As central banks are – among other things – cutting interest rates in an attempt to limit the economic fallout from COVID-19, companies may consider refinancing older debt that still yields higher interest rates. However, such a refinancing exercise may come with unforeseen tax consequences if not properly managed. Apart from a refinancing, groups may want to negotiate a waiver, extend the period of the credit facility, … . Also in this case, the tax consequences will need to be looked into.
Item #3: Tax deductibility of refinancing expenses
As of 1 January 2019, Belgium introduced new interest limitation rules (i.e. 30% EBITDA test) to assess whether interest incurred on intragroup and third party debt is tax deductible. This new 30% EBITDA test replaces the 5:1 debt equity ratio, which may still be applicable in some instances. End of December 2019, the long awaited royal decree – setting out which expenses are to be levelled with exceeding borrowing costs – was published. Unsurprisingly a broad interpretation was adopted, also targeting refinancing expenses.
Therefore, one-off bank fees relating to debt refinancing may cause a temporary surge of exceeding borrowing costs, possibly resulting in a portion of the financial expenses to turn out non-deductible (and to be carried forward to future years).
Another element to deliberate in this respect is that loans concluded before 17 June 2016 are currently out of scope of the 30% EBITDA limitation (i.e. grandfathered loans). However, a (material) change to the terms and conditions of these intercompany loans, will result in the loss of the grandfathering rule. Due to the (deemed) novation of the debt agreement and/or the loss of the grandfathered status, the quantum of exceeding borrowing costs may multiply instantly, driving a group’s effective tax rate (substantially) higher.
Additional particularities arise when one is contemplating a restructuring of intercompany debt. Indeed, flexing intercompany interest rates is dictated by the confines of the arm’s length standard. This inter alia requires assessing the risk profile of the group, the creditworthiness of the debtor companies on a standalone basis, the terms and conditions of the debt instrument, the (parental) guarantee structure, etc. But also other restructuring-related changes to existing loan agreements (e.g. to prevent covenant breaches or adjustments to repayment schedules), will require a review of the tax consequences of intercompany financing arrangements. Contemporaneous documentation should be available to successfully engage in discussions with the tax authorities.
Should you have any questions in this respect, please contact us.