Amended Thin Capitalization Rules

The Saeima has approved amendments to the Corporate Income Tax Law, revising the so-called “thin capitalization rules”.

Latvia has thin capitalization rules (thin cap rules) in force, which must be considered when attracting financing in the form of loans, as in certain cases they limit the recognition of interest payments as deductible expenses for tax purposes. Currently, two limitations are in force, exceeding which the respective amount is considered a deemed profit distribution, subject to corporate income tax (CIT).
These are:

1. the amount of interest payments exceeding the company’s average annual debt-to-equity ratio of 4 to 1 (with equity valued at the beginning of the financial year);
2. the amount of interest payments exceeding 30% of EBITDA, if the net interest expenses (interest payments minus interest income) for the reporting year exceed 3 million euros.

If a company’s situation simultaneously meets both of the above criteria, the limitation resulting in a larger amount of non-deductible interest expenses for tax purposes shall apply.

More Exceptions Hereafter

Until now, the exception to these rules applied only to interest payments made to credit institutions, as well as state or European Union (EU) financial institutions, in connection with received financing, regardless of which of the two “thin capitalization” limitations was applicable.

However, going forward, the rule that stipulates applying CIT to interest payments exceeding the average annual debt-to-equity ratio of 4:1 will no longer apply even if financing is raised from other sources. Specifically, this limitation will not apply to interest payments for:

1. securities issued in Latvia or the EU/EEA and admitted to trading on a regulated market;
2. financing raised through crowdfunding service providers licensed in Latvia or the EU/EEA;
3. financing raised through investment brokerage firms licensed in Latvia or the EU/EEA;
4. instruments issued by securitization companies;
5. loans provided by alternative investment funds, if registered in Latvia or the EU/EEA (excluding closed-end alternative funds where a participant is a related party to the taxpayer (recipient of financing)).

Similarly, the aforementioned limitation (4:1) will not apply to interest payments on loans received from a group company if:

1. the financing is raised for the needs of the group companies;
2. the interest rate applicable between group companies corresponds to the market price;
3. the said group company has raised the respective financing from credit institutions, state or EU financial institutions, or from securities issued in Latvia or the EU/EEA and admitted to trading on a regulated market.

This exception does not apply to cases where financing is raised from a person who is a related party to any of the group companies.

The aforementioned limitation (4:1) will also no longer apply to special purpose vehicles established within the framework of public-private partnership (PPP) projects.

However, it should be noted that the non-application of the (4:1) limitation does not automatically cancel the second limitation – 30% of EBITDA. That is, if the company’s net interest expenses (interest payments minus interest income) exceed 3 million euros, then the thin capitalization rule (30% of EBITDA) will still have to be applied.

When will the amendments come into force?

Although it was initially planned that the amendments would come into force only in 2028, the Saeima has approved their entry into force already from January 1, 2026.