As part of the Tax Cuts and Jobs Act (TCJA) of 2017, the United States introduced new limits on interest deductions for businesses. Although countries of the Organization for Economic Co-operation and Development (OECD) generally set interest deduction limits, starting this year, the United States uses earnings before interest and taxes (EBIT) as the tax base for the limit, which has become an anomaly.
The change effectively tightened restrictions on U.S. corporations at the same time as interest rates rose, leading to higher taxes for many. A better approach would be to reconsider the potential economic impact of this change and reset EBITDA as an interest limit to comply with international norms.
Countries may limit interest deductions for a number of reasons: for example, to reduce tax avoidance by moving debt across borders from low-tax subsidiaries to related companies in high-tax jurisdictions, and to help balance the tax treatment of debt-financed investments in equity financing (equity financing generally not deductible).
There are several types of interest deduction restrictions, known as thin capitalization (hereinafter referred to as thin capitalization) rules. One option is to limit the deduction under the transfer pricing regulations applicable to the interest rate. Other restrictions include the safe harbor rule, which creates a debt-to-equity ratio in which interest payments on debt above that ratio are not deductible. The profit stripping rule sets a limit based on the share of profit before taxes, such as earnings before interest, taxes, depreciation and amortization (EBITDA).
Several studies have shown that the thin-cover rule
There could be various adverse economic effects, such as reduced investment, reduced employment, and a decline in the market value of businesses. Thus, when designing thin-cap rules, countries face a trade-off between adverse economic impacts and limiting tax base erosion. At the same time, depending on the design of the rules, they may also reduce debt bias. However, measures that incentivize equity financing (such as corporate equity allowances) may also be effective if weakening rules are introduced to reduce debt bias.
Under U.S. federal tax law, businesses can deduct net interest payments on debt from their taxable income within certain limits. From 2018 to 2021, the cap is set at 30% of EBITDA.
As of the start of the year, the net interest deduction limit was tightened to 30% of earnings before interest and taxes, removing depreciation and amortization from the calculation. In short, this means that companies using EBITDA must multiply their deduction by 30% of their depreciation and amortization cost under the previous limit. For many companies, this represents a substantial increase in taxes—especially capital and R&D-intensive firms with relatively high debt loads—and it comes at a dangerous time, as rising interest rates lead to economic weakness across multiple sectors ( This in itself pushes more companies to the limit).
The change also raises the tax barrier for new investments. Kyle Pomerleau of the American Enterprise Institute found that tighter interest limits increased the marginal effective tax rate on new investments by 0.5 percentage point for corporations and 0.1 percentage point for pass-through businesses.
Looking at the OECD, the U.S. restriction on the use of EBIT stands out. 26 OECD countries use EBITDA as the earnings stripping limit (see table below). It is worth noting that none of the OECD countries use limits based on EBIT.
One of the reasons for the adoption of EBITDA-based limits in many European countries is the EU’s Anti-Avoidance Directive, which established EBITDA as a common definition of interest limits across the EU, as part of the Base Erosion and Profit Shifting (BEPS) project. In the EU, the most common limit is 30% of EBITDA, with separate safe harbor and transfer pricing rules.
While there is disagreement over the amount of interest that should be deducted, it is clear that the EBIT-based limit makes the US an outlier compared with other OECD countries, while endangering many companies and raising the cost of new investments.
Policymakers should consider reverting EBITDA to the interest limit threshold. This can then be aligned with any chosen level of deductible interest.
| nation | interest deduction limit |
|---|---|
| Australia | Deduction of interest is permitted if it is a return on “debt interest” incurred while earning non-capital income and other thin capitalization rules are met Debt to equity ratio of 1.5:1 for general entities and 15:1 for financial entities Exemption limit value 200 Deductions for $10,000 or less |
| Austria | Interest limitation rules apply to “excessive borrowing costs”, i.e. costs exceeding €3 million and exceeding 30% of Adjusted EBITDA Fair dealing standards apply No formal safe harbor rules, but an informal 4:1 debt-to-equity ratio applies |
| Belgium | Interest deduction limited to EUR 3 million or 30% of EBITDA, whichever is higher 5:1 debt-to-equity ratio applies to intra-group loans 1:1 debt to equity ratio applies to accounts receivable from shareholders or directors, managers and liquidators |
| Canada | Business interest deduction will be limited to 40% of EBITDA for tax years beginning after 2022 and before 2024 and 30% of EBITDA for tax years after 2023 1.5:1 tax year debt-to-equity Started after 2012 |
| Czech Republic | Interest deduction limited to SEK 80 million or 30% of EBITDA, whichever is higher A 4:1 debt-to-equity ratio (6:1 for some financial services firms) applies |
| Denmark | Interest deduction limited to 30% of EBITDA, minimum deduction allowed is DKK 22.3m Interest deduction limited to 2.3% of assets if net financing costs exceed SEK 21.3m 4:1 debt-to-equity ratio applies other rules may apply |
| Estonia | For multinational companies, interest deduction is limited to EUR 3 million or 30% of EBITDA, whichever is higher |
| Finland | Intra-group interest expense must not exceed 25% of the company’s adjusted taxable income (“taxable EBITD”, which includes taxable income and adds back interest expense and tax depreciation).with some exceptions Interest expenses do not exceed the interest income paid by the company Net interest expenses up to EUR 500,000 are fully deductible The company’s equity/asset ratio is equal to or greater than the group ratio Net interest expenses between unrelated parties must not exceed EUR 3 million |
| France | Interest deduction limited to EUR 3 million or 30% of EBITDA, whichever is higher Different limits apply to related party debt, banks and credit institutions |
| Germany | Interest deduction limited to EUR 3 million or 30% of EBITDA, whichever is higher carry forward allowed The taxpayer is not part of a corporate group The taxpayer cannot prove that the borrower’s shareholding ratio is lower than the global group’s shareholding ratio by no more than 2 percentage points |
| Greece | Net interest deduction limit for certain classes of interest if it exceeds EUR 3 million or 30% of tax-adjusted EBITDA |
| Hungary | Excess borrowing costs can be deducted up to 30% of EBITDA Separate entities are exempt from tax if their borrowing costs are less than EUR 3 million Loans entered into before June 2016 apply the previous weakened rules and apply a 3:1 debt-to-equity ratio |
| Iceland | Interest deduction limited to 30% of EBITDA The rule does not apply if the total amount of interest paid does not exceed SEK 100 million |
| Ireland | Ireland limits corporate interest deduction to 30% of tax-adjusted EBITDA from 1 January 2022 under the EU’s anti-avoidance directive The new rules do not apply to loans entered into before 17 June 2016 and there are Exemption for taxpayers with net borrowing costs below €3 million |
| Israel | There are no thin capitalization rules and no specific debt-to-equity ratio requirements for interest deductions. |
| Italy | Interest deduction limited to 30% of EBITDA |
| Japan | Deductible net interest expenses for corporations are limited to 20% of EBITDA, adjusted to exclude special income or losses Net interest expenses of less than JPY 20 million are tax-free and can be carried forward for up to seven years |
| latvia | Interest deduction over EUR 3 million not to exceed 30% of EBITDA (exempt for certain financial institutions) 4:1 debt-to-equity ratio applies for deduction up to EUR 3 million (exempt for certain financial institutions) |
| Lithuania | Interest deduction limited to EUR 3 million or 30% of EBITDA 4:1 debt-to-equity ratio applies The rule does not apply if the entity’s debt-to-equity ratio is not lower than (or at most 2 percentage points) the group consolidated ratio |
| Luxembourg | Interest deduction limited to EUR 3 million or 30% of EBITDA, whichever is higher |
| Mexico | 30% of adjusted taxable income (plus interest, depreciation, amortization, and preoperating expenses) and a limit of MXN 20 million on total interest expense applies to a 3:1 debt-to-equity ratio for interest payments between related parties |
| Netherlands | Interest deduction limited to EUR 1 million or 20% of EBITDA, whichever is higher |
| Norway | Interest deduction cannot exceed 25% of EBITDA if the deduction exceeds SEK 25 million |
| Poland | If the deduction exceeds PLN 3 million, the interest deduction is limited to 30% of EBITDA |
| Portugal | Interest deduction is limited to EUR 1 million or 30% of EBITDA, whichever is higher |
| Slovak Republic | Interest deduction cannot exceed 25% of EBITDA (except for financial institutions) |
| slovenia | A debt-to-equity ratio of 4:1 applies |
| South Korea | A debt-to-equity ratio of 2:1 applies (6:1 for financial institutions). Interest deduction cannot exceed 30% of EBITDA (except for financial institutions) |
| Spain | Interest deduction may not exceed 30% of EBITDA if the deduction exceeds EUR 1 million |
| Sweden | Interest deduction may not exceed 30% of EBITDA if the deduction exceeds SEK 5 million |
| Switzerland | Debt-to-equity ratios apply and vary by asset class |
| turkey | A debt-to-equity ratio of 3:1 applies (6:1 for financial institutions) |
| U.K. | Interest deduction cannot exceed 30% of EBITDA if the deduction exceeds £2 million |
| U.S. | Interest deduction limited to the sum of business interest income, 30% of adjusted taxable income and floor plan financing interest |
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Sources: Bloomberg Tax, “Country Guide: Anti-Avoidance Provisions – Thin Capitalization/Other Interest Deduction Rules”; and PwC, “Global Tax Digest: Corporations – Group Taxation”, “Global Tax Digest: Corporations – Deductions” , Tax Foundation, “International Tax Competitiveness Index, 2022.” |
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