Interest deduction limitation rules

Article 13 of the Finance Bill draft for 2019 transposes into French law the rules provided for in the “Anti-tax evasion” Directive (“ATAD”) adopted on 12 July 2016.

The following major changes to the current French interest deductibility limitation rules are planned:

• Cap on the deduction of “net financial expenses”: net interest expenses would be deductible from the taxable income of a company only to the extent that they do not exceed the higher of the following two thresholds: (i) €3 million or (ii) 30% of the adjusted taxable income of the company (« EBITDA », i.e., taxable income before the offset of tax losses and without taking into account net financial expenses, depreciation, provisions and capital gains/losses). The cap of €3 million is be understood as per financial year, i.e. a twelve-month period.
• Safe harbor provision: 75% of net financial expenses that exceed the cap (as above), would still be tax deductible provided that the equity-to-asset ratio of the company is equal or higher than the equity-to-asset ratio of the consolidated group to which it belongs. The ratio between shareholders’ equity and total assets of the company would be considered to be equal as to the equivalent ratio of the consolidated group in which the first ratio is not lower by more than two percentage points over the second ratio. The consolidated group refers to all French and foreign companies whose financial statements are fully consolidated for the preparation of consolidated financial statements.
• New thin-capitalization rule: in the event that the amount of debt granted by affiliated companies exceeds 1.5 times the amount of the company’s equity at the beginning or end of the financial year, the net financial expenses of the company may only be deducted up to a maximum of 10% of the “EBITDA” or €1 million if higher.
• Interest expense carryforwards: Financial charges that are not deductible under the rules summarized above may be carried forward indefinitely for possible future allocation, provided that the company’s ability to deduct these future financial charges is not already fully consumed by the financial charges incurred during these financial years.
• Deduction capacity carryforwards: if a company does not fully utilize its deduction capacity (i.e., the amount of net interest expense is lower than the above-mentioned thresholds of 30% of its EBITDA or €3 million), the unused portion of deduction capacity can be carried forward for the five following years.
• Tax Group: the above-mentioned new limitation rules also apply at the level of French tax-consolidated groups, subject to certain conditions.

These new rules would be applicable to financial years beginning on or after January 1, 2019.  Financial expenses incurred as from financial years beginning on or after that date would therefore be affected, including those relating to borrowings set up before that date.

Implementation of the general anti-abuse rule for corporate income tax

Article 48 of the Finance Bill draft introduces a general anti-abuse rule for corporate income tax. This clause provides that for the purpose of establishing corporation tax, no account shall be taken of an arrangement or series of arrangements which, having been put in place to obtain, as a main objective or under one of the main objectives, a tax advantage contrary to the object or purpose of the applicable tax law, are not authentic considering all the relevant facts and circumstances.

This new system aims to transpose into French domestic law the general anti-abuse rule provided for by the ATAD Directive and is in line with the wishes of the Member States to fight tax evasion both at EU and international level. Drafted in very general terms, this clause will allow the tax administration to challenge arrangements whose main objective is to obtain a tax advantage, in the context of an ordinary law procedure, without having to implement the abuse of rights procedure. Since the notion of “main objective” is also broader than the notion of “exclusively fiscal purpose”, this mechanism should be easier to implement by the tax administration.

This clause would apply to fiscal years beginning on or after January 1, 2019.

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In addition, the aim of this Directive is to facilitate the exchange of information between Financial Intelligence Units in identifying and monitoring suspicious transactions.

The Slovak Income Tax Act in force contains certain measures protecting against tax fraud and stipulates rules designed to strengthen the level of protection against aggressive tax planning and tax base erosion and rules against shifting profits outside the territory of the Slovak Republic.

With a view of implementing rules laid down by ATAD, the Slovak Income Tax Act and the Slovak Tax Administration Act (the Tax Procedure Code) will be amended. The change of the Tax Procedure Code is a result of a new form of exemption for the commercial use of intangible assets stipulated by the Income Tax Act, obliging the Financial Directorate of the Slovak Republic to publish a list of taxpayers who apply this type of exemption.

On 1 January 2018, the Slovak Income Tax established special tax regime for the commercial use of intangible assets. This regime exempts profits (yields) from payments for the provision of rights to use or for the use of approved and registered patents and utility templates, as well as from the use or for the use of computer programmes (software).

The special tax regime for the commercial use of intangible assets (the so-called patent box) creates incentives for tax entities to include research and development in their business activities, as the results of research and development and their commercial use will be subject to a more beneficial taxation than other types of business activities. Furthermore, this creates incentives to register the results of research and development activities with the Industrial Ownership Office of the Slovak Republic. Similarly to the increase in deductible costs for research and development, the establishment of this special tax regime can help to improve the employment rate in Slovakia.

In order to increase tax transparency, the Tax Procedure Code amended as of 1 January 2019 will extend the publishing obligation of tax entities with new lists of tax entities in relation to their levy obligation. This relates to the publishing of selected financial institutions (banks, subsidies of foreign banks) and their payments of special levies on the basis of a special regulation per calendar year and the publishing of tax entities (natural or legal persons) acting as a regulated person on the basis of a special regulation.

The extension of the number of published lists of tax entities and their tax obligations and the payment of special levies of selected tax entities is one of the tools designed to fight against tax evasion. All lists of tax entities are published and will be published by the Financial Directorate of the Slovak Republic on its website https://www.financnasprava.sk/sk/elektronicke-sluzby/verejne-sluzby/zoznamy.

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Austria has already had relevant legal rules targeting parts of ATAD, when ATAD was issued. Therefore, not all points needed to be implemented in an entirely new form, but some could be kept or adapted.

Interest Limitation

Austria introduced a limitation of interest in 2014, which was not replaced by a rule conforming to Article 4 of the ATAD, but it was kept using the rule of Article 11 of the ATAD. Under the Austrian limitation rule, interest expense paid to associated companies is only deductible, if the interest income received by the other associated company is effectively taxed at a corporation income tax rate of not below 10%. By the way, the same applies to intercompany license fees.

It remains to be seen, if and when Austria will replace this rule to match the regulatory standard of Article 4 of the ATAD.

Exit Taxation

Austria introduced exit taxation rules regarding the transfer of company assets some years ago. These remained largely unchanged, but some technical criteria were adapted and the possibility to pay tax amounts regarding fixed assets in instalments was reduced to a timeframe of 5 years conforming to Article 5 of the ATAD.

GAAR (General Anti-Abuse Rule)

Austria has been having a GAAR in its domestic tax law over a long period of time. As it was already very similar to the rules included in Article 6 of the ATAD, the existing wording was adapted to include ATAD conforming language and criteria. It remains to be seen, how significant the impact of these changes will be in practice and in the decisions of tax courts.

CFC (Controlled Foreign Company) Rule

CFC Rules were not part of the Austrian domestic tax law before Article 7 of the ATAD asked for it. So a CFC Rule was implemented for the first time into the Austrian Corporation Income Tax Act. It will apply to profits realized starting from 01 January 2019. Austria chose to exclude companies with relevant passive income of below or equaling one third of their total taxable income from the application of the CFC Rule, but Austria did not choose to implement a threshold for companies with small profits. The CFC Rule applies, if relevant passive income is taxed at a tax rate of not more than 12.5%. Therefore, the CFC Rule could apply even to companies in certain other EU Member Countries (e.g. Bulgaria, Cyprus, Hungary).

Hybrid Mismatches

Austria had already a rule restricting the deduction of interest and license fee expenses, if they were not effectively subject to a taxation of at least 10% at the recipient of the respective income. Furthermore, Austria disallows the application of the tax exemption for dividend income, if the dividend payment is a deductible expense in the subsidiary’s country. So far, those rules were not changed on the basis of Article 9 of the ATAD.

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In recent years (perhaps decades), tax law as a specific, and it must be added fiscally very important, part of public law, has been experiencing strong legislative pressure from the outside. This is mainly at the initiative of EU or OECD institutions, whose efforts are determining the direction of tax systems not only in the Czech Republic, but in all other EU Member States, at the very least. Their aim is mainly to combat the aggressive tax practices of some entities in this territory.

One of the latest measures aiming at the full or at least partial elimination of the tax advantages obtained by businesses that engage in unfair practices is the legislative proposal for the transposition of Article 6 of EU Council Directive 2016/1164, laying down rules against tax evasion practices which have a direct impact on the functioning of the internal market (the “ATAD Directive”). As the title of the article suggests, it is about enshrining the principle of anti-tax avoidance in Czech law.

As the time remaining for Member States to transpose the respective anti-tax avoidance rules is dwindling down, the topic is becoming ever more pressing. By the time this article is published, Member States will have less than two months left to complete the legislative process of transposing the proposed rules into national law. The decisive date for implementation has been set as 31 December 2018.

My aim in the following article is to briefly describe what the anti-tax avoidance rules generally entail and the manner in which the Czech Republic has decided to enshrine this principle in its tax law.

1. Anti-tax avoidance – attributes

Tax avoidance as a concept is not perceived in a unified way by the professional public. Some of them consider it an oxymoron, as there cannot at the same time exist conduct that is both permitted and not permitted by law (legally prohibited “avoidance”). Others see anti-tax avoidance as a special legal standard towards any legally permitted conduct.

A starting point for the legislation governing tax avoidance, as I state above, can be Art. 6 of the ATAD: “For the purposes of calculating the corporate tax liability, a Member State shall ignore an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of the applicable tax law, are not genuine having regard to all relevant facts and circumstances. An arrangement may comprise more than one step or part.“

2. Aspects of tax-avoidance – subjective and objective criteria

As it has for the Czech lawmaker, the anti-tax avoidance rules in the ATAD emerge from the testing of so-called subjective and objective criteria of avoidance.

• The subjective element of avoidance is directed at assessing the taxpayer’s motivation. As a rule, the presence of “ill intent” will be examined in connection with the obtaining of a tax advantage. In the end, it is necessary to also evaluate the purpose of the transaction itself (obtaining a tax advantage), which must be (according to the ATAD) the main or one of the main purposes.
• Objective criteria are focused on the evaluation of the intent and purpose of the legal standard which the taxpayer has “abused” with his conduct. Both items must be fulfilled cumulatively[1].

The assessment of whether the taxpayer abused the law falls to the tax administrator. If it concludes that abuse occurred, it bears the burden of proof for its assertion. While apparently insignificant, it is very important in relation to the conduct of tax proceedings and their outcome. Unlike the standard situation, where the taxpayer is obliged to prove facts that correlate with his submitted tax return, the taxpayer does not lose “by default” in tax litigation because tax avoidance was not proven. From the point of view of proof, it is the tax administrator that is the fully liable entity in tax proceedings.

3. Aspects of tax avoidance (ultima ratio)

With regard to the interpretation of anti-tax avoidance, whose application considerably increases the uncertainty of the recipient of the legal standards in written law, it is only possible to agree with the opinion of the Supreme Administrative Court, through its decision-making practice, that the anti-tax avoidance principle must be perceived and used as an ultima ratio tool in the fight against unfair tax practices by taxpayers. Karel Šimka, Chairman of the Judicial Panel of the Supreme Administrative Court, points out that: “you can’t use ‘carpet bombing’ methods for anti-tax avoidance whenever as a tax administrator I don’t feel like using ordinary and legally foreseen tools, such as price correction between connected persons or proving that the actual purpose of the expenditure declared by the taxpayer is tax deductible.”

4. The history of tax avoidance

The concept of anti-tax avoidance, as it is termed in Art. 6 of the ATAD, has, at least in the Czech Republic, much older roots. Already at the end of 2005, the domestic administrative courts began dealing with a file of cases in which it was possible to recognise the tendentious conduct of taxpayers to obtain an unjustified tax advantage, and that by means of legally permitted conduct. One of the first steps taken by the Supreme Administrative Court, which to a large extent determined the direction of the further development of case law in relation to the assessment of anti-tax avoidance, is decision ref. no. 1 Afs 107/2004-48 dated 10 November 2005, also known as the “Diver”. In the assessed case, the court resolved a situation where the payer had established a civic association, from whose funds he financed the activities exclusively of his family, including scuba diving, whereas the donations received by this association from its members were subsequently deducted from the income tax base.

In the conclusions of the “Diver” judgment, the Supreme Administrative Court subsequently referred to decision ref. no. 1 Afs 73/2004 dated 3 April 2007, or the publicly known judgments in the CTP case. All these decisions perceive the key aspects of anti-tax avoidance, which I discussed above, identically to Art. 6 of the ATAD.

5. Differences between abuse of the law, dissimulation, and circumvention of the law

Before moving on to the draft legislative framework for anti-tax avoidance in the Czech Republic, I would like here to clarify the differences due to which conduct demonstrating the characteristics of abuse of law cannot be regarded in the same way as so-called dissimulation or conduct circumventing the law. Each of these categories of conduct has different characteristics, and each is viewed differently from the perspective of the law. In relation to the consequences of the qualification of the conduct of taxpayers in tax law, I believe it is appropriate to examine the difference between dissimulation and abuse in more detail.

• Dissimulation can be perceived as a condition where conduct is wilfully (intentionally) disguised as conduct pursuing a different purpose. However, such conduct is merely formally pursuing a single goal – to cover up the actual conduct. An example of dissimulation may be a gift instead of tuition in the decision of the Supreme Administrative Court ref. no. 1 Afs 24/2009-71. For the purposes of tax proceedings, the principle of the priority of content over form entitles the tax administrator to base its decision only on the legal act that has been obscured.
• On the other hand, abuse of law consists in deliberate conduct which does not seek to hide anything. The will (internal subjective motive – intention) of the taxpayer is therefore fully in accordance with the manifestation of will (external conduct).

Draft codification into Czech tax law

1. State of the legislative process

The legislative draft law incorporating the anti-tax avoidance principles into domestic law is now in the Chamber of Deputies, where it awaits a second reading. In addition to anti-tax avoidance, Parliamentary Bulletin 206 also includes an amendment to other tax laws (for example, the Income Tax Act, Value Added Tax Act). In light of the current state of the legislative process, the proposed date of effectiveness of 1 January 2019 appears to be at risk. In any case, I do not think that the Czech Parliament or the president will veto the “anti-tax avoidance package” as a result. At most, the effectiveness of the law will be postponed until 2019.

2. Where will the anti-tax avoidance principle be enshrined?

The submitter of the newly proposed legislation (the Czech Government, and by extension the Ministry of Finance of the Czech Republic) is counting on the anti-tax avoidance principle being enshrined in the general procedural rules governing tax administration – the Tax Code (new Section 8 (4)). The lawmaker elaborated on the reasons for choosing this approach in the explanatory report to the proposed amendment to the law, specifically: “…the proposed amendment of Section 8 (4) of the Tax Code is not aimed only at income tax, but is designed so that anti-tax avoidance is applied in principle the same way to all types of tax. For this reason, a supplement to the general regulation is proposed for all such monetary performance, mainly for the sake of the uniformity and internal consistency of the law and for the purpose of maintaining certainty.” The submitter is aware that enshrining the anti-tax avoidance principle in the general regulations means an extension of the scope of this principle beyond the obligatory implementation of Art. 6 of the ATAD Directive, which only affects corporate income tax. Besides these reasons, the submitter added that with regard to current administrative and judicial practice, which I discussed above, in essence this is merely a legislative expression of the current state of this practice.

From the information available to me, the views on this issue within EU Member States are not uniform. A side-by-side comparison will certainly be interesting and enlightening.

3. Legislative draft of anti-tax avoidance text

The draft amendment of the Tax Code reads: “In tax administration, legal acts and other factors decisive for the administration of taxes, the overriding purpose of which is to obtain a tax advantage contrary to the intention and purpose of the tax legislation, are not taken into account.“

In its proposal, the Czech Republic honours the foundation of Art. 6 of the ATAD Directive (subjective and objective criteria). Where small differences can be perceived is in the definition of subjective criteria – the “purpose” of the conduct. The ATAD Directive discusses the “main or one of the main” purposes (obtain a tax advantage), whereas the Czech draft uses the word “prevailing“. The Czech lawmaker opted for the wording “prevailing purpose” so that the draft of the law adheres to the case law, which uses it in this way without further addition. The effort is therefore to preserve continuity with the terminology used in the case law, as any new attempt to express the rules in other words raises the risk of a different interpretation.

Concurrently with the material enshrinement of anti-tax avoidance in Section 8 (4) of the Tax Code, the lawmaker acceded to the express enshrinement of the obligation to prove facts decisive for the assessment of tax avoidance to the tax administrator. Now, not only is the burden of proof on the tax administrator to prove tax avoidance by the taxable person derived from the case law, but newly it will be explicitly enshrined in the Tax Code.

4. Where the principle does not apply

Neither tax avoidance as interpreted by Czech courts, nor the newly proposed codified regulation, address situations where the law allows a taxable person to choose between several paths leading to the realisation of his goals and he chooses one of the paths because its tax advantage is foreseen by law. If, therefore, the taxable person uses an advantage offered him in accordance with the intent and purpose of the tax regulation, this cannot under any circumstances be considered tax avoidance (absent objective criteria – conduct contrary to the intent and purpose of legal standards). Finally, the above is also supported by recital no. 11 of the ATAD Directive, which states that unless a case of tax avoidance is concerned, the taxable person should retain the opportunity to “choose the most effective tax structure for his business”.

5. Concerns about future application

Let me express my concerns about possible developments after the codification of the anti-tax avoidance principle in the Tax Code.

The lawmaker’s planned step should incorporate the principle, which today is “present” in tax law only from the pens of judges in administrative courts, among one of the overarching principles of tax collection. Not only will it become part of statutory law, it will also be “within reach” of all tax administrators. My concern is that tools which are, and mainly should be, used merely and only as a last resort, do not become systematically applied by the tax administrator when collecting taxes. In my opinion, this would introduce a significant degree of uncertainty into statutory law, thus weakening the legal system, as one of society’s key value systems.

My second concern is related to the decision-making practice of the administrative courts after the codification of the anti-tax avoidance principle and its links to previous case law. Even though the explanatory report to the amendment emphasises the consistency of the new law with existing decision-making practice, it remains to be seen if this will indeed be the case.

Food for thought

By way of conclusion, allow me to pose a question that I have been thinking about for some time in connection with our clients’ cases. It is related to the ever-stronger pressure to defend the economic rationality of individual decisions made by businesses (see evaluation of subjective criteria).

Can a business, under the constitutionally guaranteed autonomy of will, act in the way it believes to be appropriate – i.e. with the possibility of error – or must it act purely rationally? Which then raises the question: Is the tax administrator authorised to assess whether this or that conduct (decision) was or was not rational?

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Identification details for the beneficial owner are registered in the Commercial Register in the following scope: first name, last name, birth number or date of birth, if no birth number is assigned, address of permanent residence or other residence, nationality and type and number of an identity document, which are not to be disclosed. Registration of the beneficial owner into the Commercial Register regardless of if the company is considered a public sector partner and such registration in the commercial register does not replace the obligation of registering as a beneficial owner of a public sector partner in the Register of Public Sector Partners (if such registration is mandatory for the given entity).

Legal entities registered in the Commercial Register up until 31 October 2018 are obliged to submit a petition to register the details of the beneficial owner into the Commercial Register by 31 December 2019.

Given that we focus on this specific issue as a consulting company, if you need to complete such registration of the beneficial owner into the Commercial Register, please do not hesitate to contact us and we’d be happy to provide you with more information.

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Odkazy:

http://www.mojamuzika.sk/novinky/festival-osmidiv-deviatykrat-spajal-zabaval-a-rozdaval-radost

https://gregi.net/clanky/festival-osmidiv-deviatykrat-spajal-zabaval-a-rozdaval-radost/

https://www.leviceonline.sk/kultura/koncerty-a-festivaly/4776-festival-osmidiv-deviatykrat-spajal-zabaval-a-rozdaval-radost

https://www.popular.sk/festival-osmidiv-deviatykrat-spajal-zabaval-rozdaval-radost

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A draft law, that is subject to passing in the National Council of the Slovak Republic, envisions the gradual implementation of the project into practice. The first phase (April 2019) will include the HORECA segment, i.e., hotels, restaurants, cafés, and pumping stations. The second phase (July 2019) will include retail business, services, and other sectors.

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