On 8 January, 2021, The Luxembourg Tax Authorities published Circular nº168bis/1, which covers rules for limiting interest expenses under Article 168bis of the Income Tax Law (ITL). This Circular clarifies the rules for limiting interest expenses, though it leaves some concepts unclarified.
The borrowing costs (BC) are limited to 30% of the taxpayer’s EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). This rule applies regardless of the country of residence of the borrower, whether the borrower is related, or a third party.
The circular clarifies, among other things, the following aspects:
- Borrowing costs incurred by the taxpayer in order to acquire, secure and preserve income are, in principle, tax deductible although they may be subject to the rules limiting the deductibility of interest expenses, provided that their total or partial deductibility is not denied.
- Hidden dividend distributions cannot be characterized as operating expenses or costs of obtaining funding
- Certain rules, such as hybrid mismatches, among others, will apply before Article 168 bis of the ITL.
- The transfer pricing rules shall apply first.
Circular Nº168bis/1 also provides detailed analysis of the (non-exhaustive) list of financing costs included in Article 168bis (1) (2) of the ITL. The list includes:
- Issuance and redemption premiums of financial instruments.
- Derivatives, (including contracts commonly known as forwards), futures, options and swaps.
- Capitalized interest included in the balance sheet of a related asset, or the amortization of capitalized interest. The Circular establishes that the regime only applies to capitalized interest or borrowing costs when they are (or are likely to be) deducted.
- Exchange gains and losses included in taxable income and related to interest on loans and financing-related instruments are included in the definition of borrowing costs. Exchange gains and losses resulting from loan principal are not considered in the current rules.
According to the Circular, the concept of financing costs and interest income and other economically equivalent income should be defined or interpreted similarly, whether a debt receivable or a debt payable.
More on BC
The rule limiting the deduction of BC incurred to an amount equal to 30% of the taxpayer’s tax EBITDA will apply to each tax year, as defined in the ITL—so if a tax year is less than 12 months, it will be treated as a full year.
Also, the taxpayer will be able to indefinitely carry forward the BC that has not been deducted in a given fiscal year.
The Circular also states that, for taxpayers incurring borrowing costs in excess of €3 million, the unused capacity to deduct interest expense (i.e. the amount representing 30% of the tax EBITDA not absorbed by the [insufficient] amount of BC deducted during the same fiscal year) may carry forward to the following 5 fiscal years (though it must be used in chronological order, starting with the earliest of the 5 fiscal years).
Your Auxadi Tax Team is on top of all these changes and happy to discuss any that are relevant to you. Contact your Auxadi Tax Team for details.