1. Current rules - restrictions on related party interests
In 2014 Norway introduced interest limitation rules restricting deductibility on interest on related party debt and debt secured by related parties. A related party loan is deemed to exist where an entity or individual party to a loan agreement directly or indirectly owns at least 50% or exercise at least 50% control over the other party to the same loan agreement. The rules apply if the single entity has net interest expenses in excess of NOK 5m. If the net interest expenses exceed NOK 5m interests on related party debt is only deductible within 25% of the company’s taxable EBITDA, but also only if the 25% allowance is not consumed by interest on external debt. If interests on external debt exceeds 25 % of the taxable EBITDA all of the related party interest costs will be restricted (but there is no limitation in the deductibility of the interest on the external debt). Restricted interest can be carried forwards for a period of up to 10 years. Carried forward restricted interests are deducted prior to current year interests once there is room for such deductions.
As related party interest expenses are limited by taxable EBITDA it means that dividend income will not provide room for interest deductions as these to a large degree are exempt under participation exemption rules. On the other hand, taxable group contributions from another Norwegian group entity will be included in the tax EBITDA. The latter aspect of the current rules has been deemed a restriction under the EEA agreement by ESA. As a response, the Norwegian government notified ESA that it was working with new rules that would address this issue, whilst at the same time stating its disagreement.
2. New rules - extensions to external interest expenses
After a public hearing in the spring/summer of 2017 the ministry notified that it was working with new rules that it intended to present in time for them to enter into force as of January, 1 2019. The proposal for new rules were presented in the budget for 2019 made public on October 8.
The main change in the proposal is that the interest limitation rules for Norwegian companies that is part of a group will be extended to third party interest expenses. The new rules will apply only when the Norwegian companies that form part of a group have combined net interest expenses over NOK 25m. For companies in a group with interest expenses above the threshold, both related party and external interest expenses will be subject to restrictions if they exceed 25% of the tax EBITDA.
A group is deemed to exist where the companies in question is consolidated on a line by line basis in a group consolidated account prepared under IFRS, Norwegian GAAP, US GAAP, any EEA GAAP or Japanese GAAP. In addition, it will also be a group if such consolidation should have been done under IFRS (if this was applicable). Only companies that are (or could be) consolidated on a line by line basis in the group consolidated accounts are included in the group for the purpose of the new rules. Please note that if consolidation is not mandatory under IFRS such as may be the case where a top parent company is an investment vehicle (a sub group may be deemed to exist underneath such an investment vehicle), the "group" will be limited to the companies subject to mandatory consolidation group under IFRS.
Aimed at profit shifting – escape clauses
The main objective behind the rules is to prevent profit shifting. Consequently, the new rules contain escape clauses that aims to shield third party debt that is not used for profit shifting based on a comparison of equity ratios. The rules contain two alternative escape clauses;
- Single entity level; If the company in question has an equity to assets ratio that is higher or similar to the equity to assets ratio of the consolidated group on top global level, all* interest expenses are tax deductible. (We note that “similar” allows an equity ratio that is 2% lower than the ratio of the consolidated group.)
- The Norwegian part of the group: If the Norwegian part of the group has a consolidated equity to assets ratio that is higher or similar to the equity to assets ratio of the consolidated group on top global level, all* interest expenses are tax deductible.
The comparison in both cases should be made with an actual consolidated balance sheet of the top group entity globally as of the end of the prior year. This means that the balance sheet as of 31.12.18 will be important in the assessment of the applicability of the escape clauses above. If the companies in Norway are not consolidated into an actual consolidated group balance sheet, but would have been under IFRS, a consolidated balance sheet must be prepared under IFRS to enable use of the escape clauses. If a company higher up the chain than the top company that applies accepted accounting principles applies other accounting principles, it must be clarified if this higher tier company would have been obliged to prepare consolidated accounts where the Norwegian entity would be consolidated on a line by line basis under IFRS. If this is the case, such consolidated accounts must also be prepared to enable use of the escape clause.
The single entity accounts and/or the Norwegian group consolidated accounts must be prepared based on the same principles as the top group consolidated accounts. Before computing the equity to assets ratio, the rules require that certain adjustments are made to the single entity accounts;
- Positive goodwill in the consolidated accounts that are attributable to the company should be added to both balance sheet total and equity. Badwill in the consolidated accounts that are attributable to the company should be deducted from the balance sheet total and equity.
- Excess values recognized in the consolidated accounts that is attributable to the company should be added to the balance sheet total and equity. If the values recognized in the consolidated accounts attributable to the company is lower the difference should be deducted from the balance sheet total and equity.
- Deferred tax liabilities related to the excess values that are added to the balance sheet total and equity should be deducted from the equity. A deferred tax asset related to lower values that reduces the balance sheet total and equity should be added to the equity.
- If the debt of the company booked at a higher value in the consolidated accounts than in the single entity account, the difference should be added to the balance sheet total and equity. If the debt is booked at a lower value in the consolidated accounts than in the single entity accounts, the difference should be deducted from the balance sheet total and equity.
- Shares in companies that are consolidated line by line in the consolidated accounts that the global group equity ratio is based upon is deducted from the balance sheet total and equity of the company.
- Receivables on companies that are consolidated line by line in the consolidated accounts that the global group equity ratio is based upon is deducted from the balance sheet total and equity of the company.
Similar adjustments must also be made to the Norwegian consolidated accounts under the second escape clause.
An important aspect of the escape clause is that Norwegian groups without subsidiaries or branches abroad will always meet the condition under the second alternative. As such, these group companies are not required to prepare the documentation that will otherwise have to be prepared and also signed off on by the auditor.
Interest on related party loans from companies that are not part of the consolidated group
Please note that if the escape clauses are applied, interest expenses on debt from related parties that is not part of the consolidated group will continue to be subject to the current interest limitation rules that will continue to exist together with the group extension. I.e. the interests are only deductible within 25% of the tax EBITDA if the net interest expenses of the company is above NOK 5m. These rules will also apply to Norwegian companies that are not part of a consolidated group.
In addition, if the first escape clause is applied, group contribution from such companies may not be included in the tax EBITDA of companies that does not apply an escape clause.
Carry forward of restricted interests
Restricted interest deductions can be carried forward for up to 10 years. However, as the oldest interests are deducted prior to current year interest expenses, the carry forward period is for practical purposes often longer.
For a company that is part of a group who is subject to the interest limitation rules any prior year restricted interests can be deducted within 25% of the EBITDA (together with current year interests.) If the company makes use of the escape clause, prior year restricted interest can also be deducted, but only within the current year interest expenses. As such, if 25% of the tax EBITDA of a group company is higher than current year interest expenses, it may be more beneficial not to claim use of the escape clause.
For a company that is part of a group that is not comprised by the interest limitation rules, the higher of current year interest and 25% of the tax EBITDA should also be available for use of restricted interests carry forward. This however, need further clarification.
3. End note
The new rules are highly complex and will require both tax and IFRS expertise to ensure correct compliance and to benefit from the escape clauses. There are no exemptions for real estate or public infrastructure industry, and these industries may be adversely affected by the new rules if the Norwegian companies are part of multinational consolidated group.
We note that there are certain aspects of the proposal that is unclear and that clarification may come that will differ from our assumptions. The ministry of Finance will also present technical details in regulations that may impact the understanding and assumptions made by us in this memo. Further, this is a proposal and has not yet been approved by parliament.
Base on the above, no tax planning should be based on this memo and consequently BDO Advokater AS will not accept any responsibility for the use of information in this memo.