Transfer Pricing / Interest Limitation / Anti Hybrid Rules

Transfer Pricing

Finance Bill 2021 makes two key changes to Ireland’s Transfer Pricing regime.

The first amendment, dealing with the exemption for certain domestic to domestic related party transactions, is a very welcome replacement of the existing rule which was very difficult to interpret and had led to confusion in practice.

The new provisions now make it clear the exemption, subject to conditions, can apply even if there is no consideration for the transaction i.e. can apply to interest free loans and rent free leases.

The new provisions apply to chargeable periods beginning on or after 1 January 2022. 

The Authorised OECD approach (AOA) is the internationally recognised transfer pricing framework for attributing profits to branches on an arm’s length basis. The second amendment to Transfer Pricing is to adopt the AOA into Irish domestic law, aligning Ireland with International practice.

Additional documentation requirements are introduced with protection from tax-geared penalties where a taxpayer prepares appropriate documentation and provides it to Irish Revenue on a timely basis. The documentation requirements do not apply to small or medium enterprises where the income attributable to their Irish branch is less than €250,000.

The new provisions apply to accounting periods commencing on or after 1 January 2022. 

Interest Limitation

The Minister also transposed another chunky piece of EU legislation into Irish law as detailed in the EU’s Anti-Tax Avoidance Directives (‘ATAD’). In short, the ATAD directives were agreed to ensure that EU Member States implemented certain OECD BEPS rules in a coordinated way. This particular piece of legislation commonly referred to as the “interest limitation rule” was introduced to limit the maximum tax deduction on net borrowing costs to 30% of Earnings Before Interest, Tax, Depreciation and Amortisation (‘EBITDA’). Companies have the option of the interest restriction applying on a single entity or local group basis. Generally the new rules apply to all interest and interest equivalent expenses of all corporate taxpayers, unless the entity can avail of one of the exceptions listed below:

  • where the Irish taxpayer’s net borrowing costs are less than €3 million in a 12 month accounting period; 
  • where a company is a standalone company, being a company that has no associated enterprises or permanent establishments; 
  • Long-Term Public Infrastructure Projects, being a project to provide, upgrade, operate or maintain a large-scale asset in the general public interest; 
  • interest on legacy debt, being debt the terms of which were agreed before the terms of the Interest Limitation Rule were agreed on 17 June 2016 

The legislation as drafted permits Irish taxpayers that are part of a consolidated worldwide group for accounting purposes to consider the indebtedness of the overall group for the purposes of allowing additional relief. The legislation allows this additional relief by considering the Irish taxpayers debt/interest ratios as compared to the worldwide group of which it forms part. Where the Irish taxpayers debt/interest ratios are lower than the worldwide group, then its interest expense may not be restricted or a lower restriction may apply. 

It should be noted that even where the interest is restricted in a given accounting period, the restricted amount may be carried forward to a future accounting periods. There are certain restrictions on how and when this disallowed interest carried forward may be utilised. For example, should the entity in a prior year have deducted interest lower than that permitted under the Interest Limitation Rule (known as spare capacity), then this difference/”spare capacity” can be carried forward for a period of 5 years and used to increase the interest permitted as a deduction. Therefore, in cases where there is sufficient “spare capacity” in the current year, then disallowed interest carried forward from a prior year should be available to offset the profits of the current year. 

Please note the effective date for this legislation to apply is for accounting periods beginning on/after 1 January 2022. 

Anti-Hybrid Rules 

In Finance Act 2019 Ireland introduced anti-hybrid rules, in accordance with Ireland’s commitments to implementing the EU Anti-Tax Avoidance Directive (‘ATAD’). The ATAD provisions are targeted at eliminating aggressive tax planning. The anti-hybrid rules really targeted cross border structures that were used for tax avoidance purposes e.g. a deductible payment in one jurisdiction that was treated as not taxable in the jurisdiction of the receiving entity. 

In Finance Bill 2021 the Government continues with the implementation of ATAD, implementing legislation to address tax mismatches that arise where an entity is a ”reverse hybrid” entity. A reverse hybrid entity is an entity that is established in Ireland that is effectively regarded as tax transparent in Ireland (a flow through for Irish tax purposes) but tax opaque (deemed to be a taxable entity) in a territory of a relevant participator in the entity. Because of the mismatch in treatment of the entity in both jurisdictions, the income arising is effectively not taxed in either Ireland or in the territory of the participator. The legislation includes specific exemptions, including an exemption for “collective investment schemes” that are subject to investor-protection regulation, are widely held and hold a diversified portfolio of assets. There are also exemptions for hybrid entities where the foreign participators are either exempt from tax or are not taxable on foreign income. Where the provisions apply the entity is subject to corporation tax as if it were a resident company carrying on a business in Ireland. There are specific provisions included in the legislation relating to double taxation agreements. It will be interesting to see in practice how this provision interacts with double taxation agreements. 

The legislation applies to tax periods commencing on or after 1 January 2022.