It’s peace and democracy, stupid
We accountants do not care much for the front section of the newspaper. If a story cannot be reduced to prime numbers, it is not for us. After a cursory glance at the headlines we skip to Section B to be hypnotized by the latest business and finance news followed by yesterday’s football, baseball and cricket results. Reaching the back page we take a quick look at the paper’s weather forecast and then commit its earthly remains to the nearest bin.
I am grateful, therefore, to Nobel Laureate (Economics) Paul Krugman who shone a different - albeit obvious – light on the Euro Crisis in a recent New York Times article:
“Failure of the euro would amount to a huge defeat for the broader European project, the attempt to bring peace, prosperity and democracy to a continent with a terrible history”.
I am British, which explains why I have been in denial on this issue for so long. When Britain negotiated belated entry to the EEC (the forerunner of the EU) in 1973 and promptly held a referendum two years later to decide whether to have the marriage annulled, the British Government talked lots about the importance of a Common Market. What they always avoided was the unhidden agenda of the six founding fathers – West Germany, France, Italy, Netherlands, Belgium and Luxembourg – of achieving political union: a United States of Europe. The Six had one thing in common – they had all, in recent memory, been overrun by foreign troops. Britain, too, had been overrun by foreign troops – Americans – who were overpaid, oversexed and over here but, while this was hardly less traumatic (especially for the husbands dying for King and Country overseas), it did not compromise Britons’ fierce commitment to independence that has remained uninterrupted for a thousand years.
The twenty other countries that have joined since 1973 generally fit the “We had better share some independence rather than risk our heads being kicked-in every 50 years” philosophy shared by the Six.
As has been clear from Day 1 (or, to be more precise, D Day) Britain has no place in the EU. It is a bridge between the Old World and the New and should have economic status not dissimilar to Switzerland – access to the Single Market is all that it ever really wanted.
With Britain out, political union could proceed and the Euro could thrive (I joke not).
Of course there will still be a few minor roadblocks along the way like: cultural diversity; getting over a history of regularly pulverizing each other; and Greece (World War 1940-45, Civil War 1946-49). But it was pleasing to recently see troubled Spain (Civil War 1936-39) taking a leaf out of Germany’s fiscal notebook (World War 1939-45, World Cup 1966). The slow march towards the Common Consolidated Tax Base – a precursor to fiscal union, itself a precursor to political union – advanced another step.
It will be recalled that Spain is having a little trouble meeting its Teutonically imposed budget targets this year. It needs to raise more taxes.
So, following Germany’s lead a few years ago, the Spanish legislature invited the Interest Expense to step up to the executioner’s block for a haircut.
While international tax advisers will be aware that Spain has been quite a paradise for the tax planning of interest expenses (double dips et al), it does look like it is time to put the castanets back in their box and get down to serious business.
To replace the old Thin Cap (3:1) rules which apply to shareholder finance, the Spanish have introduced a general net interest deduction limitation of 30% of , basically, EBIDTA (a la Germany). To the uninitiated, who may find this as understandable as the programming language of their computer – I will explain it in English like wot it is spoken. Ladies and Gentlemen, hold on to your hats.
You start with the financial statements of the Spanish company (or consolidated tax group) and open them at the Profit and Loss Statement. Using your eyes and a calculator you work out operating profit – earnings before interest, taxes, depreciation and amortization (EBIDTA) plus a few secret ingredients. If interest expense minus interest income arrives at more than 30% of the operating profit you start to sweat and move on to Stage 2. In Stage 2, if it is a single company (as opposed to a consolidated group) the rules will only apply if financing expenses are derived from certain related party transactions. In addition, up to one million euro of net interest expense is always deductible. If you are wondering why Stage 2 is not performed before Stage 1, you are right – the accountant will now have to decide whether he can charge his client for the wasted hours on the EBITDA calculations. Accountants sometimes do that sort of thing. Amounts not deductible will be carried forward for up to 18 years to be included in the same 30% limitation each year while, if the net finance expenses are less than 30% in a given year, they can be carried forward for up to 5 years.
What, sadly, the Spanish have omitted is a (brilliant) German exception to the rule. For Germany, where an entity is in a consolidated group even if the 30% rule is breached, as long as the equity ratio (equity to debt) of the company is not less than 99% of the equity ratio of the consolidated group the rule will not apply. What is clever here is that they are effectively saying that if the German situation reflects a more conservative position than the international group as a whole – then it is fair to assume that the interest charge is not designed specifically to hurt Germany and should be allowed.
While, to paraphrase Neil Armstrong this may be “One small step for Spain, one smaller step for Europe” it is still a step in the right direction of unified policies.
Some years ago I flew Iberian to Spain and vowed never again (Iberian, not Spain). Among the numerous insults I suffered on the flight (and I was flying Business – Heaven knows what happens in Coach), was when the young female flight attendant came round offering immigration cards and, smiling politely, I refused as “I am a British citizen”. “You still need an immigration card. Britain is not part of the EU” she growled. I smiled benignly and informed her that Britain had been part of Europe when her country was still a fascist dictatorship. They didn’t allow me on the Business Bus when the plane landed. I suppose old fascist dictatorships die hard.