On July 19, 2013, the OECD presented an action plan with 15 action points to deal with base erosion and profit shifting (“BEPS”). On December 18, 2014, a discussion draft was released which deals with Action 4: interest deductions and other financial payments (Discussion Draft). The Discussion Draft intends to provide stakeholders with substantive options for analysis and comment and is addressed below.

The essence of Action 4 (Action Plan July 2013)

Action 4 of the BEPS Action Plan considers best practices in the design of rules to prevent base erosion and profit shifting using interest and economically equivalent payments, for example through the use of related-party and third-party debt to achieve excessive interest deductions or to finance the production of exempt or deferred income. In this connection, transfer pricing guidance will be developed regarding the pricing of related-party financial transactions, including financial and performance guarantees, derivatives (including internal derivatives used in intra-bank dealings), and captive and other insurance arrangements. There is interaction with many of the other BEPS Action items, including Action 2 (hybrid mismatch arrangements) and Action 3 (CFC rules).

Discussion Draft (December 2014)


The Discussion Draft stresses the need to address base erosion and profit shifting using deductible payments such as interest that can give rise to double non-taxation in both inbound and outbound investment scenarios. The primary concern appears to be that multinational groups may be able to claim total interest deductions that significantly exceed their actual third-party interest expense.

The Discussion Draft examines existing approaches to tackle these issues and sets out different options for approaches that may be included in a best practice recommendation. The Discussion Draft also identifies specific questions where input is required in order to advance this work. EU law was taken into account.

The Discussion Draft describes a consensus approach, whereby:

  • the focus should be on related-party or otherwise structured financing regimes
  • the rules adopted should operate directly by reference to the level of interest expense, and not the level of debt
  • those rules should be limited to net interest expense, and not gross interest expense

It subsequently describes two main approaches to limit the deductibility of interest expense (and a third approach that is a combination of the first two), and invites comments from stakeholders regarding those approaches.

In more detail


The Discussion Draft states that to address the issues appropriately, a rule must apply to interest on all forms of debt, payments economically equivalent to interest and other expenses incurred in connection with the raising of finance. Some examples mentioned in this regard are: payments under profit participating loans, imputed interest on convertible or zero-coupon bonds, foreign exchange gains and losses connected with the raising of finance, guarantee fees with respect to financing arrangements and loan arrangement or similar fees.


The Discussion Draft recommends that the rule should apply to companies and other entities in three different scenarios: when they form part of a corporate group; when they are under common control (but are not part of a corporate group); and when the parties are otherwise related, using a 25% ownership test, or in the case of a structured arrangement.

Small entity exception

The Discussion Draft does not recommend a de minimis threshold, although many countries already have such a provision. The Discussion Draft does suggest, however, that if a country wishes to include such a provision, the better option is to apply a monetary threshold based on an amount of net interest expense, with related parties treated as one, to prevent avoidance through the “atomising” of operations, as opposed to a threshold based on the entity’s size.

Approaches under consideration

The Discussion Draft sets forth three principal frameworks for a general limitation on the deductibility of interest expense.

  1. Limitation based on the worldwide group
    Under this framework, an entity’s net interest expense would be limited by reference to its allocable share of the group’s net interest expense, either by allocating a worldwide group’s net third-party interest expense in accordance with a measure of economic activity (such as earnings or asset values), or based on a relevant financial ratio that compares, for example, the entity’s net interest vs. earnings to the group’s overall ratio of net interest vs. earnings.
  2. Limitation based on a fixed ratio
    Under this approach, an entity would be entitled to deduct net interest expense up to a specified proportion of its earnings, assets or equity. For purposes of determining the appropriate limitation under this approach, the Discussion Draft notes that even the lower 25% and 30% ‘interest to earnings’ ratios currently used by some countries may be too high to address BEPS concerns.
  3. Combined approach
    This framework describes two approaches that combine elements of the foregoing, each of which includes a general rule and then a carve-out from the general rule. The Discussion Draft also discusses several other types of interest expense restrictions currently in use, but rejects these approaches as the basis for a best practice rule.

Targeted rules

In addition, the Discussion Draft suggests that targeted rules may be needed to address specific interest disallowance situations, such as for interest paid to connected or related parties, interest accrued on excessive debt push-downs and interest used to fund or acquire tax-exempt or tax-deferred income-yielding assets. The Discussion Draft does not recommend any specific targeted rule, and instead presents such inclusion as a discussion point.

Specific industries

The Discussion Draft acknowledges the special issues presented by banking and insurance companies, and suggests separate rules apply in that context because the proposed general rule (focused on net interest expense) will not be effective at addressing BEPS concerns for financial companies. Consideration will also be given to other sectors such as those taxed under special regimes (e.g., natural resources), infrastructure and non-bank or insurance financial companies (including asset management, leasing, and credit card companies).

Interaction with other BEPS Action items

The Discussion Draft acknowledges the interaction of any limitations on interest expense with many of the other BEPS action items, including Action 2 (hybrid mismatch arrangements), Action 3 (CFC rules), and Action 4 (transfer pricing guidance for related-party financial transactions). It generally focuses on the need for coordination between the action items and does not rank the overlapping solutions.

Next steps

Interested parties are invited to comment on this discussion draft. Submissions close on February 6, 2015. All comments will be made publicly available. A public consultation meeting on Action 4 will be held at the OECD Conference Centre on February 17, 2015. The Action Plan calls for the work to be completed by September 2015 and the recommendations ultimately agreed upon will be delivered to the G20 Leaders and Finance Ministers in late 2015, along with other 2015 BEPS deliverables.

Final remark

The Discussion Draft on BEPS Action 4 is one of six BEPS documents that were released last week. The other items were discussion drafts addressing commodities transfer pricing issues, the use of the profit split method in transfer pricing with respect to global value chains, changes to the OECD’s transfer pricing guidelines to address risk, recharacterisation, and special measures, potential improvements to treaty dispute resolution mechanisms, and international VAT/GST guidelines.

If you would like more information on this topic, we will naturally be happy to be of assistance.

Click here to download the memorandum in pdf format