On January 20, 2021, the Court of Justice of the European Union (CJEU) ruled that arm’s length interest paid by a Swedish company to an EU/EEA resident group company on a loan of which the terms and conditions are similar as between unrelated parties cannot be denied deductability if such interest would be deductible in a domestic situation. Such tax legislation is contrary to the freedom of establishment as provided for in article 49 of the Treaty on the Functioning of the European Union (TFEU) (C-484/19).
Facts of the case and legal context
The case concerns an intra-group acquisition of a shareholding in a Belgian company by a Swedish company. The acquisition price was financed with a loan from a French group company that acted as a bank. The French lender could offset the interest paid by the Swedish borrower against tax losses. Sweden denies the interest deduction on a cross border intra-group loan, unless the loan was entered into for sound business reasons, or would have been taxed at a rate of at least 10%.
The ruling of the CJEU
As mentioned above, Swedish tax law did not deny the interest deduction in a domestic situation. In order to assess whether there is a distinction or discrimination, the CJEU first assesses whether the situation at hand, a French lender and a Swedish borrower, are in a comparable situation as a Swedish lender and a Swedish borrower. The CJEU assessed that these situations are comparable and that the Swedish law therefore makes a distinction.
The Swedish authorities argued that there are two justifications for the tax measure. First, it is a measure to combat tax abuse. Second, it is a measure needed to balance the allocation of taxing rights.
In brief, the CJEU assessed that because the Swedish measure targets all cross-border loan transactions, it is apparently not meant to solely target wholly artificial arrangements, and can therefore not be accepted as anti-abuse measure.
Furthermore, the CJEU assessed that because the interest would have been deductible in case of a similar interest payment to a third party, the Swedish measure cannot be accepted on the basis of the need to balance the allocation of taxing rights, and neither can a combination of the two possible justifications be accepted, basically for the same reasons.
This ruling is relevant for the application of the Dutch interest deduction limitation of article 10a of the Dutch Corporate Income Tax Act 1969. Article 10a denies deduction of interest payments to group companies related to certain transactions, unless the taxpayer proves that the transaction and the loan were made for sound business reasons or that the corresponding interest income is effectively subject to a profit tax of 10% over a comparable tax basis to the Dutch tax basis. If subject to such a tax, the tax inspector may still provide evidence that the transaction and loan were not made for sound business reasons, in which case the interest deduction may still be denied:
- Article 10a makes a distinction between situations where the creditor is a Dutch tax resident and the situation where it is not, because of the 10% effective tax rate test. This requirement is generally always met when the creditor is a Dutch tax resident, because the creditor is subject to Dutch CIT. This distinction cannot be justified as this anti-abuse measure also targets interest payments that are at arm’s length, which, according to this ruling, cannot be wholly artificial;
- Special tax incentives that bring down the effective tax rate of the recipient below 10%, such as notional interest deductions provided in Cyprus or Malta, do not result in the shift of the burden of proof to the taxpayer, because this would be an unjustified distinction; and
- The loss carry forward aspect may have influence on the 10% effective tax rate test as this also applies to Dutch tax resident creditors, meaning that no distinction is made in this respect.