Long-Awaited Guidance on Grandfathering Escape Clause in Interest Limitation Rule

 September 18, 2019 | News

The Circular Letter provides some useful guidance but, at the same time, it is quite conservative and chances are that taxpayers who are heavily impacted will challenge it.

On 11 September 2019, the Belgian Tax Authority published Circular Letter No. 2019/C/89 ("the Circular Letter") providing guidance on the Grandfathering Escape Clause in the Belgian version of the Interest Limitation Rule. All in all, the Circular Letter provides some useful guidance but, at the same time, it is quite conservative and chances are that taxpayers who are heavily impacted will challenge it.

Late 2017, Belgium transposed the first ATAD Directive (Council Directive (EU) 2016/1164 of 12 July 2016) into national law, including Article 4 thereof on the Interest Limitation Rule. In essence, the Interest Limitation Rule limits the amount of net interest that a corporate taxpayer is allowed to deduct for tax purposes, which, in principle, is no more than 30 per cent of the taxpayer's EBITDA.

Pursuant to paragraph 4(a) of Article 4 of the ATAD Directive, "Member States may exclude from the scope of [the Interest Limitation Rule] [the] exceeding borrowing costs incurred on: (a) loans which were concluded before 17 June 2016, but the exclusion of which shall not extend to any subsequent modification of such loans". This carve-out is referred to as the Grandfathering Escape Clause and Belgium is one of the few Member States that have adopted it and transposed it into national law (Income Tax Code 1992, Article 198/1, §2, second limb, second dash). In line with the eighth preamble to the ATAD Directive, the Belgian statute provides that the Grandfathering Escape Clause is applicable only if "no fundamental changes are made to the loans on or after [17 June 2016]". The Circular Letter now provides guidance with respect to the notion "fundamental changes" (Part 2.2. of the Circular Letter).

It is clear from legislative history that changes to the parties to the loan, the interest rate, the duration or the principal amount of the loan are all considered "fundamental changes". The Circular Letter slightly softens this rule by adding that the specific circumstances of each case must be taken into consideration.

The re-financing of a pre-17 June 2016 loan will, in principle, be considered a fundamental change. The Circular Letter refers to Section 1271 of the Belgian Civil Law Code (BCLC), which defines the term "novation":

  • the borrower enters into a new debt vis-à-vis the lender and this new debt replaces the existing debt, which disappears;
  • a new borrower replaces the existing borrower and the latter is released from debt; or
  • pursuant to a new obligation, a new lender replaces the existing one and the borrower is released from his obligations vis-à-vis the latter.

If there is novation within the meaning of Section 1271 BCLC or an equivalent foreign-law provision, the Grandfathering Escape Clause will not apply.

Although the Circular Letter does not explicitly say so, it would seem that as long as there is no novation, there is no fundamental change. However, Section 9 of the Circular Letter brings some nuance to this general rule, stating that " the question whether or not a change is fundamental must be answered on a case-by-case basis."

Then follows a non-exhaustive list of changes that are considered non-fundamental changes:

  • minor administrative amendments, such as the financial account number to be used by the debtor to make payments of (interest and) principal;
  • a change in the name or legal form of one of the parties;
  • a change in the address of one of the parties;
  • a change in the duration of the loan, provided that such change was contractually provided for prior to 17 June 2016 and results from an automatic extension;
  • a change in the interest rate or computation of the interest, but only if this was contractually provided for prior to 17 June 2016 (for example, if the interest rate is based on a formula and the application of such formula results in a different interest rate after 17 June 2016);
  • a change in the payment terms of the interest (for example, quarterly interest payments instead of monthly payments);
  • a change of the initial security interest, it being understood that if the security interest provider or guarantor is replaced, it must be assessed on a case-by-case basis whether or not such replacement leads to a fundamental change;
  • the drawing of (a part of) the principal amount under a loan agreement concluded and in accordance with the terms agreed prior to 17 June 2016.

The Circular Letter does also list changes which, in principle, are considered fundamental, meaning that the occurrence thereof constitutes a change that disqualifies the loan for purposes of the Grandfathering Escape Clause:

  • a change in the duration of the loan that was not agreed upon before 17 June 2016;
  • a change in the interest rate of the loan that was not agreed upon before 17 June 2016;
  • a change in the principal amount;
  • a change in the computation of the interest that was not agreed upon before 17 June 2016;
  • a change or replacement of one or more of the original parties to the loan, except for the change or replacement of an original lender that was agreed upon prior to 17 June 2016.

In a footnote, the Circular Letter confirms that – under the proviso of the General Anti-Abuse Rule of Section 344 of the 1992 Income Tax Code– a merger or de-merger of the lender and/or the borrower should not normally affect existing loans in such a way that these loans disqualify for purposes of the Grandfathering Escape Clause.

Unfortunately, in Section 11 of the Circular Letter, the Belgian Tax Authority takes the view that in the event of a "fundamental change", the totality of the interest on the affected loan disqualifies it for purposes of the Grandfathering Escape Clause ("all or nothing" principle).

  • For example, if the interest rate on a pre-17 June 2016 loan were to increase on or after that date and such increase were not the result of a formula that was included in the original loan agreement, the total interest payments under the new rate would have to be taken into consideration for purposes of computing the 30-per-cent-of-EBITDA-rule, and not merely the incremental interest.
  • If the lender under a pre-17 June 2016 loan were to transfer or assign part of his creditor position to a second lender on or after 17 June 2016, the totality of the interest paid or owed by the borrower after the accession of the second lender would be disqualified for purposes of the Grandfathering Escape Clause rather than just the interest paid or owed to the new lender/creditor taking over part of the position on or after 17 June 2016.

The Interest Limitation Rule entered into effect on 1 January 2019, for taxable periods (accounting years) starting on or after that date. The guidance in the Circular Letter applies to the same taxable periods.

In Belgium, unlike several other jurisdictions, administrative guidance laid down in circular letters is not binding on the taxpayer. A taxpayer can take a different position and if his position is challenged on audit, he can go to court and defend his own position. The court will then decide on the merits of the case and either side with the taxpayer or with the tax authority.

On 11 September 2019, the Belgian Tax Authority published Circular Letter No. 2019/C/89 ("the Circular Letter") providing guidance on the Grandfathering Escape Clause in the Belgian version of the Interest Limitation Rule. All in all, the Circular Letter provides some useful guidance but, at the same time, it is quite conservative and chances are that taxpayers who are heavily impacted will challenge it.

Late 2017, Belgium transposed the first ATAD Directive (Council Directive (EU) 2016/1164 of 12 July 2016) into national law, including Article 4 thereof on the Interest Limitation Rule. In essence, the Interest Limitation Rule limits the amount of net interest that a corporate taxpayer is allowed to deduct for tax purposes, which, in principle, is no more than 30 per cent of the taxpayer's EBITDA.

Pursuant to paragraph 4(a) of Article 4 of the ATAD Directive, "Member States may exclude from the scope of [the Interest Limitation Rule] [the] exceeding borrowing costs incurred on: (a) loans which were concluded before 17 June 2016, but the exclusion of which shall not extend to any subsequent modification of such loans". This carve-out is referred to as the Grandfathering Escape Clause and Belgium is one of the few Member States that have adopted it and transposed it into national law (Income Tax Code 1992, Article 198/1, §2, second limb, second dash). In line with the eighth preamble to the ATAD Directive, the Belgian statute provides that the Grandfathering Escape Clause is applicable only if "no fundamental changes are made to the loans on or after [17 June 2016]". The Circular Letter now provides guidance with respect to the notion "fundamental changes" (Part 2.2. of the Circular Letter).

It is clear from legislative history that changes to the parties to the loan, the interest rate, the duration or the principal amount of the loan are all considered "fundamental changes". The Circular Letter slightly softens this rule by adding that the specific circumstances of each case must be taken into consideration.

The re-financing of a pre-17 June 2016 loan will, in principle, be considered a fundamental change. The Circular Letter refers to Section 1271 of the Belgian Civil Law Code (BCLC), which defines the term "novation":

  • the borrower enters into a new debt vis-à-vis the lender and this new debt replaces the existing debt, which disappears;
  • a new borrower replaces the existing borrower and the latter is released from debt; or
  • pursuant to a new obligation, a new lender replaces the existing one and the borrower is released from his obligations vis-à-vis the latter.

If there is novation within the meaning of Section 1271 BCLC or an equivalent foreign-law provision, the Grandfathering Escape Clause will not apply.

Although the Circular Letter does not explicitly say so, it would seem that as long as there is no novation, there is no fundamental change. However, Section 9 of the Circular Letter brings some nuance to this general rule, stating that " the question whether or not a change is fundamental must be answered on a case-by-case basis."

Then follows a non-exhaustive list of changes that are considered non-fundamental changes:

  • minor administrative amendments, such as the financial account number to be used by the debtor to make payments of (interest and) principal;
  • a change in the name or legal form of one of the parties;
  • a change in the address of one of the parties;
  • a change in the duration of the loan, provided that such change was contractually provided for prior to 17 June 2016 and results from an automatic extension;
  • a change in the interest rate or computation of the interest, but only if this was contractually provided for prior to 17 June 2016 (for example, if the interest rate is based on a formula and the application of such formula results in a different interest rate after 17 June 2016);
  • a change in the payment terms of the interest (for example, quarterly interest payments instead of monthly payments);
  • a change of the initial security interest, it being understood that if the security interest provider or guarantor is replaced, it must be assessed on a case-by-case basis whether or not such replacement leads to a fundamental change;
  • the drawing of (a part of) the principal amount under a loan agreement concluded and in accordance with the terms agreed prior to 17 June 2016.

The Circular Letter does also list changes which, in principle, are considered fundamental, meaning that the occurrence thereof constitutes a change that disqualifies the loan for purposes of the Grandfathering Escape Clause:

  • a change in the duration of the loan that was not agreed upon before 17 June 2016;
  • a change in the interest rate of the loan that was not agreed upon before 17 June 2016;
  • a change in the principal amount;
  • a change in the computation of the interest that was not agreed upon before 17 June 2016;
  • a change or replacement of one or more of the original parties to the loan, except for the change or replacement of an original lender that was agreed upon prior to 17 June 2016.

In a footnote, the Circular Letter confirms that – under the proviso of the General Anti-Abuse Rule of Section 344 of the 1992 Income Tax Code– a merger or de-merger of the lender and/or the borrower should not normally affect existing loans in such a way that these loans disqualify for purposes of the Grandfathering Escape Clause.

Unfortunately, in Section 11 of the Circular Letter, the Belgian Tax Authority takes the view that in the event of a "fundamental change", the totality of the interest on the affected loan disqualifies it for purposes of the Grandfathering Escape Clause ("all or nothing" principle).

  • For example, if the interest rate on a pre-17 June 2016 loan were to increase on or after that date and such increase were not the result of a formula that was included in the original loan agreement, the total interest payments under the new rate would have to be taken into consideration for purposes of computing the 30-per-cent-of-EBITDA-rule, and not merely the incremental interest.
  • If the lender under a pre-17 June 2016 loan were to transfer or assign part of his creditor position to a second lender on or after 17 June 2016, the totality of the interest paid or owed by the borrower after the accession of the second lender would be disqualified for purposes of the Grandfathering Escape Clause rather than just the interest paid or owed to the new lender/creditor taking over part of the position on or after 17 June 2016.

The Interest Limitation Rule entered into effect on 1 January 2019, for taxable periods (accounting years) starting on or after that date. The guidance in the Circular Letter applies to the same taxable periods.

In Belgium, unlike several other jurisdictions, administrative guidance laid down in circular letters is not binding on the taxpayer. A taxpayer can take a different position and if his position is challenged on audit, he can go to court and defend his own position. The court will then decide on the merits of the case and either side with the taxpayer or with the tax authority.

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