effect from 1 April 2017. The UK proposal, broadly, is to limit corporation tax deductions for net interest expense to 30% of a group’s UK EBITDA. See here for our earlier commentary on the UK’s proposals. The UK government said, at the time, that it would continue to work with the OECD to “develop appropriate rules for groups in the banking and insurance sectors”.
The OECD paper recognises that the characteristics of banks and insurers may mean that the “general” approach proposed for interest deductibility under BEPS may not be appropriate as:
- banks and insurers will, typically, have net interest income rather than net interest expense. The proposed fixed and group ratio rules would therefore not limit the ability of such banks and insurers to deduct all their interest expense (even that which could be linked to BEPS)
- banks and insurers are subject to regulatory capital rules, requiring a minimum amount of equity and limiting the amount and ways in which debt can be used.
Therefore, the OECD states that individual countries could exclude banks and insurers from the scope of the proposed fixed and group ratio rules, in return for applying specific rules to such entities. The OECD also recognises that whilst banks and insurers have been grouped together for the purposes of the discussion paper, they are of course very different businesses and there is no requirement for a country to apply the same rules to each type of entity.
The discussion paper makes the following points, amongst others:
- a distinction should be made between BEPS risks posed by banks and insurers on the one hand, and BEPS risks posed by entities grouped with banks and insurers, on the other
- “Excessive” leverage is seen as more of a risk posed by entities grouped with banks and insurers (rather than the banks and insurers themselves)
- permanent establishments (PEs) of banks and insurers pose a particular issue as, in many countries, no regulatory capital rules apply to PEs. Such rules may, for the HQ of a bank or insurer, “naturally” produce an outcome that means a specific interest deductibility rule is not required.
It remains to be seen, as far as the UK is concerned, how the UK now deals with banks and insurers as part of the UK rules due to take effect from 1 April 2017.
The discussion paper can be viewed here.