Legal updates covering current topics.
The deductibility of interest expenses has been limited since 2014, but only in relation to related party debt. Currently, interest expense is always deductible up the amount of interest income. Further, interest expense exceeding interest income (“net interest expense”) is deductible provided that the amount does not exceed EUR 500,000. If the said EUR 500,000 threshold is exceeded, Finland applies a fixed ratio rule limiting a Finnish company’s tax deductions for net interest expenses on related party debt to 25% of its EBITDA (as adjusted for tax purposes). For calculation purposes, however, both related party and third party debt are taken into account and to the extent that the interest expenses exceed EUR 500,000, the entire amount is subject to the fixed ratio rule. The rules apply on a company-by-company basis, although, for example, amounts of group contributions are added back or deducted, as applicable, from the EBITDA figure. Further, the restrictions on interest deductibility are not applied if the borrower company’s equity ratio (equity vs total balance) is equal to or higher than the same ratio calculated on the basis of a consolidated group balance sheet of the ultimate parent (the “balance sheet test”). In addition, certain industry sectors, such as banking, insurance and most real estate businesses, are currently also excluded from the application of the rules.
In response to the Anti-Tax Avoidance Directive (ATAD I) compiling the BEPS issues identified in the BEPS project, the Finnish government issued last Friday a draft government bill introducing new restrictions on the tax deductibility of interest expenses that are more consistent with the OECD recommendations. Under the proposed new rules, the fixed ratio rule of 25% will remain, but the limitations will be extended to cover also third party debt. Similarly, the EUR 500,000 de minimis rule on related party debt will remain, but companies will, additionally, be faced with a net interest expense threshold of EUR 3,000,000 on third party debt. However, for calculations purposes, interest expenses on third party debt are always deducted first and interest expenses on related party debt may be deducted only to the extent that they are within the 25% fixed ratio rule, assuming that the total amount of net interest expenses exceed the EUR 500,000 threshold. It is additionally proposed that both the balance sheet test and the exclusion of banking, insurance and real estate businesses from the scope of the rules is abolished. Accordingly, all businesses are effectively proposed to come within the scope of the new rules, although purely independent companies (non-group companies) will still be left out.
Clearly, the EUR 3,000,000 de minimis rule on third party debt will target at large businesses where the greatest BEPS risks lie, which, accordingly, to some extent will minimise the impact on smaller companies. The new rules are generally not expected to impact on banking and insurance companies due to the significant net interest income arising from their main operating entities. However, it also means that the effectiveness of the fixed ratio rule could be reduced for groups (through the Finnish group contribution regime) that have, for example, banking type of activities alongside their other businesses. Nonetheless, also banking companies could temporarily find themselves in a net interest expense position as a result of, for example, impairment losses. The position is less clear for investment banking companies which may have leveraged balance sheets but at the same time generate significant non-interest income from advisory, underwriting, and equity or commodity trading businesses.
For real estate companies, the proposed new rules may have a particular impact on the cost of capital as they tend to be more highly leveraged in Finland compared with many other businesses. This could potentially affect their investment decisions and make some marginal investments uneconomic. In the real estate business, EBITDA is sometimes also an ineffective way to measure debt leverage as a number of Finnish real estate companies, due to their structure, have a fairly low EBITDA. Also, as real estate companies are currently not in a position to use the Finnish group contribution regime, and unless these rules are changed, the impact on real estate companies could be more severe compared to others. However, if for example a real estate portfolio is split in a greater number of single real estate companies, each financed based on the target’s particular needs, the net interest expense per each single real estate company could be reduced to have the interest expense match the relevant threshold.
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