The Court of Justice of the European Union (CJEU) ruled on 4 October 2024 that the Dutch interest expense deduction limitation in article 10a of the Corporate Income Tax Act (CITA) does not violate EU law. The court’s decision is broadly in line with the opinion of Advocate General Emiliou released on 14 March (for prior coverage, see the article in the May 2024 issue of Corporate Tax News).
Article 10a CITA is designed to prevent erosion of the Dutch tax base and disallows the deduction of interest on loans from related parties based on a presumption that such loans are aimed at artificially lowering the tax base even if the transaction was on arm’s length terms. A taxpayer can avoid forfeiting the deduction if it can demonstrate that there are predominantly sound business reasons for the debt and the “tainted transaction” (i.e., the transaction to which the loan is connected).
In a decision issued in 2019 (Lexel (C‑484/19)), the CJEU ruled that a seemingly similar interest deduction limitation rule in Sweden was not compatible with EU law and appeared to imply that a loan granted on arm’s length terms cannot be considered an artificial arrangement. Following the Lexel decision, the Dutch Supreme Court requested a preliminary ruling from the CJEU on the compatibility of article 10a CITA with the EU treaty freedoms (Case C-585/22).
Advocate General Emiliou opined in March that article 10a does fall within the scope of the EU freedom of establishment and that the Dutch rules restrict that freedom, but that the restriction can be justified based on the need to combat tax avoidance.
The CJEU concluded that, while article 10a CITA limits the freedom of establishment, this limitation can be justified because the legislation aims to combat tax avoidance and applies only to wholly artificial arrangements. Determining whether an arrangement is ‘wholly artificial’ should be based on objective and verifiable criteria. The CJEU identifies one such criterion to be whether the loan adheres to the arm’s length principle. The CJEU stresses that assessing compliance with the arm’s length conditions must reflect the economic reality of the transaction. This assessment requires an examination of the terms of the loan, including the interest rate, and importantly, whether concluding the loan as such and any related transactions align with what independent parties would have agreed upon under similar circumstances.
The CJEU concluded that EU law allows national legislation to disallowThe the deduction of the entire interest on a loan that lacks economic justification and would not have been obtained without the intragroup relationship between the parties involved and the potential tax advantage. This is true even if the loan was made on arm's length terms and the interest rate was in line with what independent parties would have agreed upon.
The CJEU also addressed its decision in the Lexel case, stating that article 10a CITA is not analogous to the Swedish interest deduction limitation rule since their purposes differ. The Swedish rule aimed to counter aggressive tax planning, not purely artificial arrangements, and its application was broader. The CJEU also clarified that arm’s length transactions should not automatically be considered non-artificial based on the Lexel decision.
The CJEU has remanded the case to the Dutch court to rule on whether the taxpayer has successfully rebutted the presumption of tax avoidance. With confirmation from the CJEU that article 10a CITA complies with EU law, there is no need for the Dutch legislator to amend the rules. If the taxpayer is able to rebut the presumption of tax avoidance, it would be able to deduct the interest expense. Potentially affected taxpayers should consider article 10a CITA when setting up financing structures.
Bart van der Burgt
Ferry van Hal
Lisanne Rijff
BDO in Netherlands
Background
Article 10a CITA is designed to prevent erosion of the Dutch tax base and disallows the deduction of interest on loans from related parties based on a presumption that such loans are aimed at artificially lowering the tax base even if the transaction was on arm’s length terms. A taxpayer can avoid forfeiting the deduction if it can demonstrate that there are predominantly sound business reasons for the debt and the “tainted transaction” (i.e., the transaction to which the loan is connected).In a decision issued in 2019 (Lexel (C‑484/19)), the CJEU ruled that a seemingly similar interest deduction limitation rule in Sweden was not compatible with EU law and appeared to imply that a loan granted on arm’s length terms cannot be considered an artificial arrangement. Following the Lexel decision, the Dutch Supreme Court requested a preliminary ruling from the CJEU on the compatibility of article 10a CITA with the EU treaty freedoms (Case C-585/22).
Advocate General Emiliou opined in March that article 10a does fall within the scope of the EU freedom of establishment and that the Dutch rules restrict that freedom, but that the restriction can be justified based on the need to combat tax avoidance.
CJEU Decision
The CJEU concluded that, while article 10a CITA limits the freedom of establishment, this limitation can be justified because the legislation aims to combat tax avoidance and applies only to wholly artificial arrangements. Determining whether an arrangement is ‘wholly artificial’ should be based on objective and verifiable criteria. The CJEU identifies one such criterion to be whether the loan adheres to the arm’s length principle. The CJEU stresses that assessing compliance with the arm’s length conditions must reflect the economic reality of the transaction. This assessment requires an examination of the terms of the loan, including the interest rate, and importantly, whether concluding the loan as such and any related transactions align with what independent parties would have agreed upon under similar circumstances.The CJEU concluded that EU law allows national legislation to disallowThe the deduction of the entire interest on a loan that lacks economic justification and would not have been obtained without the intragroup relationship between the parties involved and the potential tax advantage. This is true even if the loan was made on arm's length terms and the interest rate was in line with what independent parties would have agreed upon.
The CJEU also addressed its decision in the Lexel case, stating that article 10a CITA is not analogous to the Swedish interest deduction limitation rule since their purposes differ. The Swedish rule aimed to counter aggressive tax planning, not purely artificial arrangements, and its application was broader. The CJEU also clarified that arm’s length transactions should not automatically be considered non-artificial based on the Lexel decision.
Comments
The CJEU has remanded the case to the Dutch court to rule on whether the taxpayer has successfully rebutted the presumption of tax avoidance. With confirmation from the CJEU that article 10a CITA complies with EU law, there is no need for the Dutch legislator to amend the rules. If the taxpayer is able to rebut the presumption of tax avoidance, it would be able to deduct the interest expense. Potentially affected taxpayers should consider article 10a CITA when setting up financing structures.Bart van der Burgt
Ferry van Hal
Lisanne Rijff
BDO in Netherlands