Peter Barnes Authors Chapter in United Nations Handbook, Selected Issues in Protecting the Tax Base of Developing Countries

The United Nations has released the second edition of its handbook, Selected Issues in Protecting the Tax Base of Developing Countries.  Peter A. Barnes, Of Counsel to Caplin & Drysdale’s International Tax Group, contributed to Chapter IV: “Limiting Interest Deductions” (see pages 179 to 213). While the updated edition contains new chapters on rent and royalty payments and general antiavoidance rules, tax administrators will want to pay particular attention to the handbook’s assertions that developing countries must devise their own creative solutions beyond the OECD’s base erosion and profit-shifting project and tailor their anti-BEPS activities in a manner that conserves administrative resources. Mr. Barnes is also a Senior Fellow at the Duke Center for International Development at Duke University.

Chapter IV: “Limiting Interest Deductions,” by Peter A. Barnes.

In the fourth chapter, Barnes summarizes the issues that developing countries face when addressing the deductibility of interest payments and trying to determine whether a taxpayer has excessive debt. According to Barnes, the issues that developing and developed nations face in this arena are similar, but resource limitations and other issues might make bright-line rules more attractive to developing countries as compared with the complex OECD recommendations in BEPS action 4.

The OECD approach contains four steps, loosely summarized:

1) A taxpayer can deduct all its interest expense, provided it does not exceed a de minimis monetary threshold.

2) A taxpayer can deduct its net interest expense up to a benchmark ratio of net interest to earnings before interest, taxes, depreciation, and amortization. According to the OECD, an acceptable benchmark would be 10 to 30 percent of EBITDA.

3) A taxpayer can apply an additional test that would allow it to deduct a greater amount of interest expense by comparing the ratio in step 2 with a ratio of the global group’s net interest expense to EBITDA. Tax authorities can also choose to apply an uplift (up to 10 percent) to the global ratio.

4) Countries allow taxpayers to carry forward or carry back disallowed interest expense.

According to Barnes, assembling and auditing global group information as required by the third step poses a challenge to administrators and taxpayers. Handling related-party lending also raises tax administration issues — whether the matter requires special rules or whether administrators can handle it through other means. Withholding taxes, which developing countries like to impose on interest payments to nonresident lenders, also present their own set of challenges. Governments need to balance reducing the tax costs of interest deductions against ensuring that the withholding tax does not increase interest rates or stymie investment.

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Excerpt taken from the article “Book Review: UN Handbook Calls for Creative BEPS Solutions in Developing Countries” by Nana Ama Sarfo for Tax Notes.