Evaluation of the Earnings Stripping Rules

Member States had to have implemented the anti-earnings stripping rules by 1 January 2019. In this article, these rules are evaluated from an economic and EU law perspective. The author concludes that the rules are probably not in breach of EU law because they are implemented without distinction between domestic and cross border situations. In addition, there is little room to assess rules which are the result of (full) harmonization. Nevertheless, some risks exist in particular with regard to the interaction between the group regimes and the earning stripping rules and the design of the standalone exception. An important drawback of the earnings stripping rules is the risk of double taxation. This could have been avoided by the EU legislator.

1 Introduction

Member States had to have implemented the Anti-Tax Avoidance Directive (ATAD Directive) by 1 January 2019. An important measure in the ATAD Directive is the introduction of anti-earnings stripping rules. This article evaluates these rules, in particular in the light of EU law. The author will examine whether the earnings stripping rules are consistent with the purposes of the ATAD Directive, principles of EU law, the TFEU and other EU tax policy initiatives. Since most Member States have implemented the rules, section 3 briefly considers the way the ATAD Directive is being transposed into national law by the Member States. By adopting the ATAD Directive, the EU followed the OECD’s recommendations in its (Base Erosion and Profit Shifting Report (BEPS report) to introduce earnings stripping rules. The BEPS Action 4 Final Report identified the following BEPS risks in the area of interest deduction:

  • groups place higher levels of third-party debt in high-tax countries;
  • groups use intercompany loans to generate interest deductions in excess of their actual third-party interest expense; and
  • groups use third-party or intragroup financing to finance the generation of tax-exempt income.

The introduction of the earnings stripping rules follows a trend which is basically a shift away from the historically more widely used specific targeted interest limitation rules towards more general interest limitation rules which now also cover debt vis-à-vis third parties. According to the ATAD Directive:

‘It is essential for the good functioning of the internal market that, as a minimum, Member States implement their commitments under BEPS and more broadly, take action to discourage tax avoidance practices and ensure fair and effective taxation in the Union in a sufficiently coherent and coordinated fashion. In a market of highly integrated economies, there is a need for common strategic approaches and coordinated action, to improve the functioning of the internal market and maximize the positive effects of the initiative against BEPS.’

An important reason for the EU initiative was that uncoordinated implementation of the OECD BEPS proposal could lead to a fragmentation of the internal market and that national implementation of measures which follow a common line across the Union would provide taxpayers with legal certainty in that those measures would be compatible with Union law.

The purpose of these earnings stripping rules is to create a ‘minimum level of protection for national corporate tax systems against tax avoidance practices across the Union’. The rules have to be flexible so that Member

States can choose those that best fit their needs and they should not give rise to any form of double taxation since that would hinder the efficiency of the internal market.

The ATAD Directive can be seen as a second-best response. The EU policy goal was not to create a more equal treatment of debt and equity (although some Member States have adopted this rationale to defend the rules) and/or to establish a fair division of taxing rights with regard to mobile income such as interest. The Directive only tries to increase fairness in the tax system by curbing BEPS, and the allocation of external debt to a country when it does not have the right to tax foreign dividends remains a particular issue given inter-nation equity considerations. The ATAD Directive notes in recital 6 that tax-exempt revenues should not be set off against deductible borrowing costs.

Policy initiatives that try to establish a fairer allocation of taxing rights are politically more controversial. As examples of this, the author would suggest the Common Consolidated Corporate Tax BaseC(C)CTB initiative and the current debate on the taxation of digital companies. The OECD Pillar One initiative aims to change allocation rights and shift them more to market jurisdictions but remains more or less within the boundaries of the BEPS approach. The Pillar Two initiative tries to guarantee that companies pay a minimum amount of corporate tax in all jurisdictions.

In order to make it politically acceptable (the recital points out that Member States are better placed to shape the specific elements of the rules in a way that fits best their corporate tax system), the ATAD Directive includes many options from which Member States can choose, creating a tension with the policy goal to create a uniform and coordinated system and leaving room for tax competition between Member States.

The ATAD Directive prescribes minimum standards. Under Article 3, Member States are allowed to maintain or enact stricter rules in regard to the areas covered by it. They are obliged to implement the rules but only to the extent that they do not already (or will in the future) provide for a ‘higher level of protection’.

The purpose of the interest limitation rule is to discourage BEPS by limiting the deductibility of taxpayers’ exceeding borrowing costs. This is achieved by limiting deduction of borrowing costs to 30% of earnings before interest, tax, depreciation and amortization (EBITDA):

Member States could reduce this percentage or place time limits and/or restrict the amount of unrelieved borrowing costs that can be carried forward or back to ensure a higher level of protection. Given that the aim is to lay down minimum standards, it could be possible for Member States to adopt an alternative measure referring to a taxpayer’s earnings before interest and tax (EBIT) in a way that it is equivalent to the EBITDA-based ratio. Member States could in addition to the interest limitation rule provided by this Directive also use targeted rules against intra-group debt financing, in particular thin capitalization rules. Tax-exempt revenues should not be set off against deductible borrowing costs. This is because only taxable income should be taken into account in determining how much interest may be deducted.’

The interest limitation rules should apply in relation to a taxpayer’s exceeding borrowing costs without distinction of whether the costs originate in debt taken out nationally, cross-border within the Union or with a third country, or whether they originate from third parties, associated enterprises or intra-group.

Member States can postpone implementation of the earnings stripping rules until 1 January 2024 provided that they have adequate domestic rules in place that are equally effective to the interest limitation rules set out in the Directive. This option, too, increases the number of possible departures from the Directive.


The full article, written by Stan Stevens, can be opened in PDF via this link.

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