Excessive Interest Deductions

The Challenge

Companies can finance a mining investment through debt or equity. Interest payments on the debt are tax deductible by the mining company, while dividends that compensate for providing equity are not. Unless there are limitations on the deduction of interest, there is a risk that companies will allocate higher debt levels to the host country in order to pay less tax.

Companies may use related-party debt (e.g., from a headquarters entity to a subsidiary in the mining country) to shift profit offshore via excessive interest payments to the related entities. “Debt shifting” is not unique to mining, but it is particularly significant for mining projects that require high levels of capital investment not always directly obtainable from third parties, making substantial related-party borrowings common.

Many tax authorities are increasingly alert to the disproportionate allocation of debt to operations in their jurisdictions relative to elsewhere in the group and the terms at which loans are provided to local entities. In the absence of limitations on interest expenses, there is an elevated risk that companies will allocate higher debt levels to host countries.

Interest rate markup example graphic

Our Response

Our practice note aims to assist countries in understanding how mining companies legitimately use debt finance within a corporate group. It also explores how countries can best set limitations on the use of interest where there is demonstrable, aggressive profit shifting occurring.

Some of the topics covered include:

  • The financing needs of mining companies and how debt finance is used in the sector.
  • The base erosion behaviours and structures identified by developing countries as concerning, and case studies that illustrate these challenges.
  • How the OECD’s BEPS Action 4 operates to limit interest deductions, and other policy tools available, focusing on the mining sector.

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