Interest deduction on group loans allowed regardless of tax motive has been saved
Interest deduction on group loans allowed regardless of tax motive
The Supreme Court ruled that the deduction of interest on group loans to finance internal and external acquisitions is allowed, irrespective of the tax beneficial motives for the financing structure.
21 July 2021
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- Interest deduction for group loans
- Arm’s length interest charges
- Article 10a not applicable in case of parallel loan
- No fraus legis
Article 10a of the Dutch CITA 1969 may limit the deduction of interest paid on loans between group companies in case of base erosion. This concerns situations where, within a group, financing structures are aimed at achieving a tax advantage through the optimal use and creation of interest deduction in combination with untaxed or low-taxed interest income. The Supreme Court recently ruled on the assessment that must take place within the framework of the rebuttal scheme of article 10a. In its judgment, the Supreme Court also expressed an opinion on the arm’s length nature of the interest charges and the application of fraus legis.
Interest deduction for group loans
X bv, a transparent entity according to US tax standards, is part of a worldwide group of companies. Within the group, X bv is the parent company of a fiscal unity. The years 2007-2010 showed various financial flows within the group that were used for capital contributions and loans to group companies, also for internal and external acquisitions. In this context, X bv borrowed an amount of EUR 482,000,000 from its US parent company in 2009. This parent company had borrowed the funds from a Luxembourg finance company belonging to the group, which in turn obtained the funds through an external bond loan. In December 2010, the EUR 482,000,000 loan was converted into two loans of EUR 191,000,000 and EUR 291,000,000 respectively, which the Luxembourg finance company granted to two affiliated subsidiaries of X bv.
In its 2009 and 2010 tax returns, X bv deducted the interest it owed on the loan from its US parent company and the interest owed by its subsidiaries to the Luxembourg group company. However, the Tax Inspector refused this interest deduction, citing three reasons. Firstly, the interest was not deductible because it was a non-arm’s length interest charge. Secondly, the application of the anti-base erosion rule (Article 10a CITA 1969) would prevent the deduction of interest. Finally, the Tax Inspector argued that this involves fraus legis. After the The Hague Court of Appeal ruled that the interest paid was allowed to be deducted from the profit of X bv, the State Secretary of Finance lodged an appeal in cassation.
Arm’s length interest charges
In cassation, the Supreme Court upheld the ruling of the The Hague Court of Appeal that the interest charges qualified as arm’s length interest charges. The Supreme Court argued first and foremost that a taxpayer has freedom of choice in the form of financing of a company in which it participates and that this freedom also applies to the organisation of a group of companies. This means that the financing of the acquisition and holding of participations through loans is, in principle, a business matter of a group company. The interest paid hence is an arm’s length expense, even if it is owed to a group company. This is not altered by the fact that the way in which the bv - a private limited company - is financed is motivated by the group interest to pay as little tax as possible worldwide. The Supreme Court further considered that the concept of a group is not limited to companies in which the taxpayer directly or indirectly participates.
Article 10a not applicable in case of parallel loan
Furthermore, the Court of Appeal judgment that article 10a does not preclude the interest deduction was contested in cassation. Because the conditions of the group loans were almost identical to the conditions of the external bond loan of the Luxembourg group company, the Court ruled that there was sufficient parallelism between the group loans and their external financing. From a substantive perspective, the interest is then payable to third parties. In that case, the rebuttal scheme of article 10a(3)(a) is met and the interest deduction limitation does not apply. The Supreme Court agreed with this opinion and added that the assessment of parallelism within the context of article 10a must be made according to Dutch standards, as a result of which it is not relevant for this assessment that a hybrid entity is involved in the loan. The Supreme Court further argued that the fact that X bv was engaged by the group for tax reasons is not relevant for the assessment of the presence of business motives for the respective legal act and the loan.
No fraus legis
Finally, the Supreme Court ruled that the Court of Appeal did not err in law in deciding that there was no fraus legis. The tax advantage that X bv obtains with the interest deduction is mainly due to the use of the “Bosal Gap” that was part of the system of the CITA at the time. Therefore, there is no erosion of the corporate income tax base, as a result of which, according to the Supreme Court, allowing the deduction of the interest does not lead to a violation of the aim and purpose of the law. The Supreme Court added that this would be different if the interest charges were set off against purchased profits or other benefits that have been achieved in an artificial manner. The appeal in cassation lodged on behalf of the State Secretary is unfounded.
Source: HR 9 juli 2021, 19/05112, ECLI:NL:HR:2021:1102.