The Long-Term Infrastructure Project carve-out under Ireland’s interest limitation rules: residual issues where no LTIP debt exists

In this article, Colm O’Shea examines the carve out in the Interest Limitation Rules for long-term public infrastructure projects. His analysis focuses in particular on how the carve out affects scenarios where an entity is profitable but does not have associated borrowing costs.

Introduction

Ireland’s interest limitation rules (“ILR”), introduced with effect from 1 January 2022 following the transposition of Article 4 of the EU Anti-Tax Avoidance Directive (“ATAD”), are now a settled part of the corporate tax landscape. While early commentary focused on the headline mechanics of the regime, experience has shown that many of the more difficult issues arise from the interaction between statutory carve-outs and the calculation of tax-EBITDA.

One such carve-out applies to long-term public infrastructure projects (“LTIPs”). ATAD permits Member States to exclude certain long-term public infrastructure projects from the interest limitation framework, reflecting a policy view that restricting interest on projects that are capital-intensive in nature, have a long-term investment horizon and are undertaken for broader public or societal benefit may be inappropriate.

However, the manner in which the LTIP carve-out has been implemented in Ireland can, in certain circumstances, produce outcomes that appear inconsistent with that underlying policy intent. In particular, the exclusion of LTIP profits from “relevant profits or losses” can reduce tax-EBITDA and restrict interest deductibility on non-LTIP borrowings in scenarios where the LTIP itself is entirely equity funded.

Overview of the Irish interest limitation framework

At a high level, the ILR restrict the deductibility of a taxpayer’s “exceeding borrowing costs” to 30% of tax-EBITDA, subject to various elections, exclusions and reliefs. A €3m de minimis threshold also applies.

Tax-EBITDA is calculated under section 835AAB Taxes Consolidation Act 1997 (“TCA”) as the sum of relevant profits or losses (“R” – defined in s835AZ TCA), net interest equivalent (“I”) and certain other statutory add-backs (for example, tax depreciation). While the calculation is mechanical, the definition of relevant profits or losses is critical, as any statutory exclusion from that base directly affects the taxpayer’s interest capacity under the ILR.

The LTIP carve-out in Irish legislation

Irish tax legislation provides that income and expenses attributable to a qualifying long-term infrastructure project are excluded from the ILR computation. In particular, section 835AZ(5) TCA provides for the exclusion of profits and losses attributable to an LTIP from “relevant profits or losses”.

As a matter of policy, borrowing costs attributable to an LTIP are also intended to fall outside the scope of interest limitation. This approach reflects the option available to Member States under Article 4(4)(b) of ATAD, which refers to loans used to fund long-term public infrastructure projects where the project operator, borrowing costs, assets and income are all located within the European Union.

Revenue guidance and LTIP debt

In practice, where a qualifying LTIP is debt-funded, Revenue guidance confirms that interest income and interest expense attributable to the LTIP are excluded from both taxable and deductible interest equivalent. This treatment is set out in Revenue Tax and Duty Manual Part 35D-01-01 and ensures that debt-funded LTIPs are effectively taken outside the ILR computation.

It is notable, however, that this exclusion is not articulated in express terms within the statutory definitions of “net interest equivalent” or “exceeding borrowing costs” in section 835AAB TCA. While this does not generally give rise to difficulty in practice, it highlights a reliance on guidance to achieve the intended outcome where LTIP debt exists.

Focus of this article

This article focuses on a narrower and more residual issue: the impact of the LTIP carve-out where the LTIP is profitable but does not have associated borrowing. In that scenario, the LTIP exclusion operates only on the profits side of the calculation, with no corresponding adjustment to net interest equivalent.

Where the difficulty arises

Because LTIP profits are expressly excluded from relevant profits or losses, profitable LTIP activity reduces the tax-EBITDA base used to determine the interest capacity of the taxpayer as a whole. Where the LTIP is equity funded, there is no corresponding exclusion from net interest equivalent, as no LTIP borrowing exists. As a result, the presence of an LTIP can reduce interest deductibility on entirely separate, non-LTIP borrowings.

Worked example

Consider the following simplified scenario.

Facts:

Relevant (taxable) Profit from LTIP activities: €5.0m
Relevant (taxable) Profit from non-LTIP activities: €25.0m
Net borrowing costs (non-LTIP): €20.0m (assume tax deductible)

Ignoring the LTIP carve-out, tax-EBITDA is €50.0m and 30% of EBITDA is €15.0m, resulting in €5.0m of disallowed interest under the ILR (assume all profits taxable at the same tax rate for ease).

Applying the LTIP carve-out, tax-EBITDA is reduced to €45.0m and 30% of EBITDA is €13.5m, resulting in €6.5m of disallowed interest. The additional €1.5m restriction arises solely because of the presence of a profitable, equity-funded LTIP.

ATAD context and domestic implementation

Article 4 of ATAD provides Member States with discretion in relation to the treatment of long-term public infrastructure projects. Article 4(4)(b) refers to the exclusion of exceeding borrowing costs incurred on loans used to fund a long-term public infrastructure project where the project operator, borrowing costs, assets and income are located within the EU.

ATAD further provides that, where this option is exercised, income arising from a long-term public infrastructure project may be excluded from the EBITDA of the taxpayer and any excluded exceeding borrowing costs should not be included in the exceeding borrowing costs of the group for the purposes of the interest limitation rule. The directive therefore allows some flexibility as to whether, and how, qualifying infrastructure projects are taken outside the interest limitation framework.

In circumstances where an LTIP is equity funded and no borrowing costs arise, ATAD does not appear to mandate the exclusion of profits from the EBITDA base. The exclusion of LTIP profits from relevant profits or losses in such cases therefore reflects a domestic implementation of the directive rather than a requirement of the directive.

Possible policy considerations

The outcome illustrated above suggests that the exclusion of LTIP profits from relevant profits or losses operates more broadly than is required to achieve the policy objective of protecting infrastructure financing. In particular, the restriction of interest on unrelated borrowings where an LTIP is equity funded appears to be a residual consequence of the mechanical operation of the legislation.

Potential approaches to address this outcome could include:

Limiting the exclusion of LTIP profits from relevant profits or losses to the extent that the LTIP is debt-funded; or
Providing a targeted adjustment to tax-EBITDA where a profitable LTIP has no associated borrowing.

Recent policy developments

The Department of Finance is currently undertaking a broader review of interest deductibility in Ireland, with a stated objective of simplification and refinement of the existing regime. A number of submissions made as part of this consultation highlight complexity and unintended consequences arising from the interaction of the interest limitation rules with other provisions of the tax code.

In that broader context, the interaction between the LTIP carve-out and the calculation of tax-EBITDA where no LTIP debt exists is an area worthy of consideration.

Conclusion

The LTIP carve-out under Ireland’s interest limitation rules is intended to protect long-term public infrastructure projects from inappropriate interest restrictions. However, the exclusion of LTIP profits from relevant profits or losses can, in certain circumstances, restrict interest deductibility on unrelated borrowings where the LTIP itself is equity funded.

This outcome arises from the mechanical operation of the legislation rather than from any misapplication in practice. It appears to reflect an unintended consequence of the current drafting, whereby profitable, equity-funded infrastructure projects can reduce interest capacity elsewhere within the same taxpayer. As such, it is an issue of which practitioners should be aware and one that merits further consideration in the context of any future refinement of the interest limitation rules.

Colm O’Shea is a Director in the BDO Tax department. Colm has over 9 years’ experience advising clients on all tax-related matters, with significant expertise advising property developers & investors, Irish trading businesses and family offices, providing a full range of tax advisory and compliance services to his clients.