Interest Limitation
Interest Limitation
Interest limitation rules restrict the deductibility of net borrowing costs to prevent excessive debt financing from eroding the tax base. These rules are a cornerstone of international anti-avoidance policy, targeting both inbound and outbound interest payments.
BEPS Action 4
OECD/G20 BEPS Action 4 addresses base erosion through interest deductions and other financial payments. The action recommends a fixed ratio rule that limits an entity's net interest deductions to a fixed percentage of its EBITDA, supplemented by an optional group ratio rule.
The recommended approach targets three key risks: entities with third-party debt that generate excessive interest deductions relative to taxable income, entities that use intragroup loans to generate interest deductions, and entities with third-party debt that invest in tax-exempt income.
ATAD Art. 4
The EU Anti-Tax Avoidance Directive implements interest limitation through Article 4, requiring all Member States to adopt rules limiting the deductibility of exceeding borrowing costs. The provision defines borrowing costs broadly to include interest on all forms of debt, economically equivalent payments, and incidental costs.
Exceeding borrowing costs are defined as borrowing costs net of taxable interest revenue. The directive allows Member States to exclude financial undertakings from the scope of the rule, recognizing the distinct nature of debt in the financial sector.
Fixed Ratio Rule
The primary mechanism limits the deductibility of net borrowing costs to 30% of the taxpayer's EBITDA (earnings before interest, tax, depreciation, and amortisation). This ratio is computed using tax-basis figures rather than accounting EBITDA.
Calculation
Deductible interest = min(Exceeding borrowing costs, 30% x EBITDA). Any exceeding borrowing costs above this threshold are non-deductible in the current period.
Member States may set a lower ratio than 30% if they choose, and some have done so. The EBITDA figure is calculated for tax purposes — starting from taxable income and adding back net interest expense, depreciation, and amortisation.
Group Ratio Rule
As an optional supplement, Member States may allow taxpayers to deduct exceeding borrowing costs above the fixed ratio, up to the group's net third-party interest expense as a percentage of group EBITDA. This accommodates groups that are highly leveraged with third-party debt for genuine commercial reasons.
Group Ratio
Group net interest / Group EBITDA. If this ratio exceeds 30%, a taxpayer may deduct up to the group ratio instead of the fixed ratio, provided the group ratio is computed using consolidated financial statements.
De Minimis Threshold
A safe harbour exempts taxpayers from the interest limitation where their net borrowing costs do not exceed EUR 3 million in a tax period. If exceeding borrowing costs remain below this threshold, the full amount is deductible regardless of the EBITDA ratio.
Member States may set a lower de minimis amount. Some jurisdictions apply the threshold per entity, while others aggregate at the group level for domestic entities — the ATAD text refers to standalone entity application.
Carry-Forward
Member States may provide for carry-forward of disallowed interest expense and/or unused interest capacity:
Disallowed Interest
Non-deductible borrowing costs from the current period may be carried forward indefinitely (or for a limited period, depending on domestic law) for deduction in future periods, subject to the interest limitation in those periods.
Unused Interest Capacity
Where a taxpayer's exceeding borrowing costs are below 30% of EBITDA, the unused capacity (the difference) may be carried forward to increase the deduction limit in future years, typically for up to five years.
Important
The de minimis threshold of EUR 3 million applies per entity, not per group — verify the domestic implementation.