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Newsletter no 3/2013 - Tax

Published 10/15/2013

The Norwegian Ministry of Finance has issued a proposal to limit the deduction of net interest expenses paid to related parties

1. Introduction

In connection with the publication of the Norwegian National Budget for 2014 on 14 October 2013, the Norwegian Government issued a proposal to limit the deduction of net interest expenses paid to related parties. The draft legislation was expected as the Norwegian Ministry of Finance issued a discussion note earlier this year presenting the proposal.

Further to the Norwegian Parliament election this autumn, there will in a short time be a change of Government in Norway. It is, however, in our view not very likely that the new Government will withdraw or make significant changes in the proposed limitation of interest deduction, although this cannot be completely excluded.

2. Background

Currently, the Norwegian Tax Act allows Norwegian companies, within the range of the arm's length principle, to deduct both internal and external interest without any limitations. The general right under the Tax Act for deduction of interest has made it economically advantageous for multinational groups to grant loans (with high interest rates) from companies resident in low tax countries to Norwegian group companies. A structure where the Norwegian borrowing company benefits from full interest deduction, combined with low or no interest taxation of the lending company, implies that the aggregated tax payable of the group can be reduced considerably.

In order to eliminate, or at least reduce, the risk of tax planning within multinational groups, the Norwegian Government has issued draft legislation proposing to limit the deduction of net interest paid to related parties.

3. The proposed limitation of interest deduction

The proposal implies that interest exceeding 30 per cent of a calculated basis (the "Calculation Basis") is not deductible (the "Limitation Rule"). The Limitation Rule shall as a starting point only apply to interest paid on internal loans, meaning that interest on external loans will still be fully deductible.

The Limitation Rule is based on a model where the right to deduct interest is limited based on the company's result, calculated on the basis of the fiscal income and costs items. This calculation method implies a fiscal approach to the company's EBITDA, which gives an indication of the company's cash flow. The disadvantage of the model is that the right to deduct interest will be reduced in years with low results, however, this disadvantage is proposed compensated by a right to carry forward "unused" interest deduction subject to the Limitation Rule the following ten income years.

The limitation is proposed to be implemented as of the income year 2014, and will apply to existing loans.

4. How to determine the limitation

The Calculation Basis is to be calculated on the basis of the company's ordinary income (before the effect of the Limitation Rule) plus the net interest cost and depreciations.

Net interest cost is calculated as the difference between the company's interest costs less interest income. The term "interest" with respect to the Limitation Rule should be interpreted in accordance with the ordinary tax meaning given to this term in Norwegian tax law. Hence inter alia guarantee commissions, gains and losses (in their entirety) on convertible loans and other composite instruments including a bond/loan element which cannot be divided for tax purposes, and currency gains- and losses on debts are to be included in the calculation of "net interest costs".

An example of how to determinate the Calculation Basis is included below:

 

Ordinary income (before the effect of the Limitation Rule)

200 
 +   Depreciations  40
 +  Net interest costs  160
 =

Calculation Basis

 400
   30 per cent of the Calculation Basis (max. interest deduction)  120
   Net interest on internal loans  30
     
  The limitation of interest deduction would in principle be 40 as net interest costs are 160 and the maximum interest deduction is 120. However, the limitation of interest deduction cannot exceed the interest paid on internal loans. Hence, in this example the denied interest deduction is 30.   
   Denied interest deduction  30

 

As follows from the example, even if the Limitation Rule as a starting point does not apply to external interest, such interest may displace the internal interest which exceeds 30 pts. of the Calculation Basis.

5. Who is subject to the Limitation Rule

In the draft legislation, the Ministry of Finance emphasize that the Limitation Rule should apply independent of the type of corporate organization. Hence, it is proposed that the Limitation Rule shall apply to:

  • Limited liability companies, and other companies and entities taxed in Norway as separate entities
  • Transparent entities (companies not considered separate entities for tax purposes) and CFC-companies
  • Companies and entities with limited tax liability to Norway (i.e. permanent establishments of foreign companies)

However, the proposal does not include individual persons. In addition, according to the proposal the limitation will not apply to companies with total net interest costs of less than 3 million Norwegian kroners (a threshold value, and not a basic tax-free allowance).

The Limitation Rule will as a starting point only apply to loans between related parties. However, it is stated in the proposal that the limitation may also apply to certain internal loans such as loans between related parties trough an external party (back-to-back) or loans where a related party has furnished security for the loan.

Apart from a requirement that the lender must be a related person, there are no limitations as to which entities or persons may be the lender in a transaction subject to the Limitation Rule, nor to the country of residency of the lender.

6. Community of interests – related parties

It is proposed that the term "internal interest cost" shall be defined as interest paid to a related party. A related party is e.g. a person, company or entity which the borrowing company directly or indirectly owns or controls with at least 50 per cent, or a person, company or entity which directly or indirectly owns or controls the borrowing company with at least 50 per cent.

When determining whether the lender is a related party in connection to transparent entities and CFC-companies, the ownership requirement shall be applied as if the relevant company was a separate entity for tax purposes, and not in relation to each partner/shareholder.

It is proposed that the Limitation Rule shall apply if the lender is deemed to be a related party to the borrower at any point in time during an income year.

7. Carry forward of interest subject to the Limitation Rule

As stated above, the Limitation Rule is based on a model where the right to deduct interest expenses is limited based on the company's result. As the result will vary each year, the right to deduct interest expenses will be reduced in years with low results. This disadvantage is proposed compensated by the right to carry forward the interest expenses subject to the Limitation Rule the following ten income years.

8. Specific companies and industries

In addition to a general assessment of the Limitation Rule, the proposal set out how the rule will apply to some specific industries:

Financial institutions:

It is suggested to make an exemption from the Limitation Rule for financial institutions such as banks, insurance companies and credit institutions. The proposed exemption also includes Norwegian branches of foreign institutions. The exemption is suggested linked to the definition of financial institutions in the Norwegian Financial Institutions Act.

Petroleum companies:

In Norway, income derived from petroleum production, treatment and pipeline transportation is comprised by a special tax regime governed by the Norwegian Petroleum Tax Act. Because of a special provision in Section 3d of the Petroleum Tax Act regarding the company's financial costs, the present proposal does not include petroleum companies. However, the Ministry of Finance has stated in the proposal that the ministry as soon as possible will publish a proposal regarding how the Limitation Rule should apply to petroleum companies.

Hydroelectric power companies:

The Ministry of Finance suggests that the Limitation Rule should apply to hydroelectric power companies.

Shipping companies:

Even though a company subject to the Norwegian Tonnage Tax regime as a main rule is exempt from income taxation, the company's net financial income is subject to tax according to ordinary rules (calculated according to specific rules). It is suggested that the Limitation Rule should apply to interest corresponding to the company's financial assets, and that the Calculation Basis will be determined based on the company's net financial income.

This newsletter contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgement. BAHR will not accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this newsletter.
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Advokatfirmaet BAHR AS
Tjuvholmen allé 16, NO-0252 Oslo | PO Box 1524 Vika, NO-0117 Oslo
T: +47 21 00 00 50 | E:post@bahr.no | www.bahr.no

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