Interest Deduction Limitation Rules Guide

The additional amount paid by the borrower to the lender over and above the underlying borrowed amount.

Discounts and premiums representing cost of borrowing or return on lending relating to borrowing of money or the issuance of debt instruments are considered as interest. The Guide further clarifies that discounts provided as sales incentives or for early payment are not considered Interest.

Islamic Financial Instruments (for instance Mudarabah, Murabaha, Ijara, Sukuk, etc) often contain elements, such as "profit" or "mark-up" which could be equivalent to interest regardless of their classification under IFRS. 

Where the economic substance of a transaction or arrangement is akin to a loan, the financial charges associated therewith fulfil a similar role as interest.

Interest or penalty payments related to default on payment of debt instruments are considered interest expense for borrowers and income for lenders, while loan provisions/write-offs may be deductible/taxable under the provisions of the corporate tax law subject to other deductibility conditions. 

Returns from collective investment schemes investing over 50% in cash and cash equivalents are likely to be treated as interest income, while those investing less may be considered dividends or profit distributions. 

Collateralised asset-backed debt securities are backed by a pool of cash flow generating assets like rental properties or mortgage loans. Investors receive principal and interest with the interest income derived from borrower payments.

A sale and subsequent repurchase agreement (repo) involving price difference represent interest income for the lender and interest expense for the borrower. 

A stock lending agreement involves temporarily transferring securities from a lender to a borrower in exchange for collateral and payment of fee, like loan interest for borrower and interest income for the lender. Hence, the return or profit on a stock lending transaction is treated as Interest.

Securitisation transforms assets into investable securities via a special purpose vehicle (SPV), which buys assets generating cash flows like loans. Investor’s returns, derived from interest, are treated as interest income while SPV’s return on the related underlying assets and payments to investors are treated as interest accordingly.

Hire purchase and finance leases transfer asset for use to the lessee for periodic payments. Hire purchase may transfer ownership after full payment, while finance leases cover asset costs plus financing charges. Both will likely involve recording the asset and related interest and finance charges, whereby such financing charges will construe interest. Early termination/cancellation charges in hire purchase are not considered interest.

In an operating lease, the lessee uses an asset for rental payments without ownership transfer. This lease (where there is a right-of-use) includes a finance element representing the cost of funding, treated as interest while the lessor's finance element is computed separately for accounting purposes.

Factoring involves selling accounts receivable to a third party for immediate cash. In recourse factoring, the seller retains non-payment risk, while in non-recourse factoring, the factor assumes the risk, often leading to higher fees. Factoring fees or interest-like components are treated as interest at the time it is recognised under IFRS (or IFRS for SMEs).

Foreign exchange gains or losses on interest payments are treated as interest. 

Interest capitalized as part of an asset's cost is not immediately deductible but increases the asset's depreciation base. Income and expenditure from capitalized interest are included in Net Interest Expenditure during amortization, not when initially incurred. This interest is spread over the asset's life and factored into the adjusted EBITDA. If the asset is sold before full amortization, the remaining interest is included in Net Interest Expenditure at the time of disposal.

For hybrid instruments classified as financial liabilities under IFRS (or IFRS for SMEs), the related income and expenditure are treated as interest, otherwise dividends if classified as equity.

Late payment interest on statutory dues is not considered interest for GIDLR. Conversely, late payment charges on commercial dues are treated as interest if specified as compensation for delayed funds.

Costs incurred in obtaining capital through borrowing or financial instruments, excluding equity, are considered interest and include guarantee fees, arrangement fees, commitment fees, underwriting fees, legal and professional fees, and early or pre-payment fees. If such costs are capitalised as part of the cost of the asset, the treatment applicable for capitalized interest should be applied for determining Net Interest Expenditure (discussed above). 

Any interest component of a derivative contract, including incidental costs is treated as interest.

When a debt instrument is disposed, sold, or transferred, any resulting gain or loss is considered Interest if treated as interest or other financing amount under IFRS (or IFRS for SMEs). 

Expenditure incurred wholly and exclusively for business purposes, and not capital in nature, is deductible in the tax period incurred. Apportionment rules that apply to other business expenses also apply to interest. Interest expenditure related to exempt income, such as dividends or profit distributions from participation, may be deductible if it meets GIDLR and SIDLR criteria.

Interest payable to Related Parties or Connected Persons must meet Arm’s Length/Market Value requirements. The adjusted interest amount is used for interest limitation rules unless disallowed by another legal provision.

Under SIDLR, interest expenditure on loans from related parties is not deductible if used for dividend or profit distribution, redemption of share capital, capital contribution to a related party, or acquisition of ownership in a related party business. SIDLR does not apply if the Main Purpose Test is met, showing no corporate tax advantage. The taxable person must prove this claim. No tax advantage is deemed if the related party pays at least 9% corporate tax or equivalent in their jurisdiction after meeting ALP. SIDLR may apply if the foreign jurisdiction's effective tax rate is below 9% unless the main purpose was not ‘tax advantage’.

GIDLR prevents abuse of debt financing to reduce the taxable income base. This rule must be applied after all the Corporate Tax rules, apart from Tax Loss Provisions. The Guide explains the computation mechanism for amounts for GIDLR purposes including De Minimis Net Interest Expenditure under Article 8 and Adjusted EBITDA under Article 9 of MD 126. If the Adjusted EBITDA is a negative amount, it is considered AED zero. Any Net Interest Expenditure disallowed in a tax period under GIDLR can be carried forward and utilised in the subsequent 10 tax periods in the order in which it was incurred i.e. under the “first in, first out” principle.