Module IV· Regional & Structuring NotesAdvanced
Question
What is the interest deductibility limit, and how does it affect LBO structures?
Answer
Mechanics
The interest deductibility limit caps the deduction of net interest expense at ~30% of tax EBITDA. Disallowed expense is carried forward as an interest carryforward. (ATAD implements this across the EU; the US §163(j) rule is the close analog.)
Deep diveShow more details
Example
| Item | Value |
|---|---|
| Tax EBITDA | $40m |
| Interest-deduction limit (30%) | $12m |
| Gross net interest expense | $22m |
| Immediately deductible | $12m |
| Interest carryforward | $10m |
Comparison (safe-harbor escapes)
| Escape | Condition | Effect |
|---|---|---|
| De-minimis threshold | net interest below a small floor (~$3m) | limit does not apply |
| Standalone clause | entity not part of a group | full deductibility |
| Equity-ratio test | equity ratio no more than ~2pp below the group ratio | full deductibility |
Impact on PE
- The limit often binds in Years 1–2 after an LBO (EBITDA not yet fully built up)
- The carryforward accumulates and can be used later as EBITDA grows
- Change-of-ownership rules can forfeit the carryforward at exit
Modeling drill
In the LBO model, track the interest carryforward explicitly — a separate line per year, released when EBITDA capacity is available.
Pitch tip
Raising the interest limit in an interview signals structuring credibility. Under ATAD the rule is harmonized EU-wide, and §163(j) applies the same mechanism in the US.