Interaction of the best practice approach with other rules to limit interest deductions
- 205. As described in this report, a country may apply the fixed ratio rule and group ratio rule together with targeted rules to tackle specific base erosion and profit shifting risks, including the risks discussed in Chapter 9 as well as other risks identified by the country. A country may also apply other general interest limitation rules, such as arm’s length rules, rules to disallow a percentage of all interest expense and thin capitalisation rules.
- 206. It is suggested that in most cases, these targeted and general interest limitation rules should be applied before the fixed ratio rule and group ratio rule. However, the ultimate decision as to the order in which to apply interest limitation rules is left to countries, taking into account the design of its rules and the risks they are intended to address.
Interaction of the best practice approach with withholding taxes
207. Withholding tax on interest is typically imposed in order to allocate taxing rights over income to a source country, although it is recognised that an effect of withholding taxes may be to reduce the benefits to groups of base erosion and profit shifting involving interest. Where a country applies withholding tax to payments of interest, this should in no way be impacted by the application of the fixed ratio rule, group ratio rule or targeted rules described in this report. Where the best practice approach limits an entity’s net interest deductions, leading to an interest disallowance, there is no intention that the interest expense disallowed should be re-characterised for any other purpose. Therefore, to the extent a payment would be subject to withholding tax under a country’s tax law, this would continue to apply. Where a country currently re-characterises disallowed interest, for example as a dividend payment, it may continue to apply this treatment but this is not part of the best practice approach in this report.
208. Where an entity receives interest net of withholding tax, and the country of the recipient allows a credit for this tax, the entity will typically be subject to tax on a gross amount of interest income including an amount representing the tax withheld. This treatment is not changed as a result of any aspect of the best practice approach. Therefore, where an entity would currently be able to claim credit for withholding tax on its interest income, this should not change following the introduction of the fixed ratio rule and group ratio rule.