Multinational groups cannot react fast enough to BEPS Action 4
The move from principle-based approaches to mechanical-based approaches could expose multinationals to permanent instances of over-taxation or double taxation under BEPS Action 4 across jurisdictions.
The variation in the domestic adoption of BEPS Action 4, which restricts interest deductible income, is a growing concern for multinationals because their group leveraging operations may come under fire from tax authorities.
“These restrictions may reduce the possibilities of BEPS, but [they are] still automatic and mechanic, and the taxpayer cannot react to it,” said Sandra Fernandes, tax principal at the European Bank for Reconstruction and Development, at the International Fiscal Association’s (IFA) 2019 Congress in London.
Jurisdictions are moving away from a principle-based approach such as the arm’s length principle (ALP) to a more mechanical-based approach in order to restrict interest deductibility on group income because multinationals can shift debt around to get outsized interest deductions, relative to the economic activity of their entities.
Domestic authorities are introducing interest allocation rules to align interest deductions with taxable economic activity, but multinational taxpayers with complex group structures cannot react quickly enough to domestic changes, according to advisers and taxpayers attending the IFA conference.
Despite the difficulties in following multi-layered rules on interest deductibility, there is some good news for taxpayers as the rules can include a de minimus threshold at 30% and exclude public benefit and infrastructure project expenses.
Some multinationals may find relief through ‘group equity escape' options such as public benefit projects. Interest carry back and carry forward options can transform a permanent double tax situation into a temporary issue, but rigid rules on EBITDA ratios are creating a discord that taxpayers are finding increasingly uncertain to navigate. This may lead to permanent double taxation or over-taxation situations.
“Our experience with group equity escape is that it is not widely used because it is relatively complex and has some obstacles, especially for companies that have more complex international structures,” said Bernd-Peter Bier, head of group finance at Bayer.
It is not just large multinational groups that can get tripped up by the effects of cross-border rules on interest deductibility. For example, a start-up with no earnings and hundreds of interest expenses could be targeted under the mechanical rules, where their expenses are considered excessive and not deductible.
Double taxation results from an interest tax barrier, which the OECD has recommended should be capped at 30% of EBITDA at the higher end. However, this restriction is not covered by the treaties that define double taxation, according to taxpayers. Most countries have chosen to implement the fixed ratio rule at 30% in order to remain competitive in drawing foreign direct investment.
There are layers of disallowance on deducting interest expenses, interest paid in excess of arm’s length and the limits on debt-to-equity.
“A taxpayer could see a double whammy if [their] operations cover transfer pricing and BEPS Action 4 [on group interest restrictions],” said Karishma Phatarphekar, tax partner with Deloitte India.
Industry over-taxation of interest under transfer pricing rules, thin capitalisation rules, and interest barrier rules puts pressure on multinationals and can risk slowing down international business by restricting multinationals from expanding their market share.
Advisers at IFA said that the EU is starting to see a harmonisation of rules on interest deductions and may be able to address situations and find an effective approach for taxpayers faster than other jurisdictions. A poll at the conference showed that 71.7% of taxpayers would have preferred the OECD to have tackled debt and equity bias, rather than limiting interest deductibility.
As multi-layered rules on interest deductions continue to enter the international tax environment, jurisdictions may eventually see more consistency, as examples of taxpayer difficulties on deducting interest continue to surface.