By Elizabeth Sidi (Senior Tax Consultant, PwC, Bulgaria)
Bulgaria is introducing new interest limitation rules and a new controlled foreign corporation regime from January 1, 2019.
Interest limitation and thin capitalization regimes to co-exist
From January 1, 2019,new interest limitation rules will be introduced in the Bulgarian Corporate Income Tax Act, transposing Article 4 of the EU Anti-Tax Avoidance Directive (ATAD).
The interest limitation rules aim at combating excessive debt leveraging that has been seen in international practice as a tool for (unwanted) base erosion and profit shifting (BEPS).
Building upon the minimum standard required under ATAD, Bulgaria has decided to also keep its currently existing thin capitalization tax rules.
So the two regimes will co-exist and apply in parallel – each of them based on their own triggers and scope. The thin capitalization regime is triggered where the debt-to-equity ratio of the company for a given year exceeds 3:1, and is targeted at regulating interest between related parties. While the interest limitation regime will apply to a much broader cost base including any borrowing costs under external bank financing.
Bulgaria decided to apply the maximum safe harbor threshold allowed under the ATAD, so the interest limitation regime will be triggered in a given year only if the company’s net borrowing costs (broadly speaking – borrowing costs less interest income)exceed EUR 3 million. The high safe harbor threshold would in practice narrow the scope of companies impacted by the new regime.
Where the interest limitation regime applies, net borrowing costs will be deductible for tax purposes in the year when incurred, only up to 30 percent of the company’s tax-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).
The non-deductible borrowing costs from one year can be carried forward and deducted without time limitation (based on the available 30%-EBITDA interest deductibility capacity).
As with the existing thin capitalization regime, credit institutions will not regulate their borrowing costs under the interest limitation regime.
The other optional carve-outs available for member states under ATAD, are not introduced in Bulgaria (such as the group ratio exception, the grandfathering clause for existing loans, etc.).
Overall, the parallel existence of the interest limitation and the thin capitalization regimes, would entail some extra compliance burden for those businesses that will fall under both. The impacted businesses should get familiar with the special rules regarding the interplay between the two regimes.
New controlled foreign corporation (CFC) rules
A CFC tax regime will be introduced for the first time in Bulgaria as of January 1, 2019, based on Bulgaria’s obligation under ATAD.
Undistributed tax profits of qualifying low-taxed foreign subsidiaries (and permanent establishments)will be taxed with ten percent corporate income tax in the hands of the Bulgarian controlling company.
The criteria for foreign entities to qualify as CFCs, follow the ATAD rules. A foreign entity or a permanent establishment will be treated as a CFC, where both of the following tests are met:
- Controlling interest test(controlling interest generally defined as more than 50 percent of voting rights, capital, or entitlement to profits);
- and Low taxation test (the corporate income tax actually paid abroad by the foreign entity/permanent establishment is less than 50 percent from the corporate income tax due under the Bulgarian Corporate Income Tax Act).
Certain measures are introduced to avoid double taxation (though not necessarily sufficient to eliminate it in all cases), including a tax credit for foreign tax paid by the CFC abroad, deductions in case of dividend distributions, etc.
Profits of CFCs with substantive economic activity will not be taxed in Bulgaria.
In terms of compliance and transparency measures, a special register with relevant information on the existing CFCs, should be readily available with the controlling Bulgarian company upon request by the tax authorities.
In terms of expected impact of the CFC rules in Bulgaria, it will be affected by two key factors:
- The CFC regime will apply to Bulgarian controlling companies, but not to individuals controlling similar foreign structures.
- Separately, a last-minute amendment in the rules introduced an exemption from the CFC regime that may render the regime futile with respect to certain offshore jurisdictions, which are traditionally in the focus of CFC systems. In particular, it was added that CFCs which are not subject to corporate taxation on their profits in the foreign jurisdiction, will not be taxed in Bulgaria. It would be worth monitoring whether this exemption will remain in the legislation or would be flagged as non-compliant with the minimum standard protection required by the ATAD.