All you need to know about the notional interest deduction
What is the Notional Interest Deduction?
After the European Commission declared the “co-ordination” regime a prohibited form of state aid, the Belgian government had to think of a new way to attract foreign investments. After some deliberation with the Commission, the Belgian Government abandoned its plans for a mere update of the old coordination center regime. A more comprehensive solution was adopted: the notional interest deduction.
The deduction at issue is a percentage of the net assets of a company, after some corrections. This percentage corresponds to the current risk-free interest rate. There are no other conditions: there’s no minimal investment, no minimal employment, no obligatory activities, no obligatory forms of incorporation. To make the regime even more attractive to investors, the initial minimum investment period of three years has been abolished.
Which companies can benefit?
The new notional interest deduction applies to all enterprises that are subject to tax in Belgium on their actual profits, without being skewed in favor of co-ordination centers. Highly capitalized enterprises in general will benefit the most, which means that most former co-ordination centers will be covered by the new rules.
The notional interest deduction also applies to Belgian branches of non-Belgian companies. A “branch” in the Belgian tax code does not necessarily correspond to the “permanent establishment” of international tax law and the OECD Model Convention. If they have no profits that can be attributed to them and their costs are covered entirely by the foreign headquarters, Belgian branches are not obliged to publish financial statements. When the Belgian branches want to make use of the notional interest deduction, however, they will necessarily be subject to the Belgian disclosure rules.
In the case of branches, the notional interest deduction is based on the “branch capital”. These are the net assets of the foreign company allocated to the branch for the long term.
How is the deduction calculated?
The deduction at issue is a percentage of the net assets of a company, after some corrections. This percentage corresponds to the current risk-free interest rate.
Taxable profits and net assets
The taxable profits of Belgian enterprises and Belgian branches of foreign companies are determined based on the profits disclosed in the financial statements in accordance to Belgian GAAP.
The calculation base for the deduction is the net assets determined according to Belgian GAAP at the end of the previous taxable period. These net assets, corresponding to shareholders’ equity, consist out of:
- Paid-up capital
- Share premiums
- Re-evalution capital gains
- Retained earnings
- Reserves
- Capital subsidies
Loans from shareholders to the company, subordinated or otherwise, are excluded.
In the case of branches, the notional interest deduction is based on the “branch capital”. These are the net assets of the foreign company allocated to the branch for the long term.
Corrections to the net assets
Two kinds of corrections are included in the new rules. A first series of corrections is made to avoid double exemptions. A second series is made to prevent abuse of the new regime. All corrections are made to the net assets.
Corrections: shares
The net assets on which the deduction will be calculated are reduced with the net tax value of participations and shares which qualify as financial fixed assets under Belgian GAAP. These assets benefit from participation exemption. These shares are not included in the taxable base if they have the nature of financial fixed assets, are subject to tax, held for one year, and amounting to a participation of 10% or with a value of 1.2 million EUR or more in the equity of the daughter.
Shares held as current investments are not excluded from the calculation base. These shares do not benefit from participation exemption, but capital gains on these shares are not taxed in Belgium.
A further correction made to the calculation base is the reduction with the net tax value of treasury shares and of shares held in collective investment companies, if these shares generate dividend distributions which are eligible for the participation exemption.
In all these cases, only the net tax value of the excluded shares is at issue: most probably after deduction of negative value adjustments on financial assets, even though those are normally not tax deductible in Belgium. Corrections: non-Belgian assets
Non-Belgian assets, the income of which is exempt in Belgium, are also excluded from the calculation base. If the Belgian company owns non-Belgian assets, the income of which is exempt in Belgium under applicable double tax treaties (permanent establishments or real estate in tax treaty jurisdictions), the amount of the net assets is reduced by the amount by which the net book value of these non-Belgian assets (other than the excluded shares) exceeds the liabilities attributable to these assets.
Real estate in tax treaty jurisdictions is excluded for the positive difference between the net book value of the real estate and the liabilities that are not part of the equity and are attributable to the real estate at issue.
A permanent establishment in a tax treaty jurisdiction is excluded for the positive difference between the net book value of the assets of the permanent establishment (other than the excluded shares) and the sum of the liabilities that are not part of the equity and are attributable to the permanent establishment. Once again, there could be a difference with the principles put forward in the “Discussion Draft on the attribution of profits to permanent establishments” of the OECD.
Corrections: Non-productive assets
The book value of assets which do not normally belong to a commercial company are also excluded. Targeted are the net book value of assets to the extent that the related expenses substantially exceed the professional needs; the book value of real estate (and real estate rights) used by the company’s directors (or by their family); the book value of investment goods which are not intended to generate periodic taxable income (e.g. art collections), unless they are part of the activities of the enterprise.
Corrections: Re-evaluation capital gains & capital subsidies
Re-evaluation capital gains could be used to artificially inflate equity, so they are excluded from the calculation base, except for those gains relating to excluded assets. The question remains, however, if the gains absorbed in the subscribed capital are excluded too.
Capital subsidies granted by the government are not taken into account to determine the calculation base. Moment of determining net assets
In principle, the net assets that can be taken into account for the deduction are determined at the end of the previous taxable period. In case of transactions that have an effect on the balance sheet, changes, positive or negative, are allowed on a monthly basis.
Such changes include: capital increase / decrease, distribution of dividends, acquiring / selling assets that are not taken into the calculation base. The question remains whether changes in the net assets of a non-Belgian branch lead to an allowed change in the net assets at issue.
Risk-free interest rate
For accounting year 2006, the reference rate is the average OLO interest rate of 2005. For the subsequent accounting years, the reference rate will be the average OLO rate of the preceding year. For small companies, the rate is increased by 0.50 per cent.
OLO rate refers to the interest rate on the long term Euro linear bonds (OLOs) issued by the Belgian Treasury. Even though a new reference rate is determined each year, the new rate cannot differ more than 1% from the previous rate and is capped at 6.5%.
If the accounting year is longer or shorter than the calendar year, the reference rate is taken into account on a pro rata basis (weighted average).
Order of deductions
In Belgium, taxable profits are determined by making some corrections to the accounting profits.
If there’s any profit left, the first deduction is the participation exemption (95%). If there are not enough profits, no carry-forward is allowed (which is incompatible with the Parent-Subsidiary Directive).
The next deduction will be the notional interest deduction. If the company has no profits or has insufficient profits to deduct the full amount of the notional interest, a carry-forward is available during seven years.
Finally, losses from previous taxable periods can be offset against the rest of the taxable income. Under certain conditions, an extra deduction is allowed to reward the company for making extra investments.
What are the anti-abuse measures companies need to be aware of ?
General anti-abuse measure
The general anti-abuse measure tries to prevent the use of a legal instrument or a combination of legal instruments for the sole reason of tax avoidance. This implies that the combination of legal instruments used can be requalified into another combination of legal instruments, with exactly the same consequences for the contracting parties, but that is taxed or subject to a higher levy. In practice, this general anti-abuse measure has proven to be very unwieldy.
Abuse of tax assets
To avoid the abuse of tax assets such as the loss carry-forward, investment deduction and the notional interest deduction, a company can lose these assets in case of a change in control that does not address the “justified economic or financial needs” of the parties involved in the change.
If a company gives so-called “abnormal advantages” to another company, no deduction can be offset against the income generated from these suspected non-business transactions. In practice, this last provision is only relevant in cross-border transactions.
Simulation
Simulation means that the expressed will of the parties differs from their real will. In principle, a law has to be violated. In the past, groups of enterprises that used cash rounds, where capital is moved very swiftly from daughter to granddaughter and beyond in a cascading system, have been found guilty of simulation.
