ATAD interest limitation rules

During 2018, Malta transposed into Maltese tax legislation the provisions of Council Directive 2016/1164 issued on 12 July 2016 (commonly referred to as Anti-Tax Avoidance Directive, ATAD I). Some of the provisions of ATAD I and II are included in the ATX-MLA syllabus and are examinable from June 2020 onwards, with two exceptions which are explicitly excluded:

  • The anti-hybrid mismatch rules within Malta’s transposition of ATAD II, and
  • The Equity-Escape Carve-Out (Regulation 4(5), S.L. 123.187) in the Interest Limitation Rules

This is one of three articles on this topic and explains the interest limitation rules. The other two articles explain the controlled foreign company (CFC) rules, general anti-abuse rules (GAAR) and exit tax. Candidates should note that the content of this article indicates the extent to which the provisions of Malta’s transposition of ATAD I and II are examinable at Strategic Professional (ie ATX-MLA) level.

Interest limitation rules

The principal objective of the interest limitation rule is to limit the deductibility of taxpayers’ excess borrowing costs. Through the application of the interest limitation rule, excess borrowing costs shall be allowable as a deduction only up to 30% of the taxpayer's earnings before interest, tax, depreciation and amortisation (referred to as ‘EBITDA’) in the tax period in which they are incurred. Notwithstanding this, the interest limitation rules include a de minimis rule which provides that a taxpayer may in any case, on an annual basis fully deduct excess borrowing costs up to €3 million.

Excess borrowing costs is defined as the excess of the deductible borrowing costs of a taxpayer in terms of the Income Tax Act (ITA), over the taxable interest revenues and other economically equivalent taxable revenues that the taxpayer receives. Notional interest deductions (NID) are not treated as being borrowing costs.

For the purposes of ATX-MLA, borrowing costs shall be limited to mean interest expenses on all forms of debt, other costs economically equivalent to interest and expenses incurred in connection with the raising of finance.

EBITDA shall be calculated by adding back to the taxable income the tax-adjusted amounts for excess borrowing costs and the tax-adjusted depreciation and amortisation, whilst any tax-exempt income shall be excluded. 

In the case of a fiscal unit in terms of the Consolidated Group (Income Tax) Rules, the calculation of the excess borrowing costs and the tax-adjusted EBITDA shall be made at the level of the fiscally consolidated group, excluding financial undertakings which would otherwise have been exempt, as explained below.

In the case of companies forming a group in terms of Article 16 of the ITA, the entities in a group may elect, annually, to be construed as a single taxpayer in order to calculate the excess borrowing costs and the tax-adjusted EBITDA. In such case, all entities within the group must opt-in for this election during the same year of assessment and report their results individually in their appropriate tax return. In such a case, the €3 million de minimis rule in terms of regulation may only be utilised once for the whole non-fiscally consolidated group. If the election is made, each entity within the group needs to, surrender any excess unused interest capacity to any other entity within the same group. However, an entity within a group may only claim excess unused interest capacity from another entity within the same group to the extent that the former entity has excess borrowing costs which are subject to interest deduction limitations.

Notwithstanding the above, excess borrowing costs may be deducted in full, without the €3 million annual de minimis limit, where the taxpayer is a standalone entity (which does not form part of a consolidated group and has no associated enterprises1 or permanent establishments).

In addition, by way of derogation the following excess borrowing costs are to be excluded from the scope of these regulations:

  • costs incurred on loans which were concluded before 17 June 2016, but the exclusion shall not extend to any subsequent modification of such loans. In the case of a subsequent modification, the grandfathering would not apply to any increase in the amount or duration of the loan but would be limited to the original terms of the loan, and
  • costs incurred on loans used to fund a long-term public infrastructure project within the EU, subject to a prior approval by the Commissioner for Revenue.

The interest limitation rules, include an equity-escape carve-out where the taxpayer is a member of a consolidated group, and the taxpayer’s ratio of equity over total assets is equal (defined as up to 2% lower) or higher than the equivalent ratio of the group. However, such carve out rule is not an examinable topic in ATX-MLA.

The aggregate amount of deductible excess borrowing costs shall be allocated against different sources of income at the discretion of the taxpayer provided that the amount so allocated does not exceed the excess borrowing costs attributable to each respective source.

The amount by which excess borrowing costs for each source of income exceeds the allocated deductible excess borrowing costs shall be a disallowed expense for the current year of assessment and may be carried forward to subsequent years of assessment, without any time limitation.

The unused interest capacity (the excess tax-adjusted EBITDA capacity which was not used during the year of assessment) may be carried forward up to five years and shall be utilised on a first-in-first-out basis.

It is the aim of the examining team to assess candidates’ knowledge of the interest limitation rules, through application of knowledge to a given scenario. Candidates will usually be expected to present their answers in the form of explanation with supporting calculations.

In this respect, it is the examining teams’ recommendation for candidates to refer to question 1 of the September (June) 2020 ATX-MLA exam for an example of the examining teams’ approach to assessing this topic. Candidates should also refer to the example in section 6.4 of the Commissioner for Revenue’s Guidelines in relation to the Anti-Tax Avoidance Directives Implementation Regulations.

Written by a member of the ATX-MLA examining team

(1). An 'associated enterprise' is defined as:

(a) an entity in which the taxpayer holds directly or indirectly a participation in terms of voting rights or capital ownership of 25% or more or is entitled to receive 25% or more of the profits of that entity
(b) an individual or an entity which holds directly or indirectly a participation in terms of voting rights or capital ownership in a taxpayer of 25% or more or is entitled to receive 25% or more of the profits of the taxpayer:

If an individual or entity holds directly or indirectly a participation of 25% or more in a taxpayer and one or more entities, all the entities concerned, including the taxpayer, shall also be regarded as associated enterprises.