The Ministry of Finance proposed in the State Budget for 2020 (published October 2019) amendments to the Norwegian earnings stripping rules. The proposed amendments are intended to clarify and supplement the existing rules.
In general, arm's length interest expenses are deductible on an accrual basis. Effective for all financial years ending on or after 1 January 2019, the tax deductibility of net interest expenses if the borrower is part of a consolidated group (or could have been under International Financial Reporting Standards (IFRS) principles) is limited to 25% of the borrower’s tax EBITDA (earnings before interest, tax, depreciation and amortisation). The earnings stripping rules apply if the Norwegian entities in the borrower’s consolidated group have, in aggregate, net interest expenses of more than NOK 25 million (approximately U.S. $2.7 million).
In addition, interest paid to a related party outside the group is limited to 25% of the borrower's tax EBITDA (the “EBITDA-rule”). The earnings stripping rules apply only if the net interest expense of the taxpayer exceeds NOK 5 million.
Currently, the earnings stripping rules apply to companies in a consolidated group. This includes companies consolidated on a line-by-line basis and companies that would have been consolidated had IFRS been applied. The Ministry of Finance proposes that the wording in the law "company etc. in a corporate group" would be expanded to apply to companies that could have been consolidated (line by line) in a consolidated financial statement at group level under IFRS.
Under certain circumstances, IFRS provides for an optional consolidation of subsidiaries. The Ministry of Finance proposes to amend the current wording of the rules to change "would" to "could" in order to prevent taxpayers from adjusting their financial reporting based on the Norwegian earnings stripping rules.
Under IFRS 10, investment entities are exempt from consolidation and may report investments in subsidiaries at fair market value. The proposed amendments would not affect investment entities. The amendment would only apply if consolidation "could" have been carried out in the corporate group below an investment entity had IFRS been applied.
A group equity “escape clause” applies for the group earnings stripping rules. The escape clause can be applied either at company level or at Norwegian group level. In order to counter mitigation of the escape clause, the Ministry of Finance’s proposal would not allow merged companies to apply the escape clause on a company level. The proposal points to scenarios when one company does not meet the requirements under the escape clause. If it merges into a company that does satisfy the requirements, the current law provides for full deductibility of interest. Under the proposed amendment, the merged company would only be able to avail itself of the escape clause if the conditions are fulfilled at the Norwegian group level.
By way of the merger between Sub1 and Sub2, the net interest costs of Sub2 are transferred to Sub1. Because Sub1 had an equity ratio that surpasses the equity ratio at the group level, Sub1 may claim an exemption from the earnings stripping rules. The effect of the proposed amendment is that the exemption would no longer be available for the surviving entity in the income year of the merger.
The Ministry of Finance emphasized that the exemption on Norwegian sub-group level still may be used, provided that the conditions are met. On that basis, the position of the Ministry of Finance is that tightening of the rule is viewed as not being unreasonable. However, some tax professionals question the Ministry of Finance's rationale. The proposed amendment to the rules would encompass not only mergers that lead to an improved position in relation to the escape clause at the company level but would also affect mergers between two companies that on a stand-alone basis (pre-merger) satisfy the conditions of applying the escape clause at the company level. Even though the objective of the amendment is to obstruct unwanted and tax motivated transactions, non-tax motivated mergers would be affected by the proposal.
In its proposal, the Ministry of Finance stated that there may be other forms of unwanted transfers of debt between group companies. It will therefore be critical for taxpayers to monitor whether the use of the escape clause at the company level is used in such a manner, and whether additional adjustments of the rules would be necessary.
The proposed amendment would clarify that the EBITDA-rule for related parties is also to apply to group companies in the event the Norwegian sub-group has total net interest below the threshold amount of NOK 25 million—i.e., that related-party interest may be limited to 25% of tax EBITDA if net interest cost exceeds NOK 5 million (per company). Note that this is the case also under the current rules, although it is not clear under the current legislative language.
In this example, Investment Unit holds a Norwegian group. The debtor is the Norwegian Operating entity. Since investment units do not consolidate (under IFRS), interest payments to the Investment Unit are considered debt to a related party outside of the consolidated group and therefore subject to the EBITDA-rule (the NOK 5 million threshold).
In the event the EBITDA-rule for related-party interest does not apply for group companies, stand-alone companies would have an incentive to introduce one or more entities without a significant meaning to achieve a higher threshold for interest deductions, i.e., establish a tax group.
Further, the proposed rule changes imply that interest of a company, paid to a group company, that is acquired by a third party may have a disproportionately strict treatment of interest costs in the year of the acquisition because the interest paid would be deemed to be interest to a related party outside of the group. The Ministry of Finance stated that it would consider future amendments to the rules so that the effect would be limited to interest paid to a related party outside of the group only when the related party is outside the group both at the beginning of the year and at year-end. Such a rule change may be introduced in regulations to the Norwegian tax law.
A company that will have non-deductible interest cost related to the EBITDA-rule for group companies, however, would not be affected by the EBITDA-rule for related parties. Such a measure would imply that the same interest is treated as non-deductible twice.
The Ministry of Finance stated in its proposal for the State Budget 2020 that it is aware that the current EBITDA-rule for related parties may encourage corporate groups to "camouflage" related-party interest outside the group by transferring the debt to a company between the original debtor and the creditor. By way of such transfers, interest paid would be considered to fall under the NOK 25 million threshold rather than under the threshold of NOK 5 mill.
While it is not clear what sort of structure the Ministry of Finance refers to, it is assumed that it could be referred to a structure as described in the following example.
An Investment Unit (that is regarded as a related party outside of the group because group consolidation is carried out at a lower tier in the structure) provides a loan to an Operating entity. Interest paid by the Operating entity under such a financing structure would be encompassed by the related-party rule and subject to the threshold amount of NOK 5 million. By transferring the debt through a back-to-back arrangement via an intermediate (HoldCo), the interest paid from the Operating entity would now be considered to be related-party interest within the group when the threshold amount is NOK 25 million for the rules to apply. At the level of HoldCo, the net effect would be zero, provided there is a back-to-back arrangement on equal terms. In addition, the equity ratio of the group remains the same because the debt is kept at the Operating entity level.
The proposal further states that the Ministry of Finance will evaluate the necessity of a specified anti-avoidance rule in addition to the general anti-avoidance standard. Tax professionals believe that the application of the general anti-avoidance standard would need to be assessed on case-by-case basis.
Under current law, the rules do not apply to interest paid to a financial institution that temporarily is a related party to the taxpayer (e.g., under a bankruptcy situation).
The current wording of the rules was introduced in 2014 when the earnings stripping rules first came into effect and only limited the deductibility of related-party interest (EBITDA-rule). As the current rules also encompass third-party interest cost, the scope of the wording would be expanded by the proposal. Therefore, the Ministry of Finance proposes to amend the wording to state that interest paid to a financial institution that temporarily is a related party with the taxpayer would not count towards the EBITDA-rule, but would be included in the net interest.
The amendments are proposed to apply with retroactive effect from 1 January 2019.
For more information, contact a KPMG tax professional in Norway:
Per Daniel Nyberg | +47 40 63 92 65 | firstname.lastname@example.org
Thor Leegaard | +47 40 63 91 83 | email@example.com
Marius Aanstad |+47 40 63 95 51 | firstname.lastname@example.org
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