OECD proposals for limiting interest tax relief could impact on energy companies, says expert

Tax expert Heather Self of Pinsent Masons, the law firm behind Out-law.com, was commenting as the Organisation for Economic Co-operation and Development (OECD) published its final report on limiting base erosion involving interest and other financial payments.

In the report the OECD recommended 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. The suggested range is from 10% to 30%. EBITDA means a company's earnings before interest, taxes, depreciation and amortisation.

The restriction would apply to all interest, including amounts paid to third parties, with no 'arm’s length' escape route. However, the OECD said that countries could choose to have an additional allowance where interest does not exceed the group ratio. This would mean that a subsidiary with 40% EBITDA interest would not have a disallowance if the group ratio was also at least 40%. The OECD said that this is to recognise that "some groups are highly leveraged with third party debt for non-tax reasons". 

Countries will also be able to introduce a 'public benefit exemption', to allow public infrastructure projects which are considered to have low tax risk to be exempt from the new rules. Any exemption introduced would have to comply with detailed conditions. These include that a public sector body or public benefit entity obliges the operator to provide goods or services in which there is a general public benefit. Another condition is that loans would have to be obtained from third parties on non-recourse terms so that the lender only had security over the assets or income streams of the project with no guarantees from other group companies.

Self said that although the potential exemption for public benefit projects would probably help PPP/PFI projects involving schools, hospitals and possibly roads and railways, it probably would not be sufficiently widely drawn to include the kind of capital expenditure projects incurred by energy companies.

She said: "Although the proposals offer hope for infrastructure companies engaged in PFI projects and the like, it seems unlikely that the UK will be able to introduce an exemption that will be wide enough to benefit energy companies, even though these sorts of projects are not likely to give rise to the tax risks that the OECD project is intended to address."

Self said that companies operating in the UK will now be "waiting anxiously" to see how the UK responds to the OECD recommendations. It is understood that the UK government will publish a consultation document over the next few weeks on how it should implement the recommendations into UK law.

Energy companies have been criticised in the past in the press and by MPs on the Energy and Climate Change Committee for the low levels of corporation tax paid in the UK because they have claimed capital allowances in respect of the billions of pounds spent on building power plants. Water companies have also been criticised for the tax reliefs they have claimed.

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. In July 2013, the OECD published a 15 point Action Plan and the first formal proposals dealing with seven of the 15 specific actions were published in September 2014.

The OECD estimates that tax revenues lost from BEPS could be equivalent to $100 billion to $240bn a year.

The OECD proposed 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.

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. There were concerns from many commentators that group-wide interest limitation rules could result in effective double taxation for some wholly commercial group structures. 

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.

At the same time as publishing the interest report, the OECD published 12 other final reports on other aspects of its BEPS project.

The reports were published ahead of a G20 Finance Ministers' meeting on 8 October in Lima, which is expected to consider the recommendations. They are also likely to be endorsed at the G20 leaders’ summit in Turkey on 15 November.