BEPS Action Plan: Action 4 – Financial payments

In action 4 of its BEPS Action Plan, the OECD seeks to target a broad range of what it describes as ‘excessive’ interest and other financial payments. Below, we provide commentary and links to content on the proposals.


Read our response to the latest discussion draft

9 September 2016

In our submission to the OECD, we say there is limited scope for BEPS risks arising in regulated banking and insurance groups …

due to the limits on leverage imposed through the prudential regulatory regimes which apply to groups operating in these sectors.

Given the limited BEPS risk coupled with significant potential downsides of applying the fixed ratio rule, we believe the preferred approach would be to exclude groups engaged primarily in banking and insurance activities (referred to in this paper as “Regulated Financial Groups”) from Action 4 entirely.   Further work will need to be performed to determine an appropriate definition of Regulated Financial Group for this purpose although there are precedents elsewhere which may be adopted as a starting point from a banking perspective.

While the primary focus of this letter is to recommend an exclusion for RFGs, we also recommend regulated banks (and their transactions) within non-banking groups be excluded from Action 4.

We made a number of comments on points on the detail and in response to the questions.

Visit our BEPS submissions page


25 August 2016

An OECD consolidated document including all the responses to its group ratio discussion draft encompasses …

23 responses in total in its 175 pages.


16 August 2016

Our response to the OECD’s discussion draft on the group ratio rule argues that …

a fully harmonised approach may not be optimal even though we agree that a consistent approach to the Group Ratio Rule (GRR) in particular will tend to simplify the compliance for international groups of companies. 

The actual effect of the Action 4 rule on interest deductibility in general, and the Group Ratio Rule in particular, will be very dependent on

  • the accounting standards applied by a group of companies and/ or required to be followed by the GRR, and
  • the tax law of the territory in question, and the correspondence (or lack of correspondence) between them. 

We consider that this is an important factor not identified in paragraphs 4 and 5 of the paper.

We would therefore suggest that it is more appropriate for territories to determine their rules for computing a group ratio in a manner which is consistent with their domestic rules for the taxation of interest and derivatives. 

Subject to that overall caveat, we have a number of  comments on the specific questions raised in the draft paper.

To see our detailed response, go to our BEPS submissions page


28 July 2016

A new discussion draft on approaches to address BEPS involving interest in the banking and insurance sectors

does not change any of the conclusions agreed in the Report, but provides a more detailed consideration of the BEPS risks posed by banks and insurance companies and those posed by entities in a group with a bank or insurance company, such as holding companies, group service companies and companies engaged in non-regulated financial or non-financial activities.


11 July 2016

The OECD has published a discussion draft on the design and operation of the group ratio rule within Action 4 which …

recognises that groups may be leveraged differently for non-tax reasons. So, without yet having reached consensus, the draft recommends that countries consider introducing a ‘group ratio rule’ to allow an entity to claim higher net interest deductions, based on a relevant financial ratio of its worldwide group.

The October 2015 Action 4 Report included a detailed outline of a rule based on the net third party interest/EBITDA ratio of a consolidated financial reporting group, and provided that further work would be conducted in 2016 on elements of the design and operation of the rule, focussing on approaches –

  • to calculate a group’s net third party interest income
  • to define of group-EBITDA
  • to deal with the impact of losses on the operation of the rule.

The discussion draft purports not to change any of the conclusions agreed in the Report, but does note the likelihood that some countries will want to adopt something other than a net third party interest/ EBIDTA ratio.


29 June 2016

Within the EU, the new Anti-Tax Avoidance Directive (ATAD) requirement on the deductibility of interest and other financial payments will mean …

that subject to options a Member State may adopt, including a group carve-out rule, any excess borrowing cost incurred by a taxpayer is initially deductible in that period up to 30% of the taxpayer’s EBITDA (excluding any tax-exempt income) for that period.

A Member State may allow:

  • full deduction if excess borrowing of the taxpayer’s group doesn’t exceed EUR 3m
  • full deduction if the taxpayer is a standalone entity i.e. not part of a consolidated group for financial accounting purposes (and has no 25% associated company and no permanent establishment (PE))
  • grandfathering of loans concluded before 17 June 2016 (and not changed after that date) and
  • the exclusion of loans for EU long-term infrastructure projects (on exclusion also of income from the project in EBITDA and subject to possible scrutiny over State aid as noted in recital (8)).

The group carve-out rule broadly applies in relation to consolidated entities under IFRS or local GAAP (or other standard if a Member State specifies) and allows a Member State to permit:

  • full deduction if the proportion of equity to the taxpayer’s total assets is at least 98% of that of the group or
  • a proportionate deduction by reference to the ratio of the group’s external excess borrowing costs to the group’s EBITDA.

A Member State may also allow an unlimited carryforward for non-deductible borrowing costs of a period (with or without a carryback of up to three years or a carryforward for up to five years of qualifying, but unutilized EBITDA).

See further our Tax Policy Bulletin of 29 June 2016.


5 May 2016

Action 4 will be reviewed in 2020 and two key elements which are currently being considered by individual countries...

and will be on the agenda at the time of its review are

  • the effectiveness of the agreed corridor of percentages applied to EBITDA, and
  • he more targeted rules for those not covered by the general rules.

But there are also a number of other clarifications being sought, including how to treat capitalised interest.

The OECD is expected to release a further paper on the group ratio test late May/early June.


6 February 2016

Although individual Member States within the EU have already been considering how to implement the Action 4 recommendations, there is a move for the EU as a whole...

to have a minimum standard which is slightly different to the OECD proposal. Under a draft Anti-Tax Avoidance Directive published by the European Commission, subject to a group carve-out rule, any excess borrowing cost would deductible up to the greater of 30% of EBITDA or EUR 1m. The group rule here – different from the OECD version - broadly allows full deduction if the proportion of equity to total assets of the taxpayer is at least 98% of that of the group as per appropriately audited consolidated accounts. Taxpayers would have to ignore contributions to equity/ total assets in the six months prior to the balance sheet date insofar as they are matched by withdrawals/ distributions in the six months following it.

The proposals include an unlimited carryforward for unutilized EBITDA and non-deductible borrowing costs.

There is no distinction as to where debt originates.

See further our Tax Policy Bulletin of 5 February 2016.


29 January 2016

A number of territories have been reviewing the recommendations on restricting the deductibility of interest and other financial payments...

Those with existing limits by reference to percentages of EBITDA are reviewing the detail, while those with other avoidance approaches are seeing how they might implement the recommendations and whether they replace or add to what they already have.

Some work remains on refining the definition of ‘group EBITDA’ and clarification of the detailed operation of the worldwide group ratio rule (including losses, net third party interest and financial accounting issues).

Participants in the banking or insurance sector will have to wait to see the alternative proposals for their circumstances. This is also likely to include those with regulated banking and insurance activities within non-financial groups.

A related action still outstanding is the work to look at transfer pricing aspects of financial transactions. This project is beginning and completion is expected by the end of 2017. The OECD has twice attempted to kick-start projects on financial transactions and has struggled to gain consensus. As such, the output from this action will interest many.

The final report also stated that there would be a carve-out for public benefit projects, though detail on the exact nature of this is still outstanding.


26 October 2015

The final report reminds readers of the three key scenarios viewed as BEPS risks in the area of the deductibility of interest and other financial payments:

  • Groups placing higher levels of third party debt in high tax countries
  • Groups using intragroup loans to generate interest deductions in excess of third party interest expense
  • Groups using debt to fund the generation of tax exempt income

Given the flexibility afforded by the recommendations it is likely that there will remain a variety of different approaches to target interest deductibility, and that a number of territories (e.g. Australia and Germany) may feel little or no need to amend their current rules in this area.

The OECD notes that a country should not deliberately adopt a higher fixed ratio due to a policy to attract international investment due to lenient interest deductibility rules.

The fixed ratio that a territory chooses to adopt should be determined taking into account a number of factors, the report suggests, including; the level of additional rules that might allow groups to benefit from a deduction in excess of this fixed ratio (e.g., group wide ratio rules), the level of interest rates in the relevant territory (e.g., high interest rate economies might choose a higher fixed ratio) and the number of targeted rules also in place in that territory.

The report attempts to justify the proposed fixed ratio range on the basis that 87% of listed companies it studied would in principle be able to deduct all of their net third party interest expense.  But these may not be representative of the wider population of businesses, and there is an implicit assumption that groups are equally leveraged in every single territory. The reality is that most groups will have to reassess their capital structures globally in order to still be able to obtain a deduction for third party interest expense.

It is anticipated that territories introducing new rules in this area should give groups sufficient time to restructure their arrangements before the rules come into effect.  This could, for example, include a grandfathering provision for third party debt for a certain period of time.  This would be a welcome inclusion in any new rules given the level of restructuring most groups are going to require.


5 October 2015

The perceived risks identified in the BEPS Action Plan have been addressed by linking net interest deductions to taxable economic activity, although…

the proposals do not represent a required minimum standard and are only a recommendation by the OECD.

The proposed primary fixed ratio rule has been confirmed with a range of acceptable EBITDA thresholds for countries to adopt between 10-30%. The report now identifies various factors which it hopes will help countries set the appropriate ratio. It also provides optional elements for a de minimis floor below which all interest could be allowed plus carry forward and carry back provisions.

A group ratio rule which could be adopted alongside the fixed ratio rule would allow for net interest expense above a country’s fixed ratio to be deductible up to the level of the net interest/ EBITDA ratio of its worldwide group. The earnings-based worldwide group ratio rule could also be replaced by different group ratio rules, as already adopted by some countries providing a lot of flexibility for existing regimes.

The report now includes specific rules to prevent circumvention of the basic rules.

More work is anticipated in 2016 on the worldwide group ratio.


11 February 2015

The OECD has published a composite document of all 101 responses to the discussion draft on Action 4.


6 February 2015

Our general global response to the Discussion Draft on BEPS Action 4 is one of concern that…

  • the group-wide test suggested in the Discussion Draft is impractical and will commonly lead to double taxation for a wide variety of taxpayers (dictating that groups must align their internal debt in a way that is likely to be inconsistent with a group’s commercial treasury requirements);
  • the fixed ratio test is overly restrictive and does not adequately take into account different industries, different levels of external leverage, and different policy considerations that countries may have in determining what threshold ratios should be used.

We recommend a combined approach involving a sensibly positioned fixed ratio approach as the primary measure, supplemented by one or more additional measures (such as a group-wide ratio approach, or an arm’s length test) which could be applied by groups that exceed the basic fixed ratio.


19 December 2014

A discussion draft of 18 December sets out best practice options to address BEPS through the use of interest expense and other financial payments, particularly among related parties, examining...

various current interest limitation rules and their success before concluding that current rules do not address the underlying BEPS concerns. So it then looks at group-wide rules, fixed financial ratio rules, targeted rules, and combinations of these approaches.

The options it sets out are likely to have far-reaching implications for multinational groups, in part due to the greater compliance burden. An interest cap allocation rule could have an impact on businesses’ investment choices. The rule could also increase the effective cost of capital, reducing real investment overall. Compliance issues for any best practice rule will include the need for consistency regarding the use of accounting figures under different GAAP (the OECD acknowledges the potential for mismatches to arise between accounting and tax amounts).

The OECD specifically rejects the arm's length standard and withholding tax regimes as efficient tools to prevent BEPS in this area. But the draft references other policy considerations, including

  • minimizing distortions to competition and investment, promoting economic stability, providing certainty, avoiding double taxation, and reducing administrative and compliance costs
  • potential different approaches to specific sectors and industries - comments are particularly requested on financial, infrastructure, and extractive industries
  • the importance of addressing EU law
  • interaction with other BEPS Actions items (including controlled foreign corporations, hybrids, debt pricing, treaty abuse, risks and capital valuation, country-by-country reporting, and dispute resolution).

The OECD has reached no conclusion on the best practice recommendations but identifies two potential general rules:

  • A group-wide interest allocation or ratio approach (group-wide tests). This would either limit net interest deductions to a proportion of the group’s actual net third party interest expense, based on a measure of economic activity such as earnings or asset value (interest allocation) or interest deductions based on applying a group-wide ratio (such as net interest as a proportion of earnings).
  • A fixed ratio test operating to restrict interest expense to a specified proportion of a company’s earnings, assets or equity. The OECD’s proposed fixed ratio would be set ‘deliberately low’ (current uses being too high) so that it would only permit full interest deductions for entities that pose little risk of BEPS.

The OECD also considers the use of a combination of the fixed ratio and group-wide ratio tests, with one of the tests as the default rule and the alternative only applied where the first test leads to non-deductible interest.

Some difficulties we foresee include:

  • insofar as the OECD wants interest expense deduction rules to deal with all forms of debt, payments economically equivalent to interest, and expenses incurred in connection with the raising of finance, experience from the UK worldwide debt cap suggests that this is difficult in practice (eg in dealing with derivatives)
  • annual movements in figures that drive interest allocation across a group could create uncertainty about deductible interest levels in each jurisdiction, making it difficult for groups to forecast their tax position, thereby impacting strategic decisions such as financing future investments and making acquisitions
  • a cap based on allocating worldwide interest across jurisdictions could lead to a risk double taxation because groups might not be able to deduct the full amount of their external interest expense (and any carryforward of excess interest or unused interest deduction capacity is not likely to fully reduce the double taxation risk).


2 September 2013

We consider companies should be at liberty to finance their operations with either equity or debt, as long as the arrangements are in line with …

transfer pricing principles on the level of debt and the rate of interest payable. It’s a basic tenet of the arm’s length principle, which the Action Plan endorses, that the tax treatment within a country should essentially be the same whether payments are made to a foreign group entity or to a third party. We also believe that a natural extension of this, as well as a consequence of market dynamics, is that the non-taxation of the income received by a recipient – whether or not a foreign recipient – should not impact upon deductibility to the payer provided the relevant TP tests are met. The OECD, however, wishes to link rules on the tax deductibility of interest with a consideration of whether the recipient is taxed on that interest.


29 August 2013

Overall, the tax authorities are probably closer to an agreed list of approved anti-base erosion measures that will apply consistently to MNCs …

 and others for financial payments than has hitherto been the case even without the additional impetus given by the Action Plan.


28 August 2013

The OECD seeks to target a broad range of what it describes as ‘excessive’ interest and other financial payments. Many countries have already …

introduced limitations to the deductibility of interest and other financial payments through a variety of methods. Tax authorities have noted the innovative ideas proposed and adopted with an eagerness to see how well they work in practice. Co-ordinating such a review in this area, as is envisaged by the Action Plan, will not require any major OECD initiative and will be a relatively simple action to tackle.


Financial payments archive

25 August 2013

The OECD has stated that the level of debt and interest in certain intra-group finance arrangements is sufficiently arbitrary that …

it is one of the situations in which the arm’s length principle breaks down and as a result ‘special measures’ are required. Restrictions on interest deductions alone may be pursued but the OECD may also consider that the intercompany debt might be disregarded or recharacterised, as discussed in relation to transfer pricing more generally.


21 August 2013

It has been suggested there’s room for more harmonisation across territories on what constitutes an acceptable level of debt (measured in relation to available equity) and beyond which levels of debt would lead to …

interest restrictions. As transfer pricing (TP) analysis remains at the heart of the thin cap debate, some greater accord on general ‘safe harbour’ levels of debt may be most likely.


26 July 2013

The OECD’s plan to develop further guidance on guarantees, derivatives and other financial instruments will be a welcome development …

But new ways of dealing with the ever-changing commercial environment in financial markets will inevitably mean there is a constant need to keep this under review.


19 July 2013

This focus here is on the BEPS concerns from excessive deductible payments such as interest and other financial payments. The OECD concerns relate to …

both inbound and outbound investment scenarios. In relation to the inbound situation, the concern is with excessive interest deductions for the borrower coupled with no corresponding taxation of interest for the lender. The outbound perspective relates to the use of debt to finance the production of tax exempt or deferred income. The Plan states that rules for interest deductibility (and guarantees, derivative payments, etc.) should take account of these concerns.

The action point is to develop recommendations for best practices in the design of rules to prevent BEPS through the use of interest deductions and other financial payments. The work is to evaluate different types of limitation. It is also stated that transfer pricing guidance will be developed in relation to the pricing of related party financial transactions. The work is to be completed by September 2015.

Contact us

Stef van Weeghel
Leader, Global Tax Policy & Administration Network
Tel: +31 (0) 88 792 6763

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