OECD likely to recommend fixed ratio cap on interest tax deductibility, says expert

However Heather Self of Pinsent Masons, the law firm behind Out-Law.com, said that it was not yet clear whether infrastructure projects would be "in the clear".

Self said that it is understood that the OECD's main proposal will be that countries should introduce into their tax systems an interest/ EBITDA limitation on tax deductibility, with countries free to pick a percentage level within a range. It seems likely that the upper end of the range will be 30%, in line with the current rule in Germany.  EBITDA means a company's earnings before interest, taxes, depreciation and amortisation.

The OECD is considering restrictions on interest deductibility as part of its 15 point action plan to counteract base erosion and profit shifting (BEPS). BEPS refers to the shifting of profits of multinational groups to low tax jurisdictions and the exploitation of mismatches between different tax systems so that little or no tax is paid.  Following international recognition that the international tax system needs to be reformed to prevent BEPS, the G20 asked the OECD to recommend possible solutions.

The OECD published a discussion draft in December 2014 setting out some initial proposals on interest limitation rules. This suggested that tax deductions for interest payments could be restricted on a group wide basis, by reference to a fixed ratio, or by a combination of these two solutions.

In an update in June on the BEPS project the OECD said that its discussions at that time were focused on introducing a fixed ratio rule, combined with a group wide ratio rule and an optional de-minimis threshold to remove low risk entities from the ambit of the rule and reduce compliance costs.

"The initial proposals caused great concern, and would have been likely to result in effective double taxation for some wholly commercial group structures.  The decision not to propose group-wide interest limitation rules, if confirmed, will therefore be welcome," Heather Self said.

"If the OECD does recommend a fixed ratio cap, this will be the least worst option for many groups and is what many argued for in their responses to the discussion draft. However, it could still leave risks for infrastructure – particularly if there is highly-leveraged infrastructure within a wider group," she said.

Restrictions on interest deductions can be a particular problem for infrastructure projects which tend to be highly geared.

"It is understood that specific exemptions will be proposed – such as one for Public Private Partnerships (PPP) - and that there will be specific rules for banks and insurance companies. However, although December's discussion document said that the infrastructure industry may need 'special provisions', it seems that the only concession will apply to PPP projects," Self said.

"Another important factor will be how the UK intends to implement the proposals. If a range of ratios are to be permitted, it is to be hoped that the UK opts for the highest ratio possible. There is a significant risk that lower ratios could impose additional tax costs on genuine commercial structures where no BEPS risk exists," she said.

The first formal proposals dealing with seven of the 15 specific BEPS actions were published in September 2014 and the next formal proposals, including in relation to interest deductibility are expected to be published in September.

The OECD is proposing a restriction on interest deductions as deductible payments such as interest can give rise to 'double non-taxation'. Excessive intra group interest deductions can be used by multinational groups to reduce taxable profits in operating companies, even in cases where the group as a whole has little or no external debt. The OECD is also concerned that groups can use debt finance to produce tax exempt or deferred income, thereby claiming a deduction for interest expense while the related income is brought into tax later or not at all. 

Countries including Germany, Greece, Italy, Norway, Portugal and Spain already have a limit of 30% of taxable EBITDA and France has a limit of 25%. The UK currently has a range of anti avoidance provisions that can restrict interest deductibility in specific situations, but no general ratio rule.