Following the OECD’s BEPS (“Base Erosion and Profit Shifting”) initiative, the European Union approved its own anti-tax avoidance directive.
Expected Changes in Tax Deductibility of Interest
Out of the areas covered, the new rules for tax deductibility of interest are expected to have by far the most significant impact on the Czech tax environment. The implementation of the directive is obligatory and the new rules for interest tax deductibility have to become effective as of 1 January 2019 at the latest. As the directive allows some leeway in certain specifics, the Czech Ministry of Finance recently issued a discussion paper with its vision of implementation.
New thin capitalization rules
Most importantly, the Ministry’s intention is to replace the current thin capitalization test (based on related-party debt / equity ratio) with the new one; the thin capitalization rules would remain applicable only with respect to banks. The new test should allow tax deductible interest only up to 30% of EBITDA (earnings before interest, tax and depreciation).
However, the crucial change in comparison with the current thin capitalization test is the inclusion of interest costs on loans from non-related parties as well as from related ones. Even companies with only bank financing may therefore be denied tax deductibility of interest costs, which could not occur under the current rules.
Exemptions for ‘small entities’
On the other hand, the directive also allows for some exemptions. Stand-alone entities, which the Ministry intends to define as entities with no related parties, would be exempt entirely and “small” entities with interest costs (defined as net interest costs, i.e. after deduction of any related financial revenues) up to EUR 1 million in total would be exempt as well. The amount for the de minimis test is likely to be subject to further discussions, as the directive allows the member states to use the exemption for up to EUR 3 million. Further discussions are also expected with regards to financing costs subject to the test (e.g. FX differences, capitalized interest costs etc.).
Résumé to the expected changes of BEPS
We would like to emphasize again that the rules described above are but an initial draft by the Czech Ministry, i.e. they may change in the future. However, the basic framework will have to be implemented as it is derived from an obligatory EU directive. We will keep you informed about any development in this matter.
Should you have any questions regarding the issues above or should you wish to discuss an estimated tax impact in your specific case, please do not hesitate to contact TPA tax experts in the Czech Republic.