Local tax authorities have always struggled to successfully tackle long-existing (and by now somewhat commoditized) financing structures, such as debt push-down and hybrid mismatch structures. The European ATAD and OECD measures will inevitably result in an internationally aligned, and thus more effective, anti-abuse law focused at financing structures, of which implementation will only be a matter of time.
Implications for multinationals
Considering that the announced international measures are aimed to primarily avoid these commoditized financing structures, tailor-made financing structures with business rationale will be the only sustainable way forward for multinationals.Time and effort will be required to build a new rational financing structure for multinationals that is senstitive to the many international developments.
What the proposed laws say
The European ATAD includes two specific measures on financing structures, the anti-hybrid mismatch rule and the interest barrier rule. Although the anti-hybrid mismatch proposal does not apply to non-EU jurisdictions and the interest barrier rules would still allow for interest deductions of up to 30% of the EBITDA, it is clear that these two proposed measures alone will significantly impact multinationals.
In addition, many jurisdictions in Europe are increasingly using a business rationale approach to disallow interest deductions on group and third party debt. What would the local entity have done absent group tax planning?
From research that we performed with our European offices, it shows that:
- Europe today currently has a variety of interest deduction limitations, of which hardly any are aligned with the current OECD and EU proposals;
- In Europe today, less than half the countries currently have (experience with) interest barrier rules;
- The details of the proposed changes are far from crystallized. Nevertheless, the EU is aiming for implementation as per January 2017.
Europe tomorrow will thus be a completely different place in relation to interest deduction limitation rules, and those changes are around the corner.
In addition, we asked our colleagues whether business rationale is being used by tax authorities to disallow interest deductions and how aggressively such business purpose tests are being used in practice. The results are quite significant:
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In other words, the toolkit for tax authorities to challenge group financing structures going forward will be significantly broader.
Actions to consider
Considering this new more internationally-aligned approach to group financing structures, we advise you to consider the following actions:
- Review your global group and third party debt positions:
- Identify hybrid mismatches (both hybrid loans and hybrid entities) and debt push-down structures;
- Identify whether interest deductions are taken in jurisdictions where the funds are in fact not (or no longer) being used;
- Identify how group financing is being structured in your organization and whether the debtor jurisdiction is or has been involved in the decision-making process; and
- Identify where interest deductions result in a significant reduction of taxable base (in comparison to 30% EBITDA).
- If any of the above situations exist, we advise you to reconsider (part of) your group financing structure and build-up a more tailor-made financing structure, avoiding commoditized financing "products" which may soon be disallowed. The group financing should be aligned with business needs and the relevant jurisdictions should be involved in the decision-making process.
- Finally, considering financing structures often cross EU borders, developments outside the EU should be tracked as well for potential impact on EU financing structures. To illustrate, the U.S. Internal Revenue Service and the U.S. Internal Revenue Services and the U.S. Treasury Department recently issued proposed regulations regarding, amongst others, the treatment of intercompany debt issued as part of certain intercompany transactions. As currently drafted, certain important parts of the regulations could have an impact on intercompany debt issued as of April 4, 2016. Where multinationals (U.S. headquartered or non-U.S. headquartered) have entered or will enter into these intercompany debt transactions, careful assessments of the debt arrangement and attention to documentation will be required to avoid recharacterization of the debt.