Norway: Interest limitation rules restrict freedom of establishment, ESA states

Trond Eivind Johnsen

"Norway has failed to fulfil its obligations arising from Article 31 of the EEA Agreement", states the EFTA Surveillance Authority (ESA) in a letter of formal notice to the Norwegian Ministry of Finance dated May 4 2016. The reason is Norway's interest limitation rules combined with the group relief rules

The Norwegian interest limitation rules disallow the deduction of interest expense on intragroup debt (and third-party debt guaranteed by an affiliated party) that is more than 25% of the taxpayer's earnings before interest, taxes, depreciation and amortisation (EBITDA) for tax purposes. The rules apply equally to all Norwegian taxpayers, regardless of the group's domestic or cross-border presence.

The Norwegian group relief scheme allows Norwegian resident group companies or Norwegian branches of EEA resident group companies to exchange "group contributions". The distributing company can deduct the contribution within the frame of its taxable income. The recipient must add the contribution to its taxable income, which in turn can be set off against the taxpayer's losses.

Either the group contributions can function as a substitute for internal debt, to transfer capital/debt within the group, or it can be used to adjust the EBITDA to increase deductibility of interest expenses. According to the ESA, domestic groups, due to their access to the group relief scheme, are in reality unaffected by the interest limitation rules, while EEA resident groups cannot in the same way access the relief scheme to neutralise or avoid the effects of the interest limitation rules. Thus, it seems that ESA is of the view that when comparing solely domestic groups with cross-border groups, only the latter is de facto affected by the interest limitation rules, which in turn leads to a higher tax charge for such groups. In conclusion, the ESA states:

The legislation at issue amounts to a restriction on the freedom of establishment for groups of companies where the loan is provided by an affiliated company residing in another EEA State in cases where the conditions for eligibility for group contributions would have been fulfilled had both companies been Norwegian residents.

Upon stating the existence of a restriction, the ESA continue to investigate whether the restriction is justified by overriding reasons in the public interest and further if the rules go beyond what is necessary to attain that objective ("the proportionality test"). While ESA easily conclude that the objective of preventing tax abuse is an "overriding reason of public interest", they find that the rules are not proportionate.

The Norwegian interest limitation rules rely solely on objective elements and ESA states that the "rules lead to a general presumption of abuse". However, the rules are not designed with the objective to prevent "wholly artificial arrangements" only, and there was no assessment on the substance vs artificiality of the debt arrangement in the application of the rules. In the absence of an escape clause giving taxpayers the possibility to provide economic justification for their intragroup arrangements, the ESA found that the rules violate the EEA agreement.

The Norwegian authorities have two months to give their view on the formal notice. If their response fails to satisfy ESA, they can expect a reasoned opinion on the alleged breach, which in turn could result in either a law change or an EFTA court case.

It will be interesting to read the response from the Norwegian authorities. The ESA's understanding of the Norwegian rules in question may seem to lack some nuances, which we do expect the Norwegian authorities to point out. Our experience is that also domestic groups, regardless of their access to group contributions, are limited by the interest limitation rules – not only in theory, but also in practice.

Trond Eivind Johnsen (tjohnsen@deloitte.no)

Deloitte Norway

Tel: +47 901 94 496

Website: www.deloitte.no