Thin Capitalization Rules - A Practical Approach
- Tax Experts
- Jun 6
- 3 min read
May 20, 2025
Following our article on CFC Rules, we now present a practical approach to Thin Capitalization Rules, another key anti-tax avoidance measure implemented by various jurisdictions, particularly in line with the OECD’s BEPS (Base Erosion and Profit Shifting) framework. These rules aim to prevent multinational corporations from excessively financing their subsidiaries with debt instead of equity, thereby reducing taxable profits through high-interest deductions.
What Are Thin Capitalization Rules?
Thin Capitalization Rules are designed to limit the tax benefits of excessive interest deductions on related-party debt. In line with the OECD’s BEPS Action 4, many jurisdictions have adopted standardized rules to ensure that interest expenses reflect real economic activity.
These rules generally involve the following provisions:
30% of EBITDA rule: A company can deduct interest expenses up to 30% of its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
Cap of € 3,000,000: If the excess borrowing costs exceed €3,000,000, the rules will impose a cap on the deductible interest.
The OECD’s Inclusive Framework promotes consistent implementation of such rules globally, reducing harmful tax competition and enhancing transparency.
Practical Examples
Example 1: Full Deductibility of Interest under Thin Capitalization Rules
Let's assume Company A reports the following financial figures for the fiscal year 2024:
Fiscal Year 2024 Data:
o Depreciation: €2,000,000
o Interest expenses: €5,200,000
o Interest income: €400,000
o Taxable income: €18,500,000
Step 1: Calculation of Excess Borrowing Costs
Interest expenses−Interest income = 5,200,000 − 400,000 = € 4,800,000
Step 2: Calculation of EBITDA
Taxable Income + Excess Borrowing Costs + Depreciation = 18,500,000 + 4,800,000+ 2,000,000= € 25,300,000
Step 3: Determination of Deductible Interest
Since the excess borrowing cost of €4,800,000 exceeds the threshold of €3,000,000, Thin Capitalization Rules apply. The amount deductible from the company’s gross income is:
30% × EBITDA= 30% × 25,300,000 = € 7,590,000
Step 4: Comparing €3,000,000 with 30% of EBITDA
Since €7,590,000 (30% of EBITDA) is greater than €4,800,000, the full excess borrowing cost is deductible. So, no interest needs to be carried forward to future tax years.
Example 2: Interest Deduction Limitation under Thin Capitalization Rules
Let's assume Company B reports the following financial figures for the fiscal year 2024:
Fiscal Year 2024 Data:
o Depreciation: €1,500,000
o Interest expenses: €4,800,000
o Interest income: €300,000
o Taxable income: €-9,500,000
Step 1: Calculation of Excess Borrowing Costs
Interest expenses−Interest income = 4,800,000 − 300,000 = € 4,500,000
Step 2: Calculation of EBITDA
Taxable Income + Excess Borrowing Costs + Depreciation = -9,500,000 + 4,500,000+ 1,500,000= - € 3,500,000
Step 3: Determination of Deductible Interest
Since the excess borrowing cost of €4,500,000 exceeds the threshold of €3,000,000, Thin Capitalization Rules apply. The amount deductible from the company’s gross income is:
30% × EBITDA= 30% × -3,500,000 = - € 1,050,000
Step 4: Comparing € 3,000,000 with 30% of EBITDA
Since €3,000,000 is greater than €-1,050,000, the €3,000,000 limit applies for deductible interest. Therefore, € 1,500,000 (€ 4,500,000 - € 3,000,000) is non-deductible but can be carried forward indefinitely for future tax years when the deductible threshold exceeds the excess borrowing cost.
At Tax Experts, we Support businesses in managing the challenges of Thin Capitalization Rules, ensuring compliance while optimizing their financial structure. These rules are essential for preventing tax avoidance through excessive intra-group borrowing and are particularly relevant for companies operating across low-tax jurisdictions. Our team provides strategic guidance on aligning debt-to-equity ratios with regulatory expectations, structuring cross-border financing in a tax-efficient way, and preparing the necessary documentation to support interest deductibility. As thin capitalization rules become more prevalent in international tax frameworks, we ensure your business remains compliant, transparent, and well-positioned in a globally regulated environment.
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