Published on 8 October 2018, the 2019 National Budget proposes to amend the Norwegian interest deduction limitation rules. The amended rules apply to companies part of a consolidated group, and limit interest deductions on bank loans, bonds and other debt to unrelated parties. The threshold amount, which determines whether the rules apply, is increased to MNOK 25. Where the threshold amount is exceeded, deductions are limited to 25 % of taxable EBITDA. Further, an equity escape clause is introduced, granting full deductions for interests if the taxpayer is able to demonstrate that the equity ratio in the Norwegian part of the company or the Norwegian part of the group is about the same as in the group as a whole. Companies subjected to the new rules are recommended to identify how the new rules may affect them and whether measures should be taken.
Interest deduction limitation also on interests to unrelated parties
In 2014, interest deduction limitation rules were introduced in Norway to limit the extent to which companies could deduct interest expenses to related parties. These rules apply where annual net interest expenses exceed a threshold amount of MNOK 5 per company. Where the threshold amount is exceeded, the right to deduct interests on debt to related parties is limited to 25 % of taxable EBITDA, i.e. taxable income before interest, taxes, depreciation and amortization. Currently, the rules do not limit deductions on interests payable on bank loans and other interests on debt to unrelated parties.
The new interest deduction limitation rules, proposed in the 2019 National Budget, include interests on any kind of debt, including debt to unrelated parties, such as bank loans and bonds. However, the threshold amount is increased to MNOK 25. Where the threshold amount is exceeded, deductions are limited to 25 % of taxable EBITDA, as before. Further, an equity escape clause is introduced, granting full deductions for interests, provided the taxpayer is able to demonstrate that the equity ratio in the Norwegian part of the group is about the same as in the group as a whole, cf. further below.
Background for the proposal
The background for the proposal is the OECD and G20 “Base Erosion and Profit Shifting” (“BEPS”) project. The purpose of the BEPS project is to develop measures to prevent companies from reducing their tax burden by shifting profits to low-tax jurisdictions, or avoiding taxation altogether. Recommendations made in the BEPS project are reflected in the EU Tax Avoidance Directive and the proposals from the Norwegian Scheel Commission from 2014.
OECD identified early on that one of the easiest ways for groups to shifts profits is to have group companies borrow money from one another. As this became an increasingly popular method of shifting profits out of Norway, legislation attempting to limit deductions on interest expenses to related parties was implemented in 2014.
However, groups can also shift profits by over-allocation of its debt to unrelated parties to entities in countries with a relatively high tax rate. In a consultation paper of 4 May 2017, the Ministry of Finance suggested that the interest deduction limitation rules be amended to include interests on debt to unrelated parties. The proposal in the National Budget 2019 is essentially in line with the suggestions in the consultation paper. The proposal will also meet the requirements in EU ATAD article 4, even though this directive does not apply to Norway under the EEA agreement.
Threshold amount of MNOK 25
The new rules do not apply if annual net interest expense is below a threshold of MNOK 25 for the Norwegian part of the group. Assuming an interest rate of 5 %, the threshold amount corresponds to a loan of MNOK 500. Consequently, small and medium-sized groups will in most cases be exempted from the new rules. In our view, this is good as there will be considerable administrative burdens in order to comply with the proposed rules. By comparison, the consultation paper suggested a threshold amount of MNOK 10.
Where a company has several companies located in Norway, the above-mentioned threshold amount will apply to the Norwegian companies together.
Note that groups with a net interest expense of less than MNOK 25 may still be subject to interest deduction limitation on interests to related parties outside of the group, cf. below.
Equity escape clause
The proposal intends to exempt interests expenses on ordinary arms-length loans. In order to achieve this, an equity escape clause is introduced. The equity escape clause applies where the taxpayer can demonstrate that the equity ratio in the Norwegian company, or the Norwegian part of the group, is equal to or not more than 2 percentage points lower than in the group as a whole. A taxpayer qualifying for the equity escape clause may deduct its full interest expenses, except interest expenses to related parties outside of the group. The rationale is that there is no profit shifting through over-allocation of debt where the equity ratio in Norwegian is about the same as for the group as a whole.
The equity escape clause may be applied either to each Norwegian company separately, or on the Norwegian part of the group. In the first case, the equity ratio in the balance sheet of the individual Norwegian company is compared with the equity ratio in the consolidated balance sheet of the group. In the other case, the equity ratio for a consolidated balance sheet of the Norwegian part of the group is compared with the balance sheet of the group. In both cases, the Norwegian equity ratio must be no more than two percentage points lower than equity ratio of the group as a whole. Note that the equity escape clause provides for a binary outcome, i.e. the interest deduction limitation rules apply fully where the Norwegian equity ratio is a fraction more than two percentage points lower than for the group.
Several adjustments have to be made to the balance sheet of the Norwegian company or the Norwegian part of the group when calculating the equity ratio. In case different accounting principles have been applied in the local Norwegian accounts and group accounts, the local accounts must be adjusted in line with the principles applied in the group accounts. For example, a debt may be at nominal value in the local accounts and fair market value in the group accounts. In addition, goodwill (or badwill) and other (positive or negative) excess values in the group accounts, relating to the Norwegian company or the Norwegian part of the company group, must be allocated to these entities.
The local balance sheets must also be adjusted for shares in, and claims against, other group companies. Shares in group companies shall be set off against equity and total assets, whereas claims against group companies shall be set off against debt and total assets. The adjustments shall be made to ensure a fair basis for comparison between the Norwegian balance sheet and the group balance sheet. Without these adjustments, it would have been easy to inflate the equity ratio in the Norwegian entity by contributing shares in other group companies to the Norwegian entities.
The equity ratio of the Norwegian company, or the Norwegian part of the group, shall be compared with the equity ratio in the group accounts. The comparison can be made with group accounts prepared under NGAAP, IFRS, IFRS for SMEs, local GAAP of an EEA country, US GAAP or Japanese GAAP. If no such group accounts exists, group accounts under IFRS has to be prepared in order to apply the equity escape-clause. The possibility to use groups accounts prepared under US GAAP or Japanese GAAP is new compared with the consultation paper. US GAAP is quite important, in particular for subsidiaries of US listed groups.
A group consisting only of Norwegian companies will always have the same equity ratio in Norway as the group as a whole. Such groups will therefore always qualify under the equity escape clause, and effectively be exempted from the new rules.
The proposal includes quite extensive documentation requirements for taxpayers who wish to apply the equity escape-clause. The group accounts and the local accounts for the Norwegian company, or alternatively, the local accounts of the Norwegian part of the group, including the above-mentioned adjustments, must be approved by the auditor.
For groups consisting of Norwegian entities only, it is sufficient to provide documentation approved by the auditor that the group does not include any foreign companies.
The documentation requirements may seem burdensome, but in our opinion they are not unreasonable as they are limited to groups with net interest expenses of more than MNOK 25.
Interests expenses to related parties outside the group
The existing interest deduction limitation rules, which limit interest expenses to related parties, will remain in force for companies that do not belong to a consolidated group.
Note that the existing interest deduction limitation rule also continues to apply to companies that belong to a group and have interest expenses to a related party outside of the group. A related party outside the group will typically be an individual who holds, directly or indirectly, 50 % or more of the shares in the company. Consequently, a Norwegian company belonging to a group and qualifying for the equity escape clause may still be exposed to the interest deduction limitation to the extent it has debt to a related party outside the group.
This blog post is written by Einar Riddervold and Benedikte Frøseth.
Jeg heter Steinar Hareide og er partner i Advokatfirmaet PwC. Jeg har nesten 20 års erfaring med å gi råd til norske og internasjonale konserner vedrørende kompliserte problemstillinger innenfor norsk og internasjonal bedriftsbeskatning. Mine spesialområder er M&A, shipping/offshore, transfer pricing samt generell bedriftsbeskatning.
My name is Steinar Hareide and I am a partner within Tax and Legal Services in PwC. I have almost 20 years of experience advising Norwegian and international groups on complex issues within Norwegian and international taxation. My areas of expertise are within M&A, shipping/offshore, transfer pricing and general corporate taxation.