The government wishes to introduce a general EBIT or EBITDA based limitation to deduct net interest expenses in the corporate sector. In addition, the right to utilize tax losses carried forward is to be temporarily limited. A number of other proposals are also presented in combination with a reduction of the corporate income tax rate to 20 percent.
On 20 June 2017, the government distributed an extensive memorandum regarding proposed changed tax rules in the corporate sector to a number of consultation parties. The goal is that these regulations are to come into effect on 1 July 2018 and are to be applied for the first time in the financial year beginning after 30 June 2018. For companies having the calendar year as their financial year, this implies that the regulations will apply from and beginning 1 January 2019.
The government proposes that the current interest deduction limitation rules are adjusted, but retained, in combination with the introduction of new limitations on so-called hybrid loan structures. In addition, general EBIT or EBITDA based interest deduction limitations are to be introduced for so-called “net interest expenses” in legal entities and Swedish partnerships. This limitation also applies to third party interest expenses.
The term ”interest expenses” is defined as interest and other expenses for credit and expenses comparable with interest, and in the case of net interest expenses, this refers to the difference between interest expenses which are deductible and the interest income which is taxable, provided the interest expenses are in excess of interest income.
In order to compensate for these further limitations, the government proposes that the corporate income tax rate is reduced to 20 percent. The so called expansion fund tax is to be reduced from 22 to 20 percent of the amount deducted in reporting a provision to the expansion fund.
As a means of financing the regulations, the possibility of utilising loss carried forwards is limited during a specified period of time.
The government adjusts the current interest deduction limitation rules
The government is of the opinion that the current interest deduction limitations regarding loans from related companies are difficult to interpret. However, the government is not willing to abolish these rules. Instead, the government proposes that the limitations will be narrowed in scope, which according to the government should result in that a deduction would be available in more cases than under the 2013 set of rules currently in place.
Interest expenses on loans from related companies are now proposed to be deductible if the company being the beneficial owner of the corresponding interest income:
- is resident in the European Economic Area, or
- is resident in a country with which Sweden has a complete double tax treaty and the company is resident in that country under the treaty, or
- is taxed at a rate of at least 10 percent if the interest income had been the only income for the company.
A deduction would however still not be available if the debt relationship exclusively, or almost exclusively, arose in order to create a substantial tax benefit for the group. With the expression “exclusively or almost exclusively”, is meant 90-95 percent.
In addition, if the debt refers to an acquisition of a share in a related company, a deduction would also require that the acquisition is deemed as significantly motivated by sound business reasons.
Hybrid regulations are introduced
Furthermore, the government proposes a prohibition to deduct interest costs in certain cross-border transactions. The regulations refer to arrangements between related enterprises. The regulations aim at so-called hybrid mismatches. This refers to differences in national regulations regarding the tax treatment of companies and financial instruments.
Stated simply, one can say that the intention is to be able to deny a deduction in Sweden in situations where no taxable income is reported abroad or where a deduction of the same interest expense would otherwise have been granted to companies in two different countries. These rules are a result of OECD’s work within the framework of the so-called BEPS project (Base Erosion and Profit Shifting).
A general interest deduction limitation is introduced
To the degree that interest expenses are deductible according to the above-mentioned targeted interest deductions limitations, further limitations are introduced. These are intended to be in line with that which has been proposed within the BEPS project and EU’s anti-tax avoidance directive.
The government presents two different alternative proposals
The government has not made a final determination as to the manner in which the general interest deduction limitation should be designed. Instead the government presents two alternative proposals. On the first hand, it is proposed that the deduction should be capped at a percentage of EBIT (Earnings Before Interest and Tax). On the second hand, there is a proposal that the deduction should be capped at a percentage of EBITDA (Earnings Before Interest, Tax, Deprecations and Amortizations). Typically, this implies that the basis of deduction is greater if the earning measure EBITDA is applied, as this applies income before depreciation.
The government’s alternative 1 implies that net interest expenses are deductible up to 35 percent of the tax EBIT result. The government’s alternative 2 implies that net interest expense are deductible up to 25 percent of the tax EBITDA result. The government requests replies from the consultative parties prior to it taking a final position regarding alternatives 1 or 2.
The government also proposes that a simplification rule – in reality a de minimis threshold - is introduced. Net interest expense would, under this rule, always be deductible up to SEK 100,000. For related companies, the combined deduction on a group level may not exceed SEK 100,000 if the companies apply the simplification rule.
A company which has not been able to fully deduct net interest expenses in a previous year has, under certain circumstances, the right to roll this amount forward and deduct this amount during six years after the income year in which the remaining net interest expense arose. Certain changes in ownership might lead to that this possibility ceases to exist.
The government proposes that companies having net interest income can be able to deduct another company’s non-utilized net interest expense against their own net interest income. A condition for this is that the companies can exchange group contributions to each other under the Swedish tax consolidation rules, and that both of the companies report the deduction in their income tax returns.
Introduction of a temporary limitation on the right to utilize loss carried forwards
The government proposes a temporary limitation on the possibility of utilizing tax losses carried forward for legal entities. This limitation applies regardless if a company has net interest expenses or not.
Tax losses carried forward from previous years can at a maximum be deducted with 50% of the company’s taxable profit. The portion of the losses that is non-deductible is rolled forward to subsequent years. In reality, this means that tax will be levied at an earlier stage.
These limitations will be in effect only during a certain period of time and will apply to income years beginning after 30 June 2018 and prior to 1 July 2020 as regards the EBIT rule, and to income years beginning after 30 June 2018 and prior to 1 July 2021 as regards the EBITDA rule. In other words, the period during which the limitation are to apply (two or three years) depends on the government’s final decision regarding the method for general deduction limitation rules for interest expenses.
The government’s conclusion is that these limitations can impact approximately 40,000 limited liability companies, but there is probably a major degree of uncertainty in this estimation.
Certain other aspects of the proposal
- The government proposes an introduction of tax rules regarding leasing. These rules would be designed with the consolidated accounting regulations as role model. The reason for this is that the general interest expense deduction limitations could otherwise be circumvented by using financial leasing agreements.
- Due to the impact on the real estate sector as a result of the general interest deduction limitations there will be the introduction, for rental properties, of the possibility of a further 2 percent depreciation per year during the first five years up until the building is completed (so called primary deduction).
- The standard income amount to be applied in deductions for provisions to the tax allocation reserves is increased from 72 percent of the government borrowing rate to 100 percent of the government borrowing rate, multiplied by the amount of the deductions reported for provisions to the tax allocation reserves.
- Rules regarding permanent, respective temporary, standard income amounts for security reserves are also proposed.
The memorandum is extensive and our blog comments above represent only a short summary of the major aspects of the proposals. Tax matters will revert with more detailed analyses regarding various aspects of the government’s proposals. The consultation period ends on 27 September 2017.
What can already be said at this point in time is that the proposals in the memorandum will impact all companies. The government’s assessment is that the proposals are expected to have a greater economic effect on larger companies than smaller ones.
The government’s objective is to improve the neutrality between equity and loan financing, while at the same time counter-act aggressive tax planning using interest deductions.
The current interest deduction limitations from 2013 would be adjusted, but are not abolished. The rules have been criticized for being difficult to interpret and some of these difficulties seem to remain also in the current proposal. Even if the possibility to deny a deduction is more limited, the question remains as to how to conclude whether the debt relationship has exclusively, or almost exclusively, arisen in order for the group to obtain a substantial tax benefit.
The general interest deduction limitations address only net interest expenses, i.e. only the portion of interest expenses that exceeds the interest income. A major change is that limitations are to be applied not only to related, but also third party, interest costs. As seen above, the government would currently appear to be in favour of the EBIT model, but depending on the outcome of the consultation replies, the government is open to instead choose the EBITDA model.
The government also proposes a temporary limitation on the possibilities of using tax losses carried forward, which will probably impact a large number of companies. The period of time during which this limitation is to apply will depend on whether the government decides to go for an EBIT or EBITDA model.
As compensation for the new limitations, the government proposes that the corporate tax rate be reduced by 2 percentage points to 20 percent.
Fredrik Ohlsson och Håkan Danmyr arbetar på PwC:s kontor i Göteborg respektive Malmö. Fredrik arbetar bland annat med nationell och internationell företagsbeskattning och är även medlem av PwC:s internationella EU-skatterättsliga nätverk EUDTG (EU Direct Tax Group). Håkan arbetar med internationell företagsbeskattning.
Fredrik: 010-213 14 19, firstname.lastname@example.org