Global Tax Alert | 15 October 2013

Norway releases 2014 Budget with proposals on new interest deductibility restrictions and reduction of corporate income tax rate

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Executive summary

On 14 October 2013, Norway’s Labor Party-led Government released the 2014 National Budget (the Budget). The Budget includes proposed significant restrictions on the deduction of interest paid to related parties and is broadly in line with the consultative paper published by the Ministry of Finance in April this year.1 In addition, the Government proposes to reduce the corporate income tax rate from 28% to 27% with effect from 1 January 2014.

The Labor Party-led Government lost the election this fall and will on 18 October concede power to the new Two-party Conservative Coalition Government. This new Government will present a revised National Budget mid-November, and it remains to be seen if it will support the law proposal.

Major changes from the consultative paper include:

  • The amount of interest which may be deducted is increased from 25% of taxable EBITDA (earnings before interest, taxes, depreciation, and amortization) to 30% of taxable EBITDA.
  • The carry forward period for interest expenses which previously have been denied is extended from 5 to 10 years.
  • External loans will in certain cases be covered by the proposed rules if supported by a guarantee by a related party.
  • An increased threshold for when the rules will apply from NOK 1 million to NOK 3 million.2
  • For Norwegian permanent establishments, the ratio between external and internal interest expenses shall be decided based on the ratio between internal and external debt at the level of the foreign head office company.
  • Entities subject to the Norwegian Petroleum Tax Act is not covered by the proposal.
  • In line with the consultative paper, the proposal does not contain an escape clause.

Currently, interest expenses are fully tax deductible in Norway. According to the new rules proposed in the Budget, interest expenses would be fully deductible against interest income. Interest expenses exceeding interest income (i.e., net interest expenses) would be fully deducted if the total amount of net interest expenses does not exceed NOK 3 million during the fiscal year or if they are paid to a non-related party. Otherwise, net interest expenses paid to a related party could be deducted only to the extent they do not exceed 30% of the taxable business profit after adding back net internal and external interest expenses and tax depreciations (a taxable EBITDA approach).

The taxable business profit includes received group contributions, while provided group contributions will reduce the taxable business profit. This implies that within a Norwegian tax group (90% holding requirement in each tier), there are potential opportunities to adjust the taxable EBITDA, and thus the amount of interest which may be deducted.

Detailed discussion

The scope of the restrictions

The proposal sets out a general restriction on interest deductibility which would apply to corporations and transparent 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. However, entities subject to the Norwegian Petroleum Tax Act are not covered by the proposal. The reason is that the rules presented in the consultative paper could potentially create adverse negative consequences for such companies. The government has indicated that they will come back with amendments to include petroleum taxed entities at a later stage.

Illustration of the proposed interest limitation rule

The below illustrative example assumes that the group company is financed with internal debt.

Ordinary income (before the effect of the interest limitation rule)

200

+

Tax depreciations

40

+

Net interest expenses

160

=

Basis of calculation

400

Max. deduction for related interest expenses (30% of the basis of calculation)

120

Net interest expenses paid to related parties

30*

Interest deduction limitation rule – income is increased with

30*

* May be carried forward for10 years

Definition of related parties

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.

Interest payments on third party debt will not be covered by the proposed new rules. However, contrary to what was presented in the consultative paper, third party debt will in certain cases be deemed as intra-group loans if the external loan is guaranteed by a related party of the lender. It is unclear from the proposal whether such third party debt only will be deemed as tainted debt in structures where the guarantee is a condition for obtaining the third party loan, as opposed to situations where the guarantee will provide for more favorable loan terms (lower interest). The security must be based on a legally binding agreement with the lender. “Letters of comfort” issued by parent companies generally will not imply that the third party debt will be regarded as tainted debt, as long as the security has not influenced the subsidiary’s debt capacity.

In line with the consultative paper, certain back-to-back arrangements will be covered by the proposed rules.

Interest expenses paid by Norwegian PE

With respect to Norwegian PEs, the ratio between external and internal interest expenses shall be decided based on the ratio between internal and external debt at the level of the foreign head office company. The debt of the foreign head office company will be decided as the average of the internal and external debt as of 1 January and 31 December in the income year.

Entities exempt from the proposed rules

Financial institutions as defined in the Financial Services Institution Act section 1-3 and 2-1 are not covered by the proposal. Such institutions comprise of among others, banks, savings banks, credit institutions, Norwegian PEs of foreign financial institutions and parent companies of financial groups.

Carry forward of non-deductible interest expenses

Interest expenses that cannot be deducted during the fiscal year can in general be carried forward for 10 years. However, the forwarded interest expenses cannot exceed 30% of the basis of the calculation to be made in any future year. Any carry forward non-deducted interest expenses shall be deducted before the current year’s interest expenses.

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 expenses will become non-deductible. The new restrictions would also increase the importance of group contributions as a tax planning method since received group contribution will increase the taxable profit for the purpose of the 30% threshold calculation. Non-deductible interest expenses carried forward would create temporary differences between accounting and taxation, potentially leading to recognition of deferred tax assets.

The proposed rules will also apply to intra-group loans between Norwegian group companies, and the rules are asymmetric. This means that a Norwegian creditor company will be taxed on any excessive interest income even if the equivalent excessive interest expenses are non-deductible for the Norwegian debtor company.

The proposed rules may potentially be in breach of the rules on freedom of establishment under the EEA (European Economic Area) agreement, and if enacted, it must be assumed that an infringement action will be brought against Norway.

The new rules are proposed to enter into force on 1 January 2014, restricting deductibility of interest paid after this date. The rules will also apply to debt drawn before 1 January 2014. The rules will also apply to companies with deviating tax year ending in 2014, which implies that the rules will have retroactive effect for 2013.

Endnotes

1. For details, see EY Global Tax Alert, Norway proposes restrictions on related party interest expense deductions, dated 15 April 2013.

2. Approximately equivalent to US$175,000 to US$425,000.

For additional information with respect to this Alert, please contact the following:

Ernst & Young AS, Oslo
  • Øyvind Hovland
    +47 24 00 22 38
    oyvind.hovland@no.ey.com
  • Aleksander Grydeland
    +47 24 00 22 30
    aleksander.grydeland@no.ey.com
  • Kari Augestad-Dyrhaug
    +47 24 00 29 51
    kari.dyrhaug@no.ey.com
Ernst & Young LLP, Scandinavian Tax Desk, New York
  • Martin Norin
    +1 212 773 2982
    martin.norin@ey.com

EYG no. CM3881