27 September 2018
Real estate investment affected by the draft 2019 Finance Law...
The draft 2019 Finance Law provides new rules limiting the tax deductibility of financial charges!
Since considerable use is made of leverage in the real estate sector, the tax deductibility of financial costs has a significant impact on the return on investment.
Deductions of financial expenses from the taxable income of a company are governed by different mechanisms: there is a limit interest rate (with reference to the market rate and a specific limit for partner loans), a minimum taxation of creditors (especially if established outside France) and the so-called thin capitalisation rules (loans granted by enterprises related to the debtor).
While it is intended that the rules on the rate and the minimum taxation of creditors will remain unchanged, the thin capitalisation rules may well be profoundly changed by the draft 2019 Finance Law as released on 24 September 2018.
This draft is in line with the EU’s ATAD Directive of 12 July 2016.
Thus, the current rules (3 ratios, exemption of €150,000, application to group and similar charges, etc.) will be abolished and superseded by new rules as explained in more detail below (intended to apply to financial years beginning as of 1 January 2019).
As it is likely that this law will be introduced in a form that fairly closely resembles the draft, it may be useful to use the next 3 months to analyse the consequences for current financing of this probable amendment and to make changes as appropriate.
Note that the changes do not affect SPPICAVs as these vehicles are exempt from corporation tax!
Summary of the new rules limiting the deductibility of financial expenses
(*) A company is said to be thin-capitalised where its total debt towards related companies is at least 1.5 times greater than its equity.
(**) EBITDA for tax purposes: result for tax purposes plus net financial charges, depreciation and provisions, net of reversals and taxable capital gains net of capital losses taxed at the rate of 19%.
(***) Calculation to be adapted for tax groups (see below).
Net financial expenses (regardless of lender) will be deductible up to the greater of the following 2 amounts:
- €3 million
- 30% of the “EBITDA for tax purposes”, taxable result plus:
- net financial charges
-depreciation and provisions net of reversals, and
-capital gains taxable at the rate of 19%, net of capital losses of the same kind.
If net financial charges < €3 million → no limit on tax deduction
If net financial charges ≥ €3 million → cap on tax deduction
These limits are reduced to €1 million and 10% of EBITDA if the company is thin-capitalised, i.e. if the average amount of group debt exceeds 1.5 times that of equity:
- One piece of good news: loans made by third parties to the group that are only guaranteed by one group company will not be counted as intra-group loans (whereas this is commonly the case today).
- For tax-integrated groups, the ratios for expenses and taxable results will be assessed at group level (rather than for each member company).
Where intra-group loans are greater than 1.5 times the equity of the borrowing company:
♦ The new regime may thus lead to the partial non-deductibility of interest owed to third parties on account of thin-capitalisation.
Calculation of all financial and similar expenses
All of the following financial charges, including where these are capitalised in the original asset cost, are subject to the above limits:
- inter-group interest
- interest on bank loans
- interest on participating loans and bond issues
- interest on derivatives and hedging contracts
- foreign exchange gains and losses on borrowings
- interest (reconstituted) corresponding to leased assets
- guarantee costs relating to financing, processing fees
- “amounts disbursed under alternative financing”
- “amounts measured by reference to a financial yield that are determined by means of a comparison with similar enterprises operating normally within the meaning of Article 57”
- “all other costs or proceeds equivalent to interest”
The last 3 items must be discussed to determine the charges to be taken into account.
The deductible amount of these charges will be applied (subject to the limit interest rate and minimum taxation of the creditor) minus the amount of financial proceeds of the same kind.
A favourable measure for consolidated groups (protective clause)
Companies or tax groups that are members of a consolidated group may deduct 75% of their non-deductible net financial charges (subject to the above ratios) where the ratio between their equity and all of their assets (or of the companies in the tax group) is greater than or equal to this ratio as determined at the level of the consolidated group.
This benefit will not apply if the company or group is thin-capitalised.
Carryover of non-deductible expenses incurred during the year
- Expenses may be deducted in subsequent years up to the difference between the limit on deductions of net financial charges subject to the above ratios and the net financial charges for the year (no time limit on carryover).
Carryover of unused deductions
- Unused deductions may be carried forward up to the difference between the limit on deductions of net financial charges subject to these ratios and the net deductible financial charges for the year.
- Such unused deductions may be used over the subsequent 5 years.