An option to exclude certain public-benefit projects
- 64. The best practice approach set out in this report places a general limit on the level of net interest expense that an entity may deduct for tax purposes. The fixed ratio rule should be applied consistently to all interest paid to third parties, related parties and group entities. However, as an exception to this general principle, a country may choose to exclude interest expense incurred on specific third party loans meeting the conditions set out below from the scope of the fixed ratio rule and group ratio rule. Except as set out in this report, other exclusions should not be applied.
- 65. In some countries, privately-owned public-benefit assets may be large-scale assets financed using a high proportion of debt. However, because of the nature of the assets and the close connection with the public sector, some such financing arrangements present little or no base erosion or profit shifting risk.
- 66. Taking account of the specific circumstances of the public sector, a country may exclude certain amounts with respect to third party loans linked to specific assets when calculating an entity’s net interest expense which is subject to limitation under the best practice approach. To ensure this approach is tightly targeted only on those projects which do not pose a base erosion or profit shifting risk, the following conditions must be met:
- • An entity (the operator) establishes a project to provide (or upgrade), operate and/or maintain assets on a long-term basis, lasting not less than 10 years, and these assets cannot be disposed of at the discretion of the operator.
- • A public sector body or a public benefit entity (the grantor),2 contractually or otherwise obliges the operator to provide goods or services in which there is a general public interest.3 This provision must be subject to specific controls or a regulatory framework in addition to rules applying generally to companies or other commercial entities within a jurisdiction.
- • Interest is payable by the operator on a loan or loans obtained from and owed to third party lenders on non-recourse terms, so that the lender only has recourse to and a charge over the assets and income streams of the specific project. Arrangements involving recourse to other assets, guarantees from other group companies or which otherwise seek to offer recourse beyond the project assets would not qualify for the exclusion.
- • The loan or loans made to the operator do not exceed the value or estimated value of the assets at acquisition or once constructed, unless additional investment is made to maintain or increase their value. Subject to minimal and incidental lending to a third party (such as a bank deposit), none of the funds should be on-lent.
- • The operator, the interest expense, the project assets and income arising from the project are all in the same country, where the income must be subject to tax at ordinary rates.4 Where the project assets are held in a permanent establishment, the exclusion will only apply to the extent that income arising from the project is subject to tax at ordinary rates in the country applying the exclusion.
- • Similar projects of the operator or similar projects of other entities of the operator's group are not substantially less leveraged with third-party-debt, taking into account project maturities.
- 67. Countries making use of the exclusion may impose additional rules before allowing an exclusion to apply, in order to prevent the exclusion being used by businesses not engaged in projects which deliver public benefits. These might include a requirement that obtaining the exclusion is not a main purpose of structuring the financing arrangements to meet the other conditions of the exclusion. Countries making use of the exclusion should publish full information about the scope of domestic legislation and the circumstances in which it can be used, and should also introduce mechanisms to provide for spontaneous exchange of information relating to the entities benefiting from the exclusion and investors in these with all relevant jurisdictions. The framework in Chapter 5 of the OECD Report Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance (OECD, 2015) would be used to determine the jurisdictions with which to spontaneously exchange such information. Countries adopting the exclusion should monitor its operation with a view to assisting in the review referred to below. Such countries should require taxpayers to clearly disclose any use of this exclusion.
- 68. Where this exclusion applies, a country applying the exclusion should also take steps to ensure that the project earnings and assets, and related interest expense, are not used to permit further interest deductions for the entity or other group entities in the country. Therefore, the country should adjust the operation of the fixed ratio rule and group ratio rule, so that where an entity benefits from this exclusion:
- • Any earnings arising from the project (and/or the project assets) are excluded from the calculation of earnings or asset values under the fixed ratio rule and group ratio rule.
- • The interest expense which has been excluded from limitation should not be included in the group's net third party interest expense when applying the group ratio rule.
- 69. There is also a risk that interest which benefits from this exclusion will be used to increase the level of net interest deductions for group entities in other countries in which a group ratio rule is applied. Therefore, in applying the group ratio rule, a country may exclude any third party interest expense which benefits from an exclusion in any other country. Similarly, project earnings and assets may be excluded from the calculation of group earnings or asset values. Countries may obtain information on whether the exclusion has been applied using the exchange of information provisions contained in applicable international agreements. A country may also choose not to require the adjustments in this paragraph, in order to minimise complexity.
- 70. The design and operation of this exclusion will be included in the initial review of the best practice, to be conducted by no later than the end of 2020. This will include consideration of how the exclusion is being used, to ensure it is not giving rise to base erosion or profit shifting risks. Following this review, the exclusion may be revised or removed.
- 71. EU law issues are considered in Annex A.