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CJEU to rule on tax deductibility of interest on acquisition loans

The Dutch Supreme Court has asked the CJEU to clarify whether the Dutch rules limiting the tax deductibility of interest costs incurred on acquisition loans are contrary to the freedom of establishment.  The Court is expected to further elaborate on its decision in Lexel case (C-484/19).

Situation - A Dutch holding company bought shares in another Dutch company and financed the acquisition with debt from a related party established in Belgium (FinCo). Due to a special tax regime, FinCo was subject to a low effective tax rate. FinCo was financed by a contribution from its Belgian parent company, which was also the parent company of the Dutch holding company.

Under Dutch rules, interest costs incurred on an intercompany loan to finance the acquisition of shares are generally not tax deductible unless the taxpayer proves the existence of commercial reasons for the loan financing and the acquisition itself. In the case of acquisitions from third parties, commercial reasons are presumed to exist unless the financing is artificially re-routed within the group.

In the present case, the administrative courts concluded that the routing of the acquisition financing through FinCo was motivated mainly by tax reasons, and therefore, the interest was not tax deductible. The Supreme Court summarised that, although the requirement of commercial reasons is more difficult to meet in cross-border arrangements, it is an infringement of the freedom of establishment which is justifiable by the fight against tax evasion and fraud. Nevertheless, the Court asked the CJEU several questions concerning the limitation of the tax deductibility of costs incurred to finance acquisitions of shares (both intra-group and from third parties). However, we will have to wait for the judgment.

In a factually similar case (Lexel), the Court of Justice stated that it is contrary to the freedom of establishment if acquisition financing costs are not deductible in a cross-border situation and would be deductible in a purely local situation if the terms of the intra-group financing are arm’s length. The Court went on to consider (inter alia) whether the restriction on the freedom of establishment could be justifiable by the fight against tax evasion and avoidance. Finally, it held that the mere fact that a taxpayer wishes to deduct interest in a cross-border situation without any artificial transfer cannot justify a measure restricting the freedom of establishment.

Recently, there have been a growing number of judgments of Czech administrative courts dealing with the deductibility of interest on acquisition financing, in particular in relation to the principle of abuse of rights. Although the Court's judgment in Lexel case appears to be positive, caution should be taken upon structuring of acquisitions of new companies.

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Author:

Karel Hronek