On November 14, 2018, Iceland issued a draft bill regarding potential amendments to Iceland’s controlled foreign company (CFC) rules and to limitation on interest deductions.
The bill includes a review of the current provisions of Article 57a of the Income Tax Act (ITA), which provides CFC rules, taking into consideration current international proposals. As with existing provisions, the main purpose of a new provision is to authorize the taxation of CFC income in Iceland to prevent domestic taxpayers from transferring funds to low-tax jurisdictions.
Iceland also proposes that restrictions on deducting interest payments under Article 57b of the ITA should not apply to groups of companies entitled to joint taxation under Article 55 of the ITA when all consolidated companies are domiciled in Iceland.
Controlled foreign corporations
Under current Article 57a of the ITA, a tax entity with direct or indirect ownership in any kind of company, fund or institution domiciled in a low-tax country shall pay income tax on the profits of these entities pro rata to its ownership share without regard to distribution. Jurisdictions are considered “low tax” when income tax on the profits of the company, fund or institution is lower than two-thirds of the income tax which the company, fund or institution would have had to pay in Iceland if domiciled there. These rules apply when Icelandic taxable entities own, directly or indirectly, at least half of the entities, or if they have had managerial control within the income year.
An exception to Iceland’s current CFC rules applies if a company, fund or institution is subject to an agreement between Iceland and a low-tax jurisdiction to prevent double taxation provided, on the basis of the agreement, Iceland can acquire all essential information and income of the company, fund or institution, or a company, fund or institution that is founded and listed in another EEA state and has real operations there, and Icelandic tax authorities can, on the basis of a double taxation agreement or other international agreement, demand all necessary information.
Under Article 7 of ATAD 1, the taxpayer’s member state must treat an entity or a permanent establishment (PE), whose profits are not subject to tax or are exempt from tax in that member state, as a CFC, where the following conditions are met:
- In the case of an entity, the taxpayer by itself, or together with its associated enterprises, holds a direct or indirect participation of more than 50 percent of the voting rights, or owns directly or indirectly more than 50 percent of the capital, or is entitled to receive more than 50 percent of the profits of that entity.
- The actual corporate tax paid by the entity or PE on its profits is lower than the difference between the corporate tax that would have been charged under the applicable corporate tax system in the taxpayer’s member state and the actual corporate tax paid.
Where an entity or PE is treated as a CFC, the taxpayer’s member state shall include in the tax base either of the following:
- Undistributed income of the CFC, which is derived from the following categories:
- Interest or any other income generated by financial assets.
- Royalties or any other income generated from intellectual property.
- Dividends and income from the disposal of shares.
- Income from financial leasing.
- Income from insurance, banking and other financial activities.
- Income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value.
- Undistributed income of the CFC arising from non-genuine arrangements, which have been put in place for the essential purpose of obtaining a tax advantage. An arrangement or series of arrangements is considered non-genuine to the extent that the entity or PE would not own the assets or would not have undertaken the risks which generate all, or part of, its income if it were not controlled by a company where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the CFC’s income.
See BEPS Action 3.
Limitation on interest deductions
Current Article 57b of the ITA provides that interest deductions for related party business expense are limited to 30 percent of tax revenue. The interest limitation does not apply if interest expense for transactions with related parties is less than ISK 100 million.
Article 4 of ATAD 1 introduces an interest limitation rule, under which, excessive borrowing costs are deductible in the tax period in which they are incurred only up to 30 percent of the taxpayer’s earnings before interest, tax, depreciation and amortization (EBITDA). Alternatively, the taxpayer may deduct excessive borrowing costs up to €3 million, or fully deduct these costs if the taxpayer is a standalone entity. See BEPS Action 4.
EU member states must adopt and publish laws, regulations, and administrative provisions, by December 31, 2018, to implement ATAD 1, which should apply in member states from January 1, 2019.
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