Building on its action 4 from the base erosion and profit shifting (BEPS) project, the OECD has developed the practice note in cooperation with  the Intergovernmental Forum on Mining, Minerals, Metals and Sustainable Development (IGF), and part of wider efforts to address some of the challenges developing countries are facing in raising revenue from their mining sectors.

The note provides background on the financing needs of mining companies and how debt finance is used; the base erosion behaviours and structures that developing countries have identified as being of concern; how BEPS Action 4 operates to limit interest deductions, and other policy tools available, focusing on the mining sector; and provides conclusions on best practices in limiting tax base erosion for developing countries.

BEPS action 4 includes three parts:  a fixed ratio rule (recommended) based on a benchmark net interest/EBITDA ratio;  a group ratio rule (optional) which allows an entity to deduct more interest expense in certain circumstances, based on the position of its worldwide group; and  targeted rules (optional) to address specific risks.

The draft practice notes says policymakers need to carefully evaluate the trade-off between tax base protection and what levels of debt financing are acceptable for mining to occur. It warns limitations on interest deductions may also not ‘end the story’ – rather, companies may move towards complex arrangements that re characterise interest into other forms of payment that are not caught by interest limitation rules.

The OECD says in capacity constrained economies, simple and clearly designed measures should be prioritised. They are easier to administer, meaning tax officials can focus on other tax risks, and where they reasonably approximate outcomes that are arm’s length, they will be accepted by business.

The practice notes says BEPS action 4 provides a simple headline rule on the overall level of debt permitted in the host country, and sends a clear message to investors. Based on current levels of worldwide net debt in major mining MNEs, the fixed ratio could be set at 20%-25% of EBITDA. Given the capital intensive nature of the industry, the carry forward of excess interest deductions are preferable to disallowance, and transitional rules may be needed.

However, the OECD warns that no single measure will address all of the myriad ways interest deductions can be used for tax base erosion and suggests a package of defences could comprise BEPS action 4, and transfer pricing provisions as a starting point. Where aggressive tax base erosion is encountered, blunter responses such as caps on interest rates or proportional disallowance of deductions based on the foreign tax rate on interest may be required.

The deadline for comments is 18 May.

OECD discussion draft: Limiting excessive interest deductions is here.

Report by Pat Sweet