Application of interest deduction limitations to external credit

New Norwegian legislation concerning limitation of interest deduction came into effect from 1 January 2019.

Interest deduction limitations are generally introduced in order to prevent profit shifting from "high tax" jurisdictions to "low or no tax" jurisdictions, by a group placing a disproportionate part of its debt in companies incorporated in jurisdictions with high interest deductions, either by way of intra-group loans or by structuring its external credit to achieve the same.

The Norwegian limitations are also designed for this purpose, and from 2019 their scope has been considerably extended by including not only related-party loans, but also bank loans, bonds and other third party debt or guarantees.

Which borrowers are affected by the new rules?

The new rules largely apply to all companies that are taxable in Norway, including companies with a branch in Norway, as long as they are part of a group.

For this purpose, a company is deemed to be part of a "group" if the company is included (line by line) in a consolidated financial statement prepared in accordance with NGAAP, IFRS, US GAAP, Japanese GAAP or any GAAP applied in a country within the EEA (which includes the EU). The company is also considered part of a group if it would have been included in a consolidated financial statement, had IFRS been applied. The assessment is based on closing balance sheets for the year prior to the relevant fiscal year.

For companies that are not part of a group, the previous rules from 2014 still apply.

The main changes:

• Previously, loans from unrelated third parties ("external loans") were exempt from the limitation rules other than in certain specific situations; typically where a related party had provided security or a back-to-back loan to the external lender.

With the new rules introduced from 2019, the situation is now the opposite: As a starting point, the interest deduction limitations now apply generally to interest on external loans.

• In an attempt to shelter ordinary loan arrangements (loans not implemented for the purpose of profit shifting) from the limitation rules, two important exceptions have been introduced, see below.

• The previous rules allowed for NOK 5 million in net interest expenses to be freely deducted without regard to the limitation rules. This amount is now increased to NOK 25 million. However, whereas the previous threshold applied on a company-by-company basis, the new threshold must be shared among the entire Norwegian part of the group if more than one group company is taxable in Norway.

• For companies encompassed by the limitation rules, net interest expenses are not deductible to the extent they exceed 25 percent of a specifically defined EBITDA measure.

More about the exceptions

Two alternative exceptions have been established, to avoid that the new rules reach beyond their intended purpose (as described in the introduction). The exceptions provide for full deduction of the Norwegian company's interest costs, whether on internal or external debt, if either:

(1) the company's own equity ratio is similar to or exceeds the equity ratio of the global group; or

(2) the consolidated equity ratio of the Norwegian part of the group is similar to or exceeds the equity ratio of the global group.

For groups consisting of Norwegian companies only, these requirements will always be fulfilled. Hence, in practice, the rules on interest deduction limitation will no longer apply to purely Norwegian groups.

In order to apply the second exception, a separate consolidated financial statement needs to be made for the Norwegian group companies , in accordance with the same accounting principles as those of the consolidated financial statements for the global group. Furthermore, under each of the exceptions, a number of specific adjustments are required to be made to the Norwegian companies' balance sheets before they are compared with the global consolidated balance.

A 2 percentage point tolerance is allowed when considering whether the equity ratio of the Norwegian company/group is "similar" to the equity ratio of the group.

Implications for structuring and negotiating external credit arrangements

A borrower and its lenders will typically have common interests in ensuring that the borrower's interest expenses can be deducted from its profits, thus reducing the borrower's tax expenses.

It is important to have the interest deduction limitation rules in mind going forward when structuring a group and its funding, taking into consideration how the various group companies are funded and the external financing structured.

It may be possible to reduce or avoid limitations on interest deduction by relatively simple measures, such as converting intra-group loans to equity, relocating financial assets or adjusting equity or debt by other means to ensure that the equity ratio of the Norwegian part of the group is at least similar to that of the wider group. In other circumstances, larger and more complex measures may be appropriate, such as altering the group structure, rearranging external or intra-group loan arrangements or even reconsidering which accounting principles to apply.

Wiersholm is regularly assisting corporate clients or lenders in the structuring of debt arrangements and has significant experience in analysing the effects of the interest deduction limitation rules, as well as how to structure a group and its debt arrangements. Wiersholm will in such assignments ensure that the relevant Wiersholm team consists of members from each of our tax and banking and finance groups, to ensure that the client, whether a corporate client or lender, will benefit from our combined strengths in these areas.