Thin Capitalization In Egypt: Tax Deduction Boundaries – Tax Authorities


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Thin capitalization is a tax term that refers to a
situation in which a company has a high level of debt and
relatively low equity. The concept aims to portray a company with a
financial structure heavily skewed towards debt financing instead
of equity financing.


A high gearing ratio can create problems for:

  • creditors, which bear the solvency risk of the company.

  • Tax Authorities, which are concerned about excessive interest
    claims.

Tax issues

Even where countries’ corporate laws permit companies to be
thinly capitalized, revenue authorities in those countries will
often limit the amount that a company can claim as a tax deduction
on interest, particularly when it receives loans at non-commercial
rates (e.g. from connected parties).

For That tax authorities limit the applicability of thin
capitalization rules to corporate groups to avoid BEPS “Base
Erosion and Profit Shifting” to other jurisdictions.

Thin Capitalization in Egyptian Tax Law

The Egyptian thin capitalization rule provided by the Egyptian
Income Tax Law #91 Y 2005 and updates #30 Y 2023, As Interest
expenses are deductible for Net income tax calculation purposes
after offsetting any tax-exempt interest income, using the rate of
debt-to-equity 4:1 and this rate will gradually change to reach 2:1
as follows:

  • 4:1 for FY 2023.

  • 3:1 for FY 2024 to 2027.

  • 2:1 for FY 2028 onwards.

Interest expense deductions are only allowed if the following
conditions are fully met

  • The interest rate does not exceed twice the discount rate as
    determined by the Central Bank of Egypt at the beginning of the
    calendar year in which the tax year ends.

  • The interest expense is in return for loans complying with the
    local thin capitalization rule debt-to-equity ratio.

  • This provision shall not apply to banks and insurance companies
    or companies exercising the financing activities to be determined
    by a ministerial decree.

  • The Egyptian transfer pricing rules (i.e. arm’s-length
    principle) are being followed (Transfer pricing section for more
    information). In case of a tax audit, if the interest rate
    isn’t proven to be at arm’s length, the tax authority has
    the right to adjust this price to arrive at the
    ‘arm’s-length price’ and re-calculate the taxes due
    accordingly.

  • The loan is business-related.

Conclusion

As per Egyptian tax legislation, the deduction of interest
payments by Egyptian companies on loans and advances is prohibited
if the total amount of such loans and advances exceeds four times
the average equity, as determined from financial statements
prepared in accordance with Egyptian accounting standards. Put
simply, any interest payments exceeding this threshold cannot be
claimed as deductions.

The scope of “debt” encompasses loans, advances,
bonds, and any other form of debt financing, regardless of whether
they involve fixed or variable interest rates. Debit interest
refers to all payments made by a taxpayer in exchange for obtaining
loans, advances, bonds, or bills.

Collaborating with a reputable tax partner, such as Andersen
Egypt, which boasts a team of tax experts, is crucial for avoiding
erroneous or poorly planned practices that could adversely affect
overall business performance.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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