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 deductibility 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 denied 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

Discrimination

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.

Justification

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.

Our comments

This ruling is relevant for the application of the Dutch group interest deduction limitation of article 10a of the Dutch Corporate Income Tax Act 1969 (CITA). The terms and conditions of a group loan must first satisfy the arm’s length principle on basis of article 8b CITA. Nevertheless, article 10a denies the deduction of interest payments to group companies related to certain group transactions, unless (1) the taxpayer demonstrates that both the transaction and the loan are predominantly (more than 50%) entered into for sound business reasons or (2) that the corresponding interest income is subject to a levy of profit tax of at least 10% over a comparable tax basis to the Dutch tax basis. If such minimum profit tax is levied, the tax inspector may still provide counter-evidence, in which case the interest deduction may still be denied.

• On basis of EU law, the tax authorities should have the burden of proof in case of an anti-abuse measure that applies to an arm’s length loan. Article 10a denies the interest deduction by way of default and shifts the burden of proof to deduct the interest to the taxpayer. This seems not in line with the CJEU decision.
• Article 10a does not make a direct distinction of the tax residence of the lender. However, in case an EU resident lender is subject to the normal domestic profit tax rules which give rise to a lower profit tax levy than 10% (such as Hungary (9%), or Malta due to the notional interest deduction), it seems that the Netherlands may not require that more profit tax should have been levied to pass the subject to a sufficient tax levy test.
• It can be further questioned whether article 10a is proportional in denying the arm’s length interest expense all together, or whether the measure should only take out the potential tax advantage.