A new production line or energy project often starts with a shareholder loan. In Lithuania, however, interest on financing provided even on market terms may not be deductible for corporate income tax purposes. Investors’ Forum is calling for the repeal of a rule in force since 2003 that makes investment more expensive and increases uncertainty for businesses.

In a proposal submitted to the Ministry of Finance, the association calls for the abolition of the so-called thin capitalisation rule. Where debt covered by the rule exceeds a prescribed ratio of four to one relative to a company’s fixed capital, interest attributable to the excess is not deductible for corporate income tax purposes unless the company demonstrates that the specified exemption applies. This increases the tax burden on financing.

The rule provides an exemption if a company proves that it could have obtained an identical loan on identical terms from an independent lender. In the association’s view, this is difficult to demonstrate. Lenders assess each project individually, and bank offers typically include additional fees, restrictions on dividend payments or collateral requirements—conditions that are usually absent from intragroup loans. Consequently, even an analysis substantiating a market interest rate does not, in itself, demonstrate that an identical loan could have been obtained.

According to information available to the association, in several tax investigations the tax authority proposed disallowing a substantial portion of interest deductions, even though the financing had been provided by a Lithuanian parent company, the interest income had been taxed in Lithuania, and several analyses had confirmed that the interest rate was consistent with market terms.

Since 2019, Lithuania has also applied a separate interest deduction limitation mechanism introduced to implement the EU Anti-Tax Avoidance Directive. Transfer pricing rules and rules targeting artificial arrangements apply alongside it. These measures would remain in force if the 4:1 restriction were abolished. The EU directive does not require countries to retain rules based on a debt-to-equity ratio. France, the Netherlands and Poland abolished such rules when implementing the directive, while Germany, Italy, Spain, Portugal and Finland had done so earlier.

“Today, the costs of the same loan may be assessed under as many as three sets of rules. A company may borrow for a genuine investment project and pay interest at a market rate, yet still be unable to deduct part of that interest. When a loan is provided by another company within the same group, the lender pays tax on the interest income while the borrower cannot deduct the corresponding expense. The tax base is not shifted elsewhere, yet financing becomes more expensive. We propose removing this additional restriction while retaining the EU-harmonised interest limitation mechanism and other measures to prevent tax avoidance,” says Nerijus Nedzinskas, Head of the Investors’ Forum Tax Working Group and Managing Partner at PwC Lithuania.

Investors’ Forum brings together Lithuanian and foreign investors seeking to create the most favourable investment climate in Lithuania, built on trust between business and government, an efficient public sector and a strong system for developing, attracting and retaining talent. These are the foundations of a safe and prosperous Lithuania.