Global Tax Alert (News from the EU Competency Group) | 10 October 2013

The CJEU finds Portuguese thin capitalization rules contrary to free movement of capital

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Executive summary

The CJEU (Court of Justice of the European Union) finds the Portuguese thin capitalization rules applicable between resident companies and companies from non-EU member countries, which are deemed related parties, to be contrary to the free movement of capital.1

Detailed discussion


Itelcar is a Portuguese company whose main economic activity is the hiring out of light motor vehicles. Before 2005, Itelcar's share capital was held by General Electric International (Benelux) BV, a Belgian company whose capital (more de 10%) is held by GE Capital. After 2006, 99.98 % of Itelcar's capital has been held by that Belgian company and 0.02 % by GE Capital.

On 23 July 2001, a loan agreement between Itelcar and GE Capital entered into force, for a period of 10 years, under which Itelcar had the use of a line of credit in return for the payment of interest at the Euribor rate, plus a “spread” of 0.5 %. Under that agreement Itelcar used credit from 2004 to 2007.

By notices of 5 December 2008 and 8 January 2009, Itelcar was informed that the final tax inspection reports made adjustments to the company's basis of assessment to tax for the years from 2004 to 2007, pursuant to Article 61 of the CIRC (Taxation of Corporate Resident Entities). Those reports found that there was excessive overall debt, as referred to in Article 61(3), and that the evidence presented by Itelcar for the application of Article 61(6) was inconclusive.

After having two administrative appeals dismissed and one court action ruled unfavorably, Itelcar brought an appeal against the later judgment before the Tribunal Central Administrativo Sul (Administrative Court of Appeal, South). The Tribunal took the view that the outcome of the prior proceedings was dependent on the assessment of the compatibility of the relevant provisions with European Union law, and requested a preliminary ruling.

General overview of the thin capitalization rules

Article 61 of the Portuguese Corporate Income Tax Code (CTC), entitled “Thin capitalization”2 states the following:

1. Where the overall debt owed by a taxable person to an entity not resident in Portuguese territory or in another Member State of the European Union, with which that person has “special relations” within the meaning of Article 58(4) (CTC), adapted as necessary, is excessive, the interest relating to the part regarded as excessive shall not be deductible for the purposes of determining the taxable profit. (…)

3. The overall debt shall be regarded as excessive where, at any time during the tax year, the sum of the debts owed to each of the entities referred to in paragraphs 1 and 2 exceeds double the amount of that entity's holding in the taxable person's equity capital. (…)

6. With the exception of cases of debts owed to an entity resident in a country, territory or region with a significantly more favorable tax regime, which has been placed on the list approved by order of the Minister for State and Finance, paragraph 1 shall not apply if, the coefficient referred to in paragraph 3 being exceeded, the taxable person demonstrates – taking into account the type of activity, the sector in which that activity is carried on, the volume and other relevant criteria, and taking account of a risk profile for the transaction that is not predicated upon the involvement of entities with which it has special relations – that it could have obtained the same level of credit, on similar terms, from an independent entity.

Article 58 (4) of the CTC, to which Article 61, paragraph 1 above refers, states that: Special relations shall be deemed to exist between two entities in situations in which one entity has the power to exercise, directly or indirectly, significant influence over the management decisions of the other, a power which shall be regarded as established, inter alia, between:

(a) an entity and those of its shareholders, or their spouses, ascendants or descendants, who hold, directly or indirectly, not less than 10% of the capital or the voting rights; (…)

(g) entities between which, as a result of the commercial, financial, business or legal relations between them, whether established or applied directly or indirectly, there is a de facto position of dependence in respect of the carrying out of the activity concerned, inter alia, where one of the following situations arises between them:

(1) the carrying out of the activity by one entity is substantially dependent on the assignment of industrial or intellectual property rights or knowhow held by the other

(2) one entity is substantially dependent on the other for the supply of raw materials or access to sales networks for products, goods or services;

(3) a substantial part of the activity of one entity can only be carried out with the other or is dependent on decisions taken by the other;

(4) one entity has the right, pursuant to a legal measure, to set the prices or other terms of equivalent economic effect relating to goods or services traded, supplied or purchased by the other;

(5) pursuant to the rules and conditions governing their commercial or legal relations, one entity can make the management decisions of the other conditional upon matters or circumstances unrelated to the entities' particular commercial or trade relationship.(…).

CJEU Decision

From the rules at issue, it is apparent from Article 61(1) of the Code that, where the overall debts owed by a resident company to a company established in a non-member country, with which it has special relations, are regarded as excessive in accordance with Article 61(3), the interest relating to the excessive part of the debt is not deductible for the purposes of determining the taxable profit of that resident company while such deduction is permitted when the lending occurred between Portuguese companies or between companies from two different Member-States.

The court ruled this as contrary to the free movement of capital, Article 56 of the Treaty, based on the Portuguese rules acting to deter a resident company from getting credit “in a manner regarded as excessive” from a company resident in a non-EU member country.

Although, the Portuguese Government's argument of the necessity of the rule to prevent tax evasion and avoidance was accepted by the CJEU, the court found the rule to go beyond what is necessary in order to attain that objective. The reasoning laid on the fact that the term “special relations” involves situations where the lending company of a non-EU member country does not necessarily holds shares in the resident borrowing company. Where there is no such shareholding, the consequence of the method of calculating the excess, laid down in Article 61(3), is that any credit arrangement between those two companies will be regarded as excessive.

In presuming that, the national rule is saying that any credit scheme, between a national company and a company from a non-member country, which are considered to have “special relations” not based on shareholding, forms part of an arrangement designed to avoid the tax due. The rule is therefore contradictory to EU law for going beyond what is necessary to attain the main purposes.

The Court's final decision was that in the case of rules of a Member State which provide that, where interest applied to the part of an overall debt categorized as excessive has been paid by a resident company to a lending company established in a non-member country with which the borrowing company has special relations, it is not deductible as an expense for the purposes of determining taxable profit, but where such interest is paid to a resident lending company with which the borrowing company has special relations, it is deductible for those purposes, those rules are precluded where, if the lending company established in a non-member country does not have a shareholding in the resident borrowing company, they nevertheless presume that the overall debt owed by the borrowing company forms part of an arrangement designed to avoid the tax normally payable (…).


The thin capitalization rules discussed above have been in force through 31 December 2012. They were replaced as of 1 January 2013 by an interest barrier rule which limits the deductibility of net financial expenses to the higher of the following: (i) €3 million; or (ii) 30% of EBITDA (operating profits before interests, taxes, depreciations and amortizations). These limits apply to all financing costs regardless of special relations between the debtor and creditor, and the country of residence of the lender.

Companies should assess whether interest deemed excessive by the Portuguese tax authorities based on thin capitalization rules can be challenged on the grounds of the ruling in the instant case.


1. CJEU Case C-282/12.

2. Version of Decree-Law 198/2001 dated 3 July, amended by Law 60-A/2005 dated 30 December.

For additional information with respect to this Alert, please contact the following:

Ernst & Young, S.A., Lisbon
  • Carlos Lobo
    +351 217 912 146
  • Vera Figueiredo
    +351 217 949 318
Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft, Munich
  • Dr. Klaus von Brocke
    +49 89 14331 12287

EYG no. CM3862