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Base Erosion and Profit Shifting - The Impact of Action 4 on Real Estate Investors


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Summary: Action 4 of the BEPS plan addresses perceived harmful use of financing arrangements to shift the location of profits to jurisdictions with low effective rates of taxation. The final report published on 5 October 2015 provides further insight into the OECD’s proposed measures, including the 10-30% EBITDA ratio restriction on interest deductibility. These are likely to have significant implications for highly leveraged real estate investors.

Real estate investors should closely monitor developments over the next year so that they are prepared for the changes in tax administration and business modelling that will be required if these rules are implemented as expected.

What is the fixed profit ratio and how will it apply?

The OECD has concluded that the best means to counter the use of debt to shift profits cross border is to limit the interest that is tax deductible to a percentage of EBITDA. The restriction would apply to intra-group and third party interest payments. The fixed ratio is intended to operate alongside existing transfer pricing rules.

The OECD recommends that countries apply a ratio of between 10 and 30% of EBITDA. The range is intended to reflect the fact that each country’s circumstances are different but the ratio must be low enough to tackle the tax results it is designed to prevent. The OECD suggests a number of factors that should be taken into account by a country when deciding what ratio to adopt, such as having high interest rates or its economy generally being more indebted for reasons other than profit shifting.

It is likely that lobbyists will push for jurisdictions to adopt a ratio to the lower end of that scale, the 5 October report highlighting that the accounts of “the majority of publicly traded multi-national groups” show net EBITDA to third party debt of below 10%.

Other methods that may be used

The OECD recognises that a fixed ratio rule would not take into account different sectors being leveraged differently or some groups in the same sector being more highly leveraged overall than others for non-tax reasons. It has, therefore, suggested that a group ratio rule could be adopted alongside the fixed ratio. This would allow an entity to deduct interest above the fixed ratio where the group’s overall ratio of interests/EBITDA is higher. Although this group ratio rule is presented as an option that countries may choose not to introduce, it will nevertheless be welcome news for sectors with naturally higher levels of debt finance and may prove to be particularly helpful for some real estate groups.

The OECD considers that an earnings based ratio is the most appropriate measure to prevent taxable profits being shifted away from the location of the activities that generated them. However, in limited cases a country may instead apply a fixed ratio based upon asset values rather than earnings (for example, where an economy is particularly reliant on activities that depend upon tangible fixed assets). Such an approach is intended to be the exception rather than the rule.

Entities likely to be affected

The need to comply with EU law will mean it is likely that wholly UK groups will be caught by any fixed profit ratio that the UK introduces.

It is also worth noting that although the rules are primarily aimed at groups of companies, the OECD highlights concerns about large standalone companies held under trusts or partnerships or by common group of investors. Countries may choose to apply the fixed ratio rule to such standalone entities or tackle the BEPS risks posed by those entities with more targeted rules, which will also prevent groups being artificially fragmented by, for example, using an unincorporated holding entity.

Third party debt

The British Property Federation have consistently stated a clear opposition to restrictions on the deductibility of external debt: “As a matter of principle, all genuine third party debt should be tax deductible” (BPF response to OECD Public Discussion Draft BEPS Action 4: Interest Deductions and Other Financing Payments, February 2015).

The 5 October report at least provides some recognition by the OECD that the location of third party debt may be attributed to non-tax factors – for example, the credit rating of a particular group entity or the strength of currency in one jurisdiction over another. However, the EBITDA ratio restriction is intended to apply equally to intra-group and third party debt. If implemented this will inevitably affect post-tax yields for some investments.


Multi-national real estate groups will need to prepare for an increased compliance burden. There is likely to be differences in both scope and timing of implementation of Action 4 and, indeed, the remainder of the BEPS plan across jurisdictions. There has already been an indication from the US government that it favours a fixed ratio of 10% of EBITDA, whereas the German government is said to favour a 30% fixed ratio. The scope for variance is likely to increase the compliance burden for multi-national real estate corporates, particularly in the short term.

The good news

As well as the recognition that some sectors and groups are more highly leveraged for non-tax reasons and the possibility of a group ratio, multi-national real estate investors will draw some comfort from the OECD’s recognition that non-tax factors influence the location of debt within a group. As the EBITDA ratio will be applied to net interest deductions, multi-nationals should still be able to locate third party debt finance in jurisdictions which offer preferential terms for the group and on-lend intra-group, rather than being restricted to debt finance where real estate assets are ultimately situated.

The final proposals indicate that the OECD has considered the impact of BEPS on industries which hold long-term investments. As real estate development is by its very nature capital intensive and non-income producing in its early years, it makes sense that SPVs holding real estate assets should be able to carry forward unused fixed ratios during the development phase to future years when they become income generating. It is, therefore, pleasing to note such proposals in the OECD’s 5 October report. Questions still remain, however, as to whether this will be implemented by individual countries.

Next Steps

On 22 October the government published a consultation on the UK’s response to the OECD’s proposals. It states that the UK government believes that the OECD’s proposals are “an appropriate response to the BEPS issues identified”. However, it notes that implementing the Action 4 proposals would be a major change to the UK corporate tax regime and the government wants to preserve the competitiveness of the UK tax regime and continue to allow businesses deductions for interest expenses “commensurate with their activities”. The consultation asks a number of questions about how the UK should respond to the OECD’s proposals. Real estate businesses will want to take the opportunity to respond by the 14 January 2016 deadline.

Action 4, together with other BEPS proposals, will be subject to further technical review by the OECD through the course of 2016 and it is not expected that any implementation in the UK will be until at least 1 April 2017.

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