Norway: Breach of EEA law rejected and plans to change interest cap rules announced
Daniel M H Herde
Trond Eivind Johnsen
In October 2016, the EFTA Surveillance Authority (ESA) issued a reasoned opinion stating that the Norwegian interest deduction limitation rules (interest cap rules) constitute a restriction on the freedom of establishment within the EU/EEA area.
In short, the issue can be illustrated by a parent company in a Norwegian domestic group lending money to its subsidiary, which incurs interest expenses. To ensure full deduction of these expenses, the group can use a feature in the interest cap rules that increase the deduction frame. This is achieved by granting group contributions (GCs) between domestic group companies (e.g. the interest income on the said lending can be used to increase interest deductions for the borrower). In contrast, if an EEA resident parent company in an international group lends money to its Norwegian subsidiary, GCs are not available for a Norwegian resident parent company that lends to its EEA resident subsidiary. The result is lower deductions (and a higher tax charge) for Norwegian subsidiaries of international groups or for Norwegian parent companies with EEA resident subsidiaries. However, the Ministry of Finance (the ministry) is not convinced and argues that the two situations are not comparable.
In its response of January 31 2017, the ministry emphasised that neither of the two regimes (GC and interest cap rules) are discriminatory by themselves, and it thus has to be the combined effect of the two regimes that constitute the restriction. However, what the ministry means is that only the GC feature of the interest cap rules should be decisive. With this background, the ministry refer to the tax consolidation cases from the European Court of Justice (CJEU) where established case-law justify such regimes based on the need to safeguard balanced allocation of taxation power. However, the ESA is, on the other hand, of the view that access to GCs is just an integrated feature of the interest cap rules. Thus, the case at hand has more similarities with interest deduction (thin cap) cases from the CJEU. When applying the latter case law, the need for a balanced allocation of taxation powers is not sufficient to justify disproportionate restrictions, as restrictions would impede commercial debt arrangements that are not wholly artificial.
While the ministry is right that it is the GC feature of the interest cap rules that constitute the restriction, one could question the ministry's reasoning. The rationale behind the GC feature of the interest cap rules does not need to be same as the rationale behind the GC regime as such. The feature is an attempt to avoid the interest cap rules impeding arm's length leverage because it effectively introduces a "domestic group ratio" exemption where the taxable EBITDA of the domestic group as such (reflecting debt serving capacity) sets the limit for interest deductions. The feature has similarities with ESA's requirement that the restriction should only target artificial non-arm's length loan arrangements. Furthermore, the fact that the feature is a de facto tax reduction for domestic companies, one could hardly argue that Norway has any just interest in taxing foreigners on the same income which is basically exempt in a domestic situation.
Seemingly confident that their legal argumentation will prevail, the ministry states in its letter to ESA that it is planning changes to the interest cap rules, which are expected this year. The impression from the letter is that it is not an urgent matter for the ministry and that it does not mind that the case could end up in the EFTA Court. In line with OECD's BEPS reports, the ministry plans to include external interest expenses, which will be viewed as controversial, and some kind of a group ratio rule (either equity over assets or interest expenses over EBITDA at a group level). Our bet is that this case will end up in the EFTA Court and the outcome will have a bearing on reassessment claims.
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