The decision of the Supreme Court follows other recent Supreme Court rulings on the deductibility of interest payments in acquisition structures. We refer to our previous publication on the Hunkemöller case and two other cases regarding the deductibility of interest payments made to private equity investors for more information.
Simplified outline of the case
The case at hand concerned a Dutch taxpayer (Dutch HoldCo) that acquired a Dutch target company. To finance the acquisition, Dutch HoldCo obtained an intra-group loan from a Belgian group financing company (FinCo), that benefited from a special tax regime in Belgium and was taxed at a low effective tax rate. FinCo funded the loan through capital contributions from its Belgian shareholder, which was also the parent company of Dutch HoldCo.
Specific interest deduction limitation rules to prevent base erosion
According to article 10a of the Corporate Income Tax Act (CITA), interest payments are in principle non-deductible if, inter alia, the loans are taken up from related parties and the relevant debt is connected with an acquisition. Two entities are, inter alia, related if a joint shareholder holds an (indirect) interest of at least one-third in both entities. If a loan is within scope of article 10a CITA, the interest can under circumstances still be deducted, for example if the taxpayer demonstrates that business reasons underly the loan as well as the related transaction (business reasons rebuttal). With respect to third-party acquisitions the business reasons rebuttal is generally met if the means to fund the acquisition loan have not been artificially re-routed within a group.
In the case at hand, the lower courts ruled that the routing of the acquisition financing via FinCo was mainly motivated by tax reasons, that therefore the business reasons rebuttal did not apply and the interest was thus non-deductible.
EU law & Lexel case
The question before the Supreme Court was whether the denial of interest deduction based on article 10a CITA is in breach of the EU treaty freedoms.
The Supreme Court acknowledges that it may be more difficult to apply one of the rebuttals under article 10a CITA in cross-border situations than in domestic situations and therefore article 10a CITA may infringe the EU treaty freedoms. According to the Supreme Court, this breach can however be justified by the aim to combat tax evasion and tax avoidance. Article 10a CITA is, in the opinion of the Supreme Court, aimed at preventing wholly artificial arrangements between related entities which do not reflect economic reality and that erode the Dutch tax base. The Supreme Court therefore concludes that article 10a CITA remains within the limits set by the CJ in its case law.
The Supreme Court also specifically addresses the recent judgement of the CJ in the Lexel case. We refer to our previous publication on the Lexel case for more information. From the Lexel case it might be inferred that loans that are concluded on at arm’s length terms cannot constitute a wholly artificial arrangement. The Supreme Court does not subscribe to this view, but it acknowledges that there is uncertainty on this question, also in literature, and therefore refers several questions to the CJ. The Dutch Supreme Court also asks the CJ if it is relevant in this regard whether the intra-group debt is used for an external acquisition or for an intra-group share transfer.
Pending the decision of the CJ, we recommend reviewing existing financing structures where the deductibility of interest payments is denied by article 10a CITA in light of these new developments and assessing whether an objection can be filed by reference to this case.
We will keep you updated on further developments. Should you have queries, please contact your trusted adviser at Loyens & Loeff or one of the advisers mentioned below.