Global Tax Alert | 15 April 2013
Norway proposes restrictions on related party interest expense deductions
On 11 April 2013, the Norwegian government published a consultation paper that would impose significant restrictions on the deduction of interest paid to related parties. Currently, interest expense is fully tax deductible in Norway. According to the consultation paper, interest expense would be fully deductible against interest income. Interest expense exceeding interest income (i.e., net interest expense) could be fully deducted if the total amount of net interest expense does not exceed NOK 1 000 000 (approximately US$175,000) during the fiscal year or if the interest is paid to a non-related party. Otherwise net interest expense paid to a related party could be deducted only to the extent internal and external interest expense combined does not exceed 25% of the taxable business profit after adding back net internal and external interest expense and tax depreciation (a taxable EBITDA – earnings before interest, taxes, depreciation, and amortization – approach). The change is proposed to enter into force on 1 January 2014. The rules will also apply to debt drawn before 1 January 2014.
Scope of the restrictions
The paper sets out a general restriction on interest deductibility which would apply to corporations, partnerships, and limited partnerships as well as Norwegian permanent establishments (PEs) of foreign companies. The restriction would apply to interest payments made to related parties in both domestic and cross-border situations.
Companies taxed under the tonnage tax regime and under the hydro power tax regime will also be subject to the interest restrictions, but it is uncertain exactly how these rules will apply to these entities.
Illustration of the proposed rule
The following example of the interest limitation rule assumes that the group company is financed with internal debt.
Ordinary income (before the effect of the interest limitation rule).
Net interest expense
Basis of calculation
Max. deduction for related interest expenses (25% of the basis of calculation).
Interest expenses not deductible
Related party definition
The creditor and the debtor would be considered as related if either the creditor or the debtor, at any time during the fiscal year, has control over the other. A related party is defined in the paper as a person, company or entity which directly or indirectly controls at least 50% of the debtor, or a company or entity controlled at least 50% by the debtor. For PEs, all debt will be considered as related-party debt unless the PE, without any involvement from the head office, has borrowed from a third-party.
Interest payments on third party loans will not be affected. However, third party loans will be deemed as intra-group loans if a related party pledges to an unrelated party a receivable as security for the loan and the unrelated party provides a loan to another related party, or the loan from an unrelated party is de facto a back-to-back loan from a related party.
Carry forward of non-deductible interest expense
Interest expense that cannot be deducted during the fiscal year can in general be carried forward and deducted in the following five fiscal years.
Effect of the new rules
Under the new rules, it will be important to monitor the mix between equity, external debt and internal debt in order to ensure that interest expense will be deductible. The new restrictions would also increase the importance of group contributions as a tax planning method since the received group contribution increases the taxable profit upon which the 25% threshold is calculated. The proposed restriction would create a need for companies to track the interest expense which could not be deducted in their reporting systems. Non-deductible interest expense carried forward would create temporary differences between accounting and taxation, potentially leading to recognition of deferred tax assets. Net interest income will still be fully subject to tax.
Petroleum Tax Regime implications
The Petroleum Tax Act includes a formula for (initial) allocation of interest expense including foreign exchange gain/loss between:
- • The petroleum tax regime (offshore) subject to total of 78% tax (50% special tax + 28% ordinary tax); and
- • The ordinary tax regime (onshore) subject to 28% ordinary tax.
The allocation offshore is limited to 50% x net taxable value of assets/daily average debt. This normally means that a significant portion of interest expense is allocated onshore. For companies in the exploration phase, close to 100% of interest expense will be allocated onshore.
However, current legislation also allows companies with insufficient onshore income to “allocate back” initial allocated interest expense onshore against ordinary offshore income subject to 28% tax. This has ensured that all oil and gas companies, in particular those with no or limited onshore activity, essentially obtain full interest expense deductions against the ring fenced offshore ordinary tax basis of 28%. This has prevented a “lock-in” of onshore tax losses.
The new rule will not apply to offshore income. However, according to the paper, the new rule shall apply to onshore income for the oil and gas companies. The proposal further states that the companies will only be allowed to “allocate back” to offshore that part of the onshore interest expense deductions that will not be disallowed under the new rule.
The proposal will most likely have a significant negative impact for most of the oil and gas companies in respect of onshore income. This may result in no or very limited interest expense deductions against the ordinary tax regime.
Public comments to the proposal are requested by 24 June 2013.
No date has been set for drafting of the final proposal but is anticipated that legislation will be presented this fall with a decision by the Parliament before year-end.
For additional information with respect to this Alert, please contact the following:
EY AS, Oslo
- • Øyvind Hovland
+47 24 00 22 38
- • Aleksander Grydeland
+47 24 00 22 30
Ernst & Young LLP, Scandinavian Tax Desk, New York
- • Martin Norin
+1 212 773 2982
EYG no. CM3354