Interpretive ruling relating to the rules on the limitation of the deductibility of interest

On 10 June this year, the Ministry of Finance made an interpretive ruling relating to the rules on the limitation of the deductibility of interest. The principle points in the ruling are as follows:

Negative pledges

Negative pledges are not to be regarded as security. This point is intended to remove any uncertainty concerning other types of pledges, such as a ban on sales, a ban against raising new loans and a ban against shutting down activities. The ministry finds no reason to uphold its former view that negative pledges should be regarded as security.

Security for parts of a loan

If security has been provided for parts of a loan, the re-classification of external interest to internal interest is to be limited to a corresponding part of the interest amount. The ministry further states that if the requirements for having interest regarded as internal interest are fulfilled only for parts of a year, then only the interest relating to this period should be regarded as internal interest.

Loans in tax-transparent partnerships

In general partnerships (Norwegian company types ANS or DA), the partners have either a joint and several (ANS) or a pro-rata (DA) liability in respect of the liabilities of the partnership. In its ruling, the ministry expresses the view that the liability resulting from a partnership may be regarded as security. The ministry alleges that there is no basis in the rules on the limitation of the deductibility of interest for considering the liability resulting from a partnership as exempted from the rule concerning the re-classification of external interest to internal interest. In the view of the ministry, the purpose behind the rules on the limitation of the deductibility of interest indicates that such security/liability is comprised by the rule.

This, then, implies that external loans raised by a general partnership (ANS) with a partner holding an ownership share of 50% or more may be re-classified as an internal rather than external loan and as such be covered by the rules on the limitation of the deductibility of interest. For general partnerships with a joint and several liability (ANS) the ministry's interpretation of the law has very unfortunate implications and can have a considerable impact on the right to make deductions.

From the way in which the ruling is phrased, it appears as if general partnerships with a pro-rata liability (DA), in which the individual partners are only liable for their pro-rata share of the partnership's liabilities, will not be subject to such a risk of re-classification of external loans. The ministry's ruling is not clear on this point, however. In order to remedy any negative consequences of the ministry's interpretation, one option would be to make the change from joint and several liability (ANS) to pro-rata liability (DA). Implementing such a change will generally not trigger tax liability or stamp duty. The ruling leaves many unclarified issues, which we have raised with the ministry.

A duty to inspect in respect of bond loans

In the case of a bond loan issue the lender is not necessarily known to the borrower / issuer of the bonds. It is stated that if the taxpayer is unaware that the lender in a bond loan is a related party and the taxpayer in a careful and loyal manner has fulfilled the requirements of the Tax Assessment Act concerning the duty of disclosure, then the two-year deadline applies for the performance of reassessments.

The ruling does not indicate what kind of inspections must be made to find out who the owners of the bonds are or what kind of information must be given to the tax office in order to fulfil the requirements of carefulness and loyalty.

Indemnity, "all guarantors' liabilities" etc.

A general security from related parties, such as indemnity, costs in connection with loans not used etc, which is not related to the debt forming the basis of the interest cost, will not lead to a re-classification of the interest on the loan.

Letter of comfort

The ministry further expresses the view that a re-classification of external debt to internal debt does not just cover legally binding provision of security, but also cases of informal provision of security. An example of such informal provision of security would be a declaration from the parent company concerning financial support (letter of comfort) vis-à-vis the lenders of the company's subsidiary.

It appears from the preparatory works that it depends on the interpretation in each individual case whether or not such informal provision of security should be considered covered, and there is a requirement that the provision of security has affected the borrowing opportunity of the subsidiary as compared to what would be achievable in the market without such provision of security.

A link to the ministry's ruling can be found here.

Interest limitation rules

As will already be known, rules have, with effect from the income year 2014, been adopted on the limitation of the deductibility of interest owed to related parties. These rules imply that the deduction previously allowed in respect of net interest costs exceeding 30 percent of a specified profit amount is discontinued.

It is generally only interest payable to related parties (internal interest) which will potentially be limited. Interest payable to independent third parties (external interest) is not subject to limitation, but may still replace deductions made in respect of internal interest. In cases in which a related party has provided security in respect of debt to an independent lender the interest should still be regarded as internal interest.

The reason given for this is that the provision of security from a related party may increase the borrower’s borrowing capacity and thus a higher interest deduction would be achievable than would be the case for an independent company.

The Directorate of Taxes changes its opinion on the interest to be taken as a basis for loans from a company to its shareholder

The Directorate of Taxes has in a statement dated 3 June this year communicated that the interest on a loan from a company to its shareholder should be fixed at the market interest, not the prescribed interest rate applicable to cheap loans provided to employees, as was previously accepted by the Norwegian Tax Administration.

This change will be implemented as of 2015. No reassessments will be performed in respect of the income years leading up to 2015 if a prescribed interest rate has been agreed.

The change will mean considerably more work for the taxpayer and the Tax Administration when determining the interest rate, in that a transition has been made from the application of an accepted routine rule to the performance of a concrete assessment of creditworthiness in each individual case. The legislative reason why the prescribed interest rate should be considered acceptable for loans provided to employees but not for loans from a company to its shareholder does not appear from the directorate’s statement.

A link to the directorate's statement can be found here.

Published june 2014

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