The interest barrier according to § 4h EStG is a regulation to avoid cross-border tax arrangements due to interest payments. This includes, in particular, payments from Germany to foreign shareholders. In the past, interest expenses were paid more frequently to countries with low tax rates. Consequently, interest expenses across national borders must comply with certain rules.

The interest rate barrier was introduced in 2008 with the corporate tax reform. Deductions of debt interest in international corporations are to be limited. Because often loans are made from parent companies to subsidiaries and vice versa to reduce profits. This is possible by deducting operating expenses from interest paid. As a result, the tax burden in high-tax countries could be reduced and transferred to low-tax countries. Such a regulation exists in many countries today and is often known in the international context as an “interest or earnings stripping rule”. It has also been mandatory since 2018 through the introduction of the ATAD Implementation Act in 2016 throughout the European Union and the European Economic Area.

Since the introduction in Germany is effective for all companies for European law reasons, it is also important to observe the special regulations for natural persons and partnerships. For this purpose, an example is also given in the course.

2nd Conditions of the interest rate barrier

The interest rate barrier is applied to interest expenses within corporate structures. However, it can generally be said that all corporations, partnerships and sole proprietors, whether accounting or profit determination according to the surplus income statement, are covered by the scheme. Only the application rather plays a role in larger companies, since the interest deduction limit is still at three million euros, although sometimes controversially a reduction to a limit of one million euros is discussed. However, this change is not foreseeable and must still be pursued, otherwise many more companies would be covered by the scheme.

Not only the usual interest payments for the regulation of the interest barrier apply, but also a possible damnum or Disagio, commissions and fees. On the other hand, payments for the provision of goods such as rent or rental fees must not be included in the interest rate threshold.

Application of the interest rate barrier

Before the interest rate barrier comes into effect, it is important to check carefully whether a deduction of interest expenses must be limited at all or whether the deduction is justified. The following criteria must be reviewed.

EUR 3 million Net interest expense as exemption

First of all, it is necessary to check whether the total interest expenses exceed the interest income. If this is the case, a limitation of the deduction of these expenses in the profit determination may follow. However, the total net interest expenses, i.e. the expenses minus the income, would also have to meet the limit according to § 4h Abs. 2 EStG of EUR 3 million. In particular, the term exemption limit should be interpreted correctly, because any amounts are ultimately taken into account differently than in the case of an exemption amount. In the case of an allowance, only the value exceeding the allowance would be used.

The exemption threshold is applicable to any business of a taxable person if he maintains several of them. Excluded from this is the organ shaft, whereby the exemption limit can be invoked once at the organ carrier. In addition, the limitation of the deduction of interest expenses does not yet finally apply when the limit is exceeded, because further criteria must be met.

The next step is to determine tax EBITDA. However, it is necessary to clarify beforehand what defines EBITDA.

3.2.1. EBITDA declaration

Here it is important to know that EBITDA (Earnings before interest, tax, depreciation and amortization) is the amount of profit resulting from the ordinary business of a company. However, without taking into account interest, taxes, depreciation and other financing expenses. These compositional rules may differ depending on the definition of a country and must be observed in order to avoid avoidable additional taxation.

3.2.2. Calculation of EBITDA

In order to calculate EBITDA in the course of the calculation to limit the deduction of interest expenses, the following scheme must be followed:

Tax EBITDA = Taxable profit (before income taxes) + Interest expenses – Interest income + scheduled depreciation according to § 7 EStG + Expenditure on low-value assets (GWG according to § 6 para 2, 2a EStG)

Now the deduction of interest expenses must be limited to 30% of this value. If this is not exhausted, the possibility exists through § 4h Abs. 3 EStG to continue unused, accountable EBITDA in subsequent years as a so-called EBITDA lecture.

3.2. The stand-alone clause (group clause)

The application of the group clause is based on special criteria. Because this rule is one of the legal exceptions according to § 4h Abs. 2 p. 1 lit. b EStG from the interest rate barrier. In this case, the company may not belong to a group or only proportionally. For this purpose, the percentage limits on interest expenses to significant shareholders must be taken into account. According to § 8a para 2 KStG, for a complete deduction of interest expenses, only 10 % of the interest on liabilities to shareholders with a participation of more than 25 % may flow. Otherwise, there is talk of harmful shareholder financing, according to which the interest rate barrier would have to continue to apply.

In addition, the establishment of an organization cannot result in a stand alone escape from the interest rate barrier. Since the establishment of a body is limited to domestic companies, this excludes organic associations across national borders.

3.3. The equity ratio in the Group (escape clause)

Now the equity ratio of the subsidiary can still result in a deduction of the total interest expenses. However, this is, so to speak, the last way to escape a restriction of interest expenses in the operating expense deduction. If more than 10 % of the interest on liabilities is paid to significant shareholders, the equity ratio of the subsidiary may not be more than 2 % lower than the equity ratio of the group. The comparison shall be made in accordance with International Financial Reporting Standards (IFRS). In such a case, however, a company must convert its HGB financial statements by means of a reconciliation, which must be examined under certain conditions.

Accordingly, the deduction of interest expenses is limited to 30% of tax EBITDA if the required capital ratio is not respected. In addition, as a result of a limitation of the excess interest expense would be held as so-called interest carry-forward for the following years.

3.4 Interest rate barrier in case of abandonment

In the case of an operating task or the sale of the company as well as the exit of a co-contractor (MU), this interest carry-forward is also the EBITDA carry-forward according to § 4h para. 5 EStG completely (proportionately in the case of the MU). Thus, for example, an accumulation of excess interest expense could be circumvented.

4th Examples of the Interest Rate Barrier

4.1. Example 1

A natural person P holds a 100% stake in a GmbH in Germany. Before taking into account interest income and interest expenses, the GmbH shows an income of EUR 12,000,000 in the annual accounts. In addition, P gives the GmbH an interest-bearing loan of EUR 80.000.000 at an interest rate of 10 %. Furthermore, there are no liabilities. Since the GmbH does not receive any interest income and the interest payments amount to EUR 8,000,000, this represents the net interest expense.

The exemption limit of § 4h para 2 p. 1 lit. a EStG of three million is exceeded, but since the GmbH does not belong to any group, it is therefore spared from the interest rate barrier first of all.

However, the total interest expense consists of remuneration paid to a shareholder who holds more than 25 % of the shares in the GmbH. Therefore, in this case, the rule on the interest rate barrier still applies.

Only EUR 3,600,000 (30% of EUR 12,000,000) is deductible as interest expense (depreciation is not included for simplification).

The remaining EUR 3,600,000 interest expenses represent non-deductible operating expenses within the meaning of § 4h para. 1 EStG.

As of January 1, 2017, German C AG has loans from banks in the amount of EUR 40 million, which are subject to an annual interest rate of 10%. Furthermore, shareholder E of C AG, which holds a 60% stake, has a loan of EUR 3.5 million as of January 1, 2017. with an annual interest of 10 % and repayment on 31.12.2023. The accountable EBITDA in 2017 amounts to EUR 2 million.

Here, a surplus of interest expenses over interest income must first be checked and affirmed, since no other information is given. Furthermore, these interest expenses must exceed the exemption limit of EUR 3 million. Since EUR 4 million is due for the bank loans and EUR 350,000 for the shareholder loan, the limit is clearly exceeded. In addition, the interest expense is also EUR 2.35 million higher than the offsettable EBITDA (=30 % of the tax EBITDA) and thus not fully deductible for the time being. Since no group membership can be accepted, § 4h Abs. 2 p. 1 lit. b EStG not yet and the interest rate barrier does not apply yet.

Nevertheless, § 8a para. 2 KStG to check for harmful shareholder financing. In this case, no more than 10 % of the borrowing expenses may flow to a shareholder with more than 25 % of the shares. In this case, the shareholder with 60 % of the shares would be well above the limit of 25 %, but only just under 8 % of the total interest expenses go to him. Thus, no interest deduction restriction applies this year.

Conclusion on the interest rate barrier according to § 4h EStG