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Interest Limitation Rules: Time to assess, address and act

In this month's Finance Dublin Irish Tax Monitor, Peter McGeoghegan discusses the practical considerations in relation to ILR which may limit corporation tax relief on net interest expense.

Peter McGeoghegan outlines the practical considerations for corporates with regards to the Interest Limitation Rules introduced by the Finance Act 2021, which at a fundamental level seek to limit corporation tax relief on net interest expenses of companies. He advises that corporates need to understand the extent of the ILR impact quickly in order to understand its impact in financial statements for FY22 and beyond - and given the complexity of the rules, companies need to take considerable time to get to grips with the legislation well ahead of filing deadlines.

Finance Act 2021 introduces Interest Limitation Rules (ILR) that are applicable to all accounting periods starting on or after 1 January 2022. The author refers to previous articles on ILR in Finance Dublin which provided an overview of ILR. However, at a fundamental level, the rules seek to limit corporation tax relief on net interest expenses of companies (in a nutshell, interest expense reduced by interest income) to 30% of tax-adjusted Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) but this is subject to certain group and equity ratio provisions and other exclusions. An increased measure of relief may be available where it can be established that the net interest deductions/level of indebtedness at the relevant Irish entities reflects the group as a whole.

Revenue guidance notes on the provisions were issued in early January 2022 and it is understood that a Tax and Duty Manuals on the ILR should issue in the near future.

Practical considerations

These new rules may have a material impact on the effective tax rate of a company and have cash tax implications. Where applicable, the calculation of any restriction on tax relief as a result of the ILR may be time intensive and complex and in-house Finance and Tax functions are strongly encouraged to examine in detail the application of the provisions to your own circumstances as early as possible to identify the potential impact on the corporation tax liability for accounting periods commencing on or after 1 January 2022. Furthermore, the ILR introduces new concepts and definitions which are technical and will mean that supplementary financial accounts analysis will be required which, for the initial periods at least, may require significant manual intervention. The new rules also require companies within a group to determine whether they want to be included within an “interest group” for the purposes of the ILR. This will potentially require some scenario analysis and forecasting in order to ascertain what entities should be included in an “interest group”. The concept of an “interest group” is discussed in further detail below.

In addition, the ILR introduces new reporting obligations in the corporate tax return (Form CT1). It is also worth noting that even where it is not expected that a denial of relief will apply, an increased compliance burden arises as a result of the changes which, amongst other things, require reporting of “interest equivalent” and “EBITDA” data which would not historically have been required.

Therefore, while many companies may not be required to submit their FY22 corporate tax returns until later in 2023, it is important that due care and consideration is given to these rules sooner rather than later.

Interest Groups

Subject to satisfying certain conditions, a company may elect to join an “interest group” which will result in the ILR calculations being done at a group level. Per Finance Act 2021, companies (that are within the charge to Irish corporation tax and which are part of the same “worldwide group”, or those within the charge to Irish tax and part of the same “losses” group) may elect to be included in an interest group.

This has the benefit of allowing for interest/interest equivalents and spare capacity to be pooled between group members. The ILR calculations of an interest group are to comprise the results of all of the members.

The compilation of the results of an interest group will be important in understanding the effect of the rules. It is our understanding that the intention is that the taxpayer may have a choice between an aggregation approach or to apply a consolidation type approach involving the disregarding of transactions within the interest group but this is not clear based on the statutory language and the impending Revenue guidance will be important in establishing what methods will be accepted without challenge.

Regulatory Developments

Regulatory changes including the creation of holding companies and bond-issuance vehicles to facilitate resolution strategies together with the impending requirement for certain non-EU headquartered groups to establish intermediate parent undertakings (“IPU”) create complexities in relation to ILR especially in the context of companies which are not trading entities for Irish corporate tax purposes and which are subject to corporation tax at 25% rather than 12.5%. These companies will also need to be considered in the context of the ILR and whether they should be included as part of the “interest group”.

Assess, Address and Act

Businesses need to understand the extent of the ILR impact quickly in order to understand its impact in the financial statements for FY22 and beyond, cash flow planning for future corporation tax payments and what (if any) interest group elections will be made and what level of reporting may be required (regardless of whether the ILR applies). Given the complexity of the rules, companies will need to take considerable time to get to grips with the legislation well before preparing and filing any tax return for an impacted company.

As many groups and companies emerge from FY21 and Q1 FY22 reporting and where ILR assessments have not yet taken place, now is an opportune time for companies to assess the impact of these rules. In particular, to minimise recurring compliance work, it is to be recommended that an early stage mapping of financial accounting and tax rules be undertaken to automate the process insofar as possible.

Please note this article first featured in Finance Dublin in May 2022 and was re-published with their permission on our website.

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