Internal Interest Will No Longer Cause A Reduction In Taxable Income
As a result of the State Budget for 2014, the proposed restriction on the right to deduction for interest paid to related parties has been implemented in the Norwegian tax legislation. The new legislation became effective on January 1th 2014 and affects both international and national group of companies. The Ministry of Finance is currently drafting exceptions from this new regulation in a provision of law.
The implemented restriction in Norwegian tax legislation
- Companies are no longer able to deduct interest paid to internal parties, exceeding 30 % of a particular calculation basis (taxable EBITDA).
- The restriction includes all businesses, except financial services.
- Only net interest exceeding NOK 5 000 000 will be subject to the restrictions.
- Debt interest that has been cut off may be carried forward for 10 years.
Net interest expense includes all interest expense and income that falls 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, which is 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.
Not only interest directly paid to a related party is subject to this new rule. Also interests paid to non-related parties are covered if a related party has guaranteed for such loan. This means that a guarantee from a parent company for the subsidiary's loan exceeding NOK 100 000 000 at 5 % interest, will result in a higher taxable income for the subsidiary due to the new restriction.
However, the Ministry of Finance is currently drafting exceptions in a provision of law for a few specific financial arrangements. Where a related party has guaranteed for a loan to a non-related party, interest will be deductible in the following situations:
- In case of loan financing where an underlying company, within a group of companies, has provided security for debt. The exception requires shareholding of at least 90 %.
- Loan financing with a negative pledge, provided by an underlying company.
- Loan financing where a related party has provided shares in the borrowing company as security.
In the above mentioned exceptions, interest will be considered as external interest. This interest will therefore be fully deductible. The proposed exception will be effective from January 1th 2014.
This new legislation has become unnecessarily complicated, with a main rule – an exception – and then an exception from the exception, i.e. back to the main rule! In addition, this rule may have a negative effect for several companies, especially large company groups and Property Company. Therefore, each company should calculate whether all internal interests are deductible or not.
Who are affected?
The companies affected by this legislation are primarily limited liability companies and public limited companies, but also cooperative society, intermunicipal companies, partnership companies, Norwegian branch of a foreign company and state-owned enterprises will also be affected. Banks and other financial institutions are not subject to the restriction.
Only interest paid to and security provided by related parties is included in the deduction limitation. By related party means any direct or indirect ownership or control of at least 50 % of another company. 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.
Practical example
A subsidiary agrees to buy a business for NOK 100 million. The financing is arranged by the parent company, who borrows from the bank with the excess value of the Group as equity. The loan is then forwarded to the subsidiary, which pays market interest to the parent company. The internal interest is 6 %, similar to the parent company's loan obligation to the bank.
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Result in the subsidiary prior to the restriction: |
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| 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) |
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The following correction must be made after the new restriction: |
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| Results of the year | 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 |
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After the restriction, taxable income for subsidiary will be corrected to: |
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| 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 NOK 4 200 000. This is internal interests paid to the parent company. The company may carry this amount forward for 10 years, but a future utilization is subject to a positive result 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.
How to adjust
In general, the negative effect due to the new restrictions may be reduced as follows:
- 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 that the parent company receives adequate cash to meet the loan obligation.
If all variables are equal in the subsequent years, the company will need to achieve a return on property equal at least NOK 12 000 000, to be able to utilize the interest amount that is carried forward from previous years.
| Results of the year | NOK | 12 000 000 |
| + reversal of tax depreciation | NOK | 2 000 000 |
| + reversal of paid interest | NOK | 6 000 000 |
| = Basis of calculation | NOK | 20 000 000 |
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Net deductible interest (30 %) |
NOK | 6 000 000 |
| Return on property (ex. 12%) | NOK | 12 000 000 |
| - Operating cost | NOK | 500 000 |
| - Depreciation | NOK | 2 000 000 |
| - Interest | NOK | 6 000 000 |
| = Ordinary income | NOK | 3 500 000 |
When the company obtains a return of property equal 12 % (in this example), the amount carried forward can be utilized. This means that the company needs to generate twice as good return on the property than today. This is normally not a possibility, unless change in other variables.
The consequence of these restrictions is that company groups with substantial internal loans, will need to revaluate and possible rearrange the financing of the group. Each company group will need a specific solution to limit the negative effects provided by the new deduction limitation rule. Different models may be used to limit the consequences – and it is possible to find a custom-made solution to accommodate your business.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
