The impact of base erosion and profit shifting on international finance

Friday 22 April 2022

Rebecca Diacono

Fenech & Fenech Advocates, Valletta


Report on a session of the Taxes Committee at the 11th Annual IBA Finance & Capital Markets Tax Virtual Conference

Session Chair

Guglielmo Maisto Maisto e Associati, Milan


Adam Blakemore Cadwalader Wickersham & Taft, London

Sylvia Dikmans Houthoff, Amsterdam

Mark H Leeds Mayer Brown, New York

Stefan Mayer Gleiss Lutz, Frankfurt

Michael Nordin Schellenberg Wittmer, Zürich

Rebeca Rodriguez Martínez Cuatrecasas, Madrid


The panel discussed the impact of base erosion and profit shifting (BEPS) on international finance, focusing specifically on interest deduction rules and withholding tax rates, which have become crucial in light of rising interest rates. The panel focused on addressing two main questions:

  1. How has interest deduction evolved in the respective jurisdictions over the last two years?
  2. Has interest withholding tax become an issue in the respective jurisdictions, and specifically, is it possible to avoid withholding tax liability?

Interest deduction

United States

Mark H Leeds stated that, while in the last two years, the US has not enacted legislation that would have a significant impact on interest deductions, there is currently a proposal by the US to conform to international norms for interest deductions.

In terms of current rules, the US currently has the business interest expense deduction limitation, which was rewritten relatively recently, in 2018, and introduced a new class of interest deduction: the business interest expense (BIE). Leeds explained that the BIE should not have a significant impact on financial institutions because the deduction of interest is allowable against business interest income. On the other hand, non-financial institutions, which would not typically have business interest income, which is equivalent to their business interest expense, would be subject to an additional interest limitation, whereby the interest expense may only be deducted against 30 per cent of adjustable taxable income.

Leeds further explained that, for the purpose of BIE, business interest income or expense excludes, inter alia, loan commitment fees, and accordingly, these are not viewed as interest for the purpose of deduction. Guglielmo Maisto raised the point as to whether loan commitment fees paid to non-residents would therefore not be subject to withholding tax. Leeds stated that the matter is not that simple, and a complex analysis would need to be carried out in order to determine whether the loan commitment fee is simply a fee paid on top of the principal amount or whether it has given rise to a discount in the principal amount of the loan, among other matters, including the activities of the payee and its links to the US.

Leeds also stated that the Biden administration had proposed to fix a 'technical glitch' in the application of BIE, whereby if there was a limitation on the amount of BIE deduction claimed in a given year, this carry forward would now retain its character as BIE and would be subject to the limitation in future years (and no longer be categorised as a net operating carrying over).

Leeds concluded by explaining that, when dealing with interest deductibility between related parties, there is another interest expense limitation, which is referred to as base erosion and anti-avoidance tax (BEAT). BEAT applies only to corporate taxpayers that have an average annual revenue of at least $500m for the preceding three tax years. The BEAT rates should be amended as from 2026. There are currently proposals underway by the Biden administration that may amend BEAT, and should the proposals pass, BEAT will become a much more significant tax than it is today.

The Netherlands

Unlike the US, the Netherlands has seen increased difficulty in the application of interest deduction rules over the last two years, and this as a result of the adjustment to earning stripping rules and recent domestic case law on shareholder debt.

The earning stripping rules, referred to as the interest limitation deduction rule across European Union Member States, introduced a minimum rule that had to be transposed by all EU Member States by virtue of Council Directive 2016/1164, more commonly referred to as ATAD 1.

The Netherlands applied lower thresholds than those catered for in ATAD 1, and effectively, taxpayers can deduct the highest of € 1m or 20 per cent of their tax earnings before interest, tax, depreciation and amortisation (EBITDA) (whose threshold was reduced effective 1 January 2022 from 30 per cent to 20 per cent without any grandfathering period).

Sylvia Dikmans explained that, due to a legal loophole that is widely exploited by taxpayers, the Netherlands Government has announced further lowering of the €1m threshold or a specific anti-abuse provision in the form of an anti-fragmentation rule (in addition to the standard general anti-avoidance rule (GAAR)) denying the application of the threshold on a per taxpayer basis.

Dikmans also discussed recent case law on shareholder debt where the interest limitation deduction rule was denied on the basis of the anti-abuse provision catered for in Dutch law, whereby interest payments should be treated as non-deductible if the loans were granted between related parties and connected to a third-party acquisition, which results in the target also becoming a related party. Dikmans stated that, in recent times, the Dutch authorities have become stringent in analysing structures and the availability of an interest deduction, particularly in the private equity industry. In addition to this anti-abuse rule, the Dutch tax authorities are also applying the fraus legis doctrine in order to deny the deduction. Dikmans touched upon two landmark judgments, namely the Hunkemöller case and Telecom Italia case, where the authorities questioned whether a number of intermediate steps in a transaction had an economic rationale or whether they were put in place purely to claim the deduction.

Dikmans stated that these judgments were heavily criticised as they limit the freedom of financing, and the way a taxpayer acquires a target and funds has now become extremely relevant.


Like all other EU Member States, Germany was required to transpose Council Directive (EU) 2017/952 ('ATAD 2'), that is, the Hybrid Mismatch Rules, which has added a layer of complexity to the availability of an interest deduction.

Stefan Mayer stated that Germany does not have any debt-to-equity ratio for intercompany loans. Germany does, however, apply a test to an instrument in order to determine whether the instrument qualifies as debt or equity. This is typically done by looking at the categorisation at the level of the borrower, and requalifying, where necessary.

Mayer explained that the deduction of interest on intra-group loans is limited by an arm's-length test, especially on inbound interest. If the loan is not granted on an arm's length basis, then interest is not deductible at the level of the borrower and is re-characterised as a profit distribution in the hands of the lender, which may be subject to withholding tax.

Mayer also confirmed that, since 2008, Germany has safe harbours in place that should allow a taxpayer to benefit from an interest deduction on an intra-group basis if, inter alia, the leverage of the borrower is not higher than the leverage of the group. While this safe harbour is catered for in law, it is very complicated to apply in practice due to the detailed and technical analysis of the leverage of the group that would need to take place.

In the past two years, Germany has also seen an increase in the amount of case law that deals with the correct pricing to be applied to intra-group loans.


Michael Nordin confirmed that Switzerland has essentially very similar rules to those mentioned for Germany; that is, a requalification of excess interest into a dividend that is not tax deductible at the level of the payor and subject to withholding tax. There is one fundamental difference to Germany and that is the fact that Switzerland does have complex debt equity rules.

Unlike other jurisdictions, Switzerland does not have a GAAR enshrined in law, but there are significant amounts of case law tackling this issue. Nordin continued to state that, by virtue of Swiss domestic case law, every double tax treaty that Switzerland has in force is deemed to have a GAAR rule enacted into it for domestic purposes. The application of the GAAR rule in double tax treaties is unilaterally applied by Switzerland, although not explicitly stated in the treaty.

For a number of years and based on case law, Switzerland has taken the position that a taxpayer is not deemed to be the beneficial owner of a dividend if the dividend flows through a structure. Nordin explained that the Swiss tax authorities seem to have also applied this interpretation (although this has not been confirmed by a Supreme Court ruling yet) in the context of interest payments. For instance, this interpretation has been applied in some cases in relation to foreign banks carrying out transactions with the Swiss National Bank, for example, where interest is generated on Swiss state bonds and is passed on by the foreign banks to other parties.

United Kingdom

Adam Blakemore stated that the current interest deduction landscape in the UK is quite complicated and includes general anti-abuse, a regime targeted anti-abuse rule for loan relationships and corporate interest restriction rules based on BEPS Action 2.

Blackmore advised that Her Majesty's Revenue and Customs (HMRC) guidance on loan relationships and financial products is very extensive and has been amended in the context of various practitioners' groups over the years. Therefore, it can be useful for the taxpayer to navigate through legislation, particularly how one may legitimately use safe harbours (eg, UK securitisation companies get the full deduction on interest paid and their use is becoming increasingly common).

Over the past three years, there have been a number of interesting cases, such as the Kwik Fit Group case, BlackRock HoldCo 5 LLC v HMRC and Oxford Instruments. These judgments were focused on assessing whether the purpose of the loans was essentially to obtain a tax advantage. Therefore, the question arises as to whether interest payments on loans borrowed to repatriate share premiums or dividend reserves should be considered deductible for corporate tax purposes. According to Blakemore, similar situations should be analysed based on all the relevant facts and circumstances of the specific case, and a comparison with the tax implications of alternative transactions should be made in order to evaluate possible tax advantages arising from the loan.


Like Germany, Spain has implemented ATAD 2, which has added a layer of complexity to interest deductions in recent years in order to cope with hybrid mismatch issues.

Rebeca Rodriguez Martínez explained that one of the main differences between ATAD 2 and related Spanish implementing legislation is the definition of 'associated enterprises'. While for the purpose of ATAD 2, 'associated enterprises' made reference to a 50 per cent threshold, under Spanish tax laws, the threshold is reduced to 25 per cent, making the application of hybrid mismatch rules much wider than that of other Member States. The application of this reduced threshold also gave rise to practical issues, such as obtaining information from the associated enterprises where the shareholding was below 50 per cent. Because of such a wide definition of 'associated enterprises', it is increasingly common to include representations by the lender in financing agreements, which state that the interest paid by the borrower has the same characterisation for tax purposes in its country and is, therefore, subject to corporate income tax therein.

Maisto asked whether the new hybrid mismatch rules also apply to net interest expenses accrued in fiscal years before the date of entry into force of such rules and which are still available for carry forward. According to Rodriguez Martínez, there are no transitional rules dealing with this issue and, therefore, there are arguments to consider the interest carried forward as a deductible item for corporate tax purposes. However, it should be considered that Spain already had hybrid mismatch rules before ATAD 2, which could have come into play to limit the corporate interest deduction in such cases.

Withholding tax

The panel moved on to the second question relating to withholding taxes. Maisto introduced the next subject, stating that withholding tax has evolved over the past two years, and that the scope of this part of the session was to determine the extent of the application of withholding tax in the respective jurisdictions and to assess whether this is an area of concern in each jurisdiction.

US: neutral

Leeds stated that the position in the US vis-à-vis withholding tax is 'neutral'. The reason is that there is currently a proposal underway to amend US tax law, which would make the availability of interest deductions that are free of withholding tax very difficult. Having said that, in Leeds's view, the probability of this proposal being enacted is low.

The US has a rule that allows interest (in the classical sense) to be paid to unrelated parties, as defined, free of withholding tax. The Internal Revenue Service (IRS) and Congress have proposed amending the definition of related parties to a wider definition to curtail abuse. Should this proposal be enacted, a grandfathering period should apply, and debt issued before the law is enacted (subject to no significant amendments to the debt occurring) should fall outside the scope of the proposed amendment.

The Netherlands: negative

The Netherlands has seen the introduction of a specific anti-abuse withholding tax provision, which came into force on 1 January 2021, which homed in on abusive practices between affiliated entities.

This new tax caters for the application of withholding on the payment of interest or royalties made to affiliated entities in a low-tax jurisdiction. Dikmans raised three important points on the application of the new law. First, when the taxpayer is required to withhold tax, the quantum of the withhold tax has been defined in a complex manner in law and is not clear cut.

Second, a low-tax jurisdiction is a country that does not have profit taxation, or has profit taxation that is less than nine per cent or is listed on the EU Non-Cooperative Jurisdictions list.

Third, what constitutes an affiliated entity has not been defined in law, but refers to being dependent on the recipient of the interest. Zero guidance has been provided by the Dutch authorities on this matter.

Germany: negative

Mayer states that, in principle, Germany does not impose any withholding tax, even on standard intra-group loans, subject to the exception that in a situation in which there is a reclassification of the interest into a dividend, withholding tax would apply.

Having said that, as of 1 January 2022, withholding tax may be applied to interest paid to a lender that is resident in a tax haven, as defined in the German Anti-Tax Haven Act, but this is extremely limited in terms of jurisdiction.

Switzerland: positive

Nordin stated that Switzerland applies withholding tax, and its most common application is the '10/20 Non-Bank Rules'. In a nutshell, if a loan transaction is documented and a SwissCo has more than ten outstanding loans documented on identical terms or variable terms with non-banks as the counterparty, then the interest becomes subject to withholding tax.

Parliament passed a reform in December 2021, according to which, withholding tax on interest sourced in Switzerland should be abolished. The reform is still subject to a facultative referendum, and as other amendments are necessary, it will probably not enter into force before 2023 or 2024.

UK: negative

Blakemore stated that, while withholding tax on interest may apply, there are many exemptions, particularly in the financing industry, that may apply in the UK.

Around six months ago, HMRC started looking at the way in which 'double tax treaty passports' had been granted to taxpayers. While considering this matter, HMRC raised queries on the application for a passport regarding why the non-UK person is beneficially entitled to interest in terms of the treaty. This is likely to be a result of the Indofood International Finance case, where HMRC issued a list of safe harbours where the UK would not challenge the beneficial owner.

Spain: neutral

Rodriguez Martínez stated that there is an increasing focus by the Spanish tax authorities on issues relating to beneficial ownership. Borrowers, as withholding agents, are liable for the lack of withholding payments and may, therefore, be audited by the Spanish tax authorities should an issue arise. In practice, when dealing with beneficial ownership in the context of unrelated parties, it is difficult for the borrower to conclude whether the lender is indeed the beneficial owner of the interest receipt.

In 2019, the Spanish courts analysed the concept of beneficial ownership while also making reference to the Court of Justice of the European Union (CJEU) Danish cases. In 2021 and 2022, further judgments were handed down by the Spanish courts on anti-abuse provisions.

The courts recognise the fact that the information a borrower may have a right to obtain may be limited in nature. Therefore, taking a conclusive view as to whether there are valid economic reasons or beneficial ownership at the level of the lender for withholding tax purposes is not always clear cut.