Tax

Increased tax bill for intra group funding – but solutions exist

In the State Budget for 2014, last revised on November 8th, the Norwegian Government proposed a restriction on the right to deduction for interest paid to related parties.  This new legislation is expected to be effective from January 1th 2014, and will affect international group of companies.

The proposed legislation
The legislation proposed by the Government is as follows:  

  • Companies will no longer be able to deduct interest paid to internal parties, exceeding 30 % of a particular calculation basis (taxable EBITDA).
  • The restriction includes all businesses, except financial institutions subject to Norwegian Act on Financing Activity and Financial Institutions.
  • Only net interest exceeding NOK 5 000 000 will be subject to the restrictions.
  • Interest on debt that has been cut off, can be carried forward for 10 years.

The proposed legislation may have a negative effect on many companies, especially large company groups. Thus, each company should calculate whether their internal interest are deductible or falls within the restriction. Net interest expenses include all interest expenses and income that fall within the general tax law concept of interest, including loan with premium and discount. The calculation is based on each company’s ordinary income before tax, interest, depreciation and amortization, i.e. a taxable EBITDA. Deduction allowed is 30 % of this calculation. Internal interest that exceeds this limit will no longer result in tax deduction in Norway, which implies a higher taxable income for large company groups.  The effect of this new rule will be exemplified later in this article.

Who will be affected?
The companies affected by this legislation are primarily limited liability companies and public limited companies, but also cooperative societies, intermunicipal companies, partnership companies, Norwegian branches of foreign companies and state-owned enterprises, will be affected. Banks and other financial institutions are not subject to the restriction.

Included in the restriction are only interest paid to related parties. This means, if a party has any direct or indirect ownership or control of at least 50 % of another company, they will be considered related. The interest limitation rule applies if ownership or control of at least 50 % is fulfilled at any time during the tax year. External interest paid will still be fully deductible.

Interest paid directly to relate parties are, of course, subject to the restriction. Note that also interest paid to non-related parties are covered, if a related party has guaranteed for the loan. This means that a guarantee from the parent company for the subsidiary’s loan, that exceeds NOK 100 000 000 at 5 % interest (our example), will result in a higher taxable income for the subsidiary due to the proposed restriction.

However, the Government is considering the possibility to make an exception in a provision of law for some types of loan guaranteed by a related party. This exception is not yet published, but may include loan guaranteed by a company which is partly owned by the borrower and if stocks in the borrowing company are used as a guarantee.

A practical example
A subsidiary takes over an urban business premises for NOK 100 million. The financing is arranged by the parent company, which uses excess value of the Group as equity and borrows from a bank. Then, the liquidity is transferred to the subsidiary, which pays market interest to the parent company. The internal interest is 6 %, similar to the parent company’s rent obligation to the bank.

Prior to the restriction, ordinary result in the subsidiary will be as follows: 

Return on property (ex. 6,5%) NOK  6 500 000
Operating cost NOK     500 000
Depreciation NOK  2 000 000
Interest NOK  6 000 000
= Ordinary income NOK (2 000 000)

Deductible interest after the proposed restriction:

Ordinary income NOK (2 000 000)
+ reversal of tax depreciation NOK  2 000 000
+ reversal of paid interest NOK  6 000 000
= Basis of calculation NOK  6 000 000
 
Net deductible interest (30 %) NOK  1 800 000

 After the restriction, taxable income for the subsidiary will be as follows:

Return on property (ex. 6,5%) NOK 6 500 000
Operating cost NOK    500 000
Depreciation NOK 2 000 000
Interest NOK 1 800 000
= Ordinary income NOK 2 200 000

In this example, the subsidiary will not receive tax relief for internal interest, face value NOK 4 200 000, paid to the parent company. The company may carry this amount forward for 10 years, but is subject to a positive result for a future utilization during this period. If not, the subsidiary will receive an additional tax bill from the Norwegian tax authority, face value approximately NOK 600 000 (27 % of 2 200 000) – and this is only for the first year.

Possible adjustments
Company groups with substantial internal loans ought to, as a consequence of these restriction, revaluate and possible rearrange the financing of the group.

In general, the negative effect due to the new restrictions may be reduced as follows:

  1. A parent company borrows from the bank and transfers an amount to subsidiary as capital contribution. The subsidiary gives the parent company a group contribution, so the parent company receives adequate cash to meet the loan obligation.
  2. Two companies may consider a merger, if one company has high gearing financed by related parties and if the other company primarily is financed by equity capital.

Each company group will need a specific solution to limit the negative effects provided by the new rule of restriction. Different models may be used to limit the consequences – it is possible to find a solution to accommodate your business.  

 

This article has been written by Partner Ove-Marthin Granlund and Associate Janne Sylta Hagen

Janne Sylta Hagen, jsh@steenstrup.no
Janne Sylta Hagen is an associate at Steenstrup Stordrange in Oslo and a member of the firm’s tax group. She gives advice to new businesses on establishing and structuring of the business, and existing businesses in tax issues, mergers/demergers and structuring of group-companies.

 

The Author

Ove-Marthin Granlund
Ove-Marthin Granlund Ove-Marthin Granlund is leader of Steenstrup Stordrange’s Tax Practice which organises the tax expertise in all the firm’s offices throughout the country. He assists clients with purchases and sales of businesses and takeovers and has ongoing projects related to the management and development of commercial property.

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