The BEPS Monitoring Group has made a submission to the UK Treasury in its consultation on limiting the deductibility of interest expense.
An effective scheme for limitation of interest deductions could be a major step in stemming BEPS behaviour by multinational enterprises (MNEs). A common technique for such global corporate groups to reduce tax liability in countries, including the UK, is the use of intra-group structured financing arrangements to attribute excess debt to operating affiliates and hence shift earnings out of countries where they have real activities while reporting profits for their cash-box affiliates in jurisdictions where they are lightly taxed.
An effective solution would be to introduce a limit on such interest deductions based on the consolidated net interest expense of the whole multinational corporate group to third parties, apportioned to each group member according to its earnings before tax, interest, depreciation and amortisation (EBITDA). This would treat MNEs in line with the business reality that they are integrated and centrally-directed corporate groups, and help ensure that they are taxed fairly in each country. MNEs, like other companies, should be allowed to deduct their actual interest expense to third parties, no more and no less.
Such a group ratio rule (GRR) was proposed by the BEPS project, which we supported. However, the final report weakened the proposal by recommending the use of a fixed cap in conjunction with an optional GRR, allowing countries to fix their cap in a ‘corridor’ between 10% and 30% of EBITDA. In our view, if the system is to be effective it is essential to fix the cap at the lowest limit of 10%. Evidence put forward by business groups themselves shows that there are wide variations in the debt ratio between economic sectors and even different firms, so relying on a fixed cap is inappropriate. Since 80% had a group ratio below 30% and a majority was even below 10%, it is clear that fixing the cap higher than 10% would allow continued earnings stripping and tax avoidance by MNEs.