Germany - Changes proposed to interest expense limitation rule

Germany’s Ministry of Finance published a draft law on 14 July that is designed to enhance growth opportunities, investment and innovation, and simplify the tax rules. Included in this broad package of fiscal policy measures is a tightening of the interest expense limitation rule and abolition of certain related rules. Other measures in the bill include an extension of the loss carryback rules, a temporary suspension of the restriction relating to the offset of net operating loss carryforwards against current year profits and improved options for depreciation (for an analysis of the package, see the tax alert prepared by BDO in Germany).

Under Germany’s current interest expense limitation rule, net interest expense may be deducted in the year incurred up to 30% of the current year’s taxable EBITDA (i.e., earnings before interest, taxes, depreciation and amortisation). Interest expense that is nondeductible under this rule may be carried forward. There are some exceptions to the limitation rule:

  • The net interest expense is below EUR 3 million per year;
  • The taxpayer is not part of a group of companies (i.e., the stand-alone exemption); or
  • The taxpayer can show that its equity ratio does not fall short by more than 2% compared to the group’s worldwide equity ratio (i.e., escape clause).

Under the proposals, the domestic rules on the deduction of interest expense would be adapted to the rules in the EU Anti-Tax Avoidance Directive (ATAD) by 31 December 2023, and the stand-alone clause and escape clause would be abolished. To compensate for the tightening of the interest expense limitation, the EUR 3 million exemption limit would be converted to a EUR 3 million allowance. The introduction of an anti-fragmentation rule would aim to prevent tax structures in which several subsidiaries are established to claim the tax allowance for each of these subsidiaries as an independent business.

In addition, to prevent profit shifting to low-taxed foreign countries in the case of related parties, an interest rate cap would be introduced. The cap would operate to disallow a deduction for interest expense as from 1 January 2024 if the expenses are based on an interest rate above the maximum rate. This maximum rate is the base interest rate (currently 3.12%), increased by two percentage points.

If approved, the proposed measures would apply as from 1 January 2024.

Roland Speidel
BDO in Germany

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