Thin-Cap Rules in Europe August 27, 2020 A. Kristina Zvinys A. Kristina Zvinys High-tax countries create an incentive for companies to finance investments with debt because interest payments are tax-deductible, which is usually not the case for equity costs. This encourages global businesses to lend money internally from entities in low-tax countries to entities in high-tax countries. Tax savings in high-tax countries can exceed the increased tax paid in low-tax countries, decreasing worldwide tax liability. To discourage this form of international debt shifting, many countries have implemented so-called thin-capitalization rules (thin-cap rules), which limit the amount of interest a multinational business can deduct for tax purposes. The two most common types used in practice are “safe harbor rules” and “earnings stripping rules.” Safe harbor rules restrict the amount of debt for which interest is tax-deductible by defining a debt-to-equity ratio. Interest paid on debt exceeding this set ratio is not tax-deductible. Earnings stripping rules limit the tax-deductible share of debt interest to pretax earnings. Four of 27 countries covered have only a debt-to-equity ratio in place. For instance, Turkey’s debt-to-equity ratio is 3:1. Let’s say a Turkish business takes a $100 loan from its foreign subsidiary. Its current equity amounts to $10, resulting in a debt-to-equity ratio of 10:1. The annual interest on the loan is 5 percent, or $5. Because the business’ debt-to-equity ratio is 10:1 but Turkey’s debt-to-equity ratio is 3:1, only 30 percent of the interest, or $1.5 of the $5, is tax-deductible. Most of the European countries covered have interest-to-pretax-earning limits in place. Most commonly, the limit is set at 30 percent of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). For example, assume that a parent company takes a $100 loan from its subsidiary requiring interest payments of $5. If EBITDA are $10, only $3 (30 percent of $10) of the $5 in interest paid is tax-deductible. Ireland is the only country covered in this map with no thin-cap rules. It is important to keep in mind that thin-cap rules not only limit international debt shifting but can also impact real economic activity, such as investment and employment. Detailed information on OECD countries’ interest deduction limitations can be found here. Thin-Cap Rules in European OECD Countries, as of 2020 Country Interest Deduction Limitations Austria (AT) Informal 4:1 debt-to-equity ratio applies Belgium (BE) Interest deductions limited to the higher of €3 million or 30% of EBITDA 5:1 debt-to-equity ratio applies to intragroup loans 1:1 debt-to-equity ratio applies to receivables from shareholders or directors, managers, and liquidators Czech Republic (CZ) Interest deductions limited to the higher of CZK 80 million or 30% of EBITDA 4:1 debt-to-equity ratio (6:1 debt-to-equity ratio for certain financial services companies) applies Denmark (DK) 4:1 debt-to-equity ratio applies Interest deductions are limited to 2.7% of assets Interest deduction limited to 30% of EBITDA Other rules can apply Estonia (EE) Interest deductions limited to the higher of €3 million or 30% of EBITDA Finland (FI) Interest deductions limited to 25% of EBITDA Net interest expenses between non-related parties limited to €3 million France (FR) Interest deductions limited to the higher of €3 million or 30% of EBITDA Different limits apply to related-party debt Germany (DE) Interest deductions limited to 30% of EBITDA if deduction exceeds €3 million Greece (GR) Interest deductions limited to 30% of EBITDA if deduction exceeds €3 million Hungary (HU) Interest deductions limited to the higher of €3 million or 30% of EBITDA Iceland (IS) Interest deductions limited to 30% of EBITDA Rule does not apply if total interest paid does not exceed ISK 100 million Other exemptions can apply Ireland (IE) None However, in specific cases, interest can be reclassified as a dividend Italy (IT) Interest deductions limited to 30% of EBITDA Latvia (LV) 4:1 debt-to-equity ratio applies for deduction up to €3 million (certain financial institutions exempt) Interest deductions limited to 30% of EBITDA for deduction exceeding €3 million (certain financial institutions exempt) Lithuania (LT) 4:1 debt-to-equity ratio applies Interest deductions limited to €3 million or 30% of EBITDA Rule does not apply if entity’s debt-to-equity ratio is not lower (or at most 2 percentage-points) than the group-consolidated ratio Luxembourg (LU) Informal 85:15 debt-to-equity ratio applies Interest deductions limited to 30% of EBITDA if deduction exceeds €3 million (financial institutions exempt) Netherlands (NL) Interest deductions limited to the higher of €1 million or 30% of EBITDA Norway (NO) Interest deductions limited to 25% of EBITDA if deduction exceeds NOK25 million Poland (PL) Interest deductions limited to 30% of EBITDA if deduction exceeds PLN 3 million Portugal (PT) Interest deductions limited to the higher of €1 million or 30% of EBITDA Slovak Republic (SK) Interest deductions limited to 25% of EBITDA (financial institutions exempted) Slovenia (SI) 4:1 debt-to-equity ratio applies Spain (ES) Interest deductions limited to 30% of EBITDA if deduction exceeds €1 million Sweden (SE) Interest deductions limited to 30% of EBITDA if deduction exceeds SEK 5 million Switzerland (CH) Debt-to-equity ratios apply and vary by asset class Turkey (TR) 3:1 debt-to-equity ratio (6:1 for financial institutions) applies United Kingdom (GB) Interest deductions limited to 30% of EBITDA if deduction exceeds GBP 2 million Source: Bloomberg Tax, “Country Guides: Anti-Avoidance Provisions – Thin Capitalization/Other Interest Deductibility Rules,” https://www.bloomberglaw.com/product/tax/bbna/chart/3/10077/a8a08d05c9450b676b4d835dbb64348c; and PwC, “Worldwide Tax Summaries: Corporate – Group taxation,” https://taxsummaries.pwc.com/australia/corporate/group-taxation. Stay informed on the tax policies impacting you. Subscribe to get insights from our trusted experts delivered straight to your inbox. Subscribe Share Tweet Share Email Topics Center for Global Tax Policy Business Taxes Data Global Tax Maps Taxation of Multinational Businesses Tags Thin-Cap Rules
