Update November 15, 2024: On November 14, the Dutch House of Representatives approved an amendment to retain the SME threshold of €1 million for real estate entities. This allows real estate entities to continue benefiting from the SME threshold. Additionally, the interest deduction limit based on the tax-adjusted profit (EBITDA) has been slightly reduced from 25% to 24.5%. This reduction still requires approval from the Senate, which is expected to occur in mid-December.

The earnings stripping measure is a generic interest deduction limitation in the corporate income tax. This measure has long remained under the radar for most real estate investors, but that is about to change. With significant increases in interest rates and plans to further limit the deduction of interest expense as of 2025, another costly measure is on the horizon for real estate investors.

The earnings stripping measure.

Interest expenses are deductible from taxable income. Put briefly, under the earnings stripping measure, the deduction of interest expenses is capped at the highest amount of:

  • 20% of the tax-adjusted profit (EBITDA); or
  • an interest balance of €1 million (the SME threshold).

The €1 million SME threshold will expire on January 1, 2025 for real estate entities with leased properties. This means that interest expenses at such real estate entities will only be deductible up to 20% of the (fiscal) EBITDA as of January 1, 2025. Given the increased interest rates, this could have major consequences. Incidentally, the current government's outline agreement (which forms the basis for the coalition agreement) states that the 20% limit will be increased to 25%.

In a previous post, we used an example calculation to show that scrapping the SME threshold for real estate entities can lead to an annual decrease in returns. However, it is still possible to deduct non-deductible interest from one year in subsequent years, provided there is sufficient deduction capacity available at that time. We will illustrate this below with an example.

Example of a simplified calculation for a real estate sale

With a property portfolio worth € 30 million, financed with 70% loan capital at an interest rate of 5%, the annual interest expenses amount to € 1,050,000. From 2025, with a fiscal profit (EBITDA) of, say, € 2 million, 25% of this profit may be deducted in interest, assuming that the increase of the current 20% limit as included in the outline agreement is actually implemented. That's €500,000 in deductible interest. As a result, an amount of interest of €550,000 is not deductible. This amount is carried forward to subsequent fiscal years.

At the beginning of, say, 2035, the entire property portfolio is sold for €40 million, resulting in a tax book profit of €10 million. Assuming no other results in 2035, the interest deduction in that year amounts to € 2.5 million (25% of EBITDA). During the previous 10 years - from 2025 to 2034 - the real estate entity has not been able to deduct €550,000 of interest annually and an unsettled interest balance of €5.5 million has been accumulated. In 2035, only 25% of the book profit (which is equal to the fiscal EBITDA), being €2.5 million, can be deducted while the unsettled interest balance is €5.5 million. In the year of sale, therefore, € 3 million in interest is not yet eligible for deduction.

Attention when selling the shares

Despite the sale of the real estate, the unsettled interest balance remains available within the company for offset against taxable profits from other (existing or new) activities.

If not the real estate itself but the shares of the company that holds (or held) the real estate are sold, there is a risk that the unsettled interest balance will fully expire. A 30% change in the company's interest may be enough to make this happen.

Future

The further limitation of the deduction of interest expense for real estate entities has been discussed for many years, and it has now been announced that it is coming as of 2025. Although at the time of writing no (draft) legislation detailing this limitation has yet been published, it is already clear that the impact on real estate entities could be significant. We therefore encourage real estate investors and entrepreneurs in particular to develop a strategy with our advisors to anticipate the short- and long-term consequences.