On 2 September 2022, the Supreme Court of the Netherlands referred questions for a preliminary ruling to the European Court of Justice (“ECJ”) on whether EU law precludes the application of the base erosion rule of Article 10a of the Dutch Corporate Income Tax Act of 1969 (“CITA”).
Article 10a CITA
Article 10a CITA provides that a Dutch company is not allowed to deduct interest in respect of a loan taken out with a related company in order carry out a ‘tainted transaction’. One of the tainted transactions enumerated in article 10a CITA is the acquisition of shares in a(nother) related company. A company is exempted from article 10a CITA if it successfully proves that there are predominantly sound business reasons for the debt and for the associated tainted transaction. Solely evidencing that the loan is at arm’s length is insufficient for this exception. Other exceptions may apply but are not relevant to the case at hand.
Previous case law
The ECJ has, in previous case law, taken the position that Article 10a CITA is compatible with EU law (see i.a. case ECLI:EU:C:2018:110)). The limitation on interest deduction as a result of Article 10a CITA was considered justified as it seeks expressly to prevent the erosion of the Dutch tax base which could result from tax planning wherein interest is deducted in the Netherlands but not subject to reasonable taxation elsewhere. Moreover, Article 10a CITA was considered proportionate as it exclusively prevents conduct involving the creation of wholly artificial arrangements which do not reflect economic reality with a view to evading the tax normally due on the profits generated by activities carried out on national territory. In addition it was considered to provide the taxpayer with ample opportunities for rebuttal.
In a recent ECJ case Lexel (ECLI:EU:C:2021:34), a Swedish limitation on interest deduction similar to article 10a CITA was deemed discriminatory by the ECJ and incompatible with EU law. In short, this limitation on interest deduction measure could not be justified as it did not only target purely artificial arrangements: the scope of this measure included transactions which were carried out at arm’s length. A similar conclusion was reached by the EFTA Court in case PRA Group Europe AS (Case E-3/21).
Case at hand
In the case at hand, a Dutch company acquires initially a majority, and hereafter all of the shares, in another company. This external acquisition was funded by means of a loan from a related Belgium company that applied the now long-abolished Belgian coordination centre regime. The Dutch tax inspector denied the deduction of interest at the level of the Dutch company on the loan granted by the Belgium company on the basis of Article 10a CITA. Although the loan related to an external acquisition, the funds were considered to be ‘re-routed’ as immediately before the financing, they were contributed into the coordination centre-company by its Belgian parent entity.
Since Lexel, it appears that a limitation on interest deduction measure may be incompatible with EU law if it applies to transactions which are carried out at arm’s length and which, consequently, are not purely artificial or fictitious arrangements created with a view to escaping the tax normally due on the profits generated by activities carried out on national territory. This focus on the excessiveness of the interest expenses (do they exceed what it at arm’s length?) is a different one from Article 10a, which focuses more on erosion due to (alleged) artificial creation and use of the funds (is there a real financing function without artificial re-routing?).
Next steps
Lexel and PRA Group Europe AS thus raised enough doubt with the Dutch Supreme Court on the interpretation of EU law as regards Article 10a and it rightly referred preliminary questions. We look forward to the ECJ providing clarity. Taxpayers whose interest deduction is denied through Article 10a may now seek to object to tax assessments that are still open and may consider this development in the preparation of their tax returns.
In case you would like to explore the merits for your specific situation, please contact us.