Judgment summary
This is a reference for a preliminary ruling under Article 267 TFEU made by the Hoge Raad der Nederlanden (Supreme Court of the Netherlands) in proceedings between X BV and the Netherlands tax authorities. The dispute concerned the deductibility, for corporation tax purposes, of interest paid by X BV on an intra-group loan used to finance the acquisition of shares in a company that became, as a result of that acquisition, related to the group.
The Court held, in essence, that Article 49 TFEU on freedom of establishment does not preclude national legislation such as Article 10a of the Netherlands Law on Corporation Tax 1969, under which such interest may be disallowed in full where the underlying debt is classified as a wholly artificial arrangement, even where the loan was contracted on an arm's length basis and the interest itself does not exceed what independent parties would have agreed.
Background
X BV is a company incorporated under Netherlands law and forms part of a multinational group. Its sole shareholder is A, a company incorporated under Belgian law, part of whose shares were held by another Belgian company, B (39% until 22 December 2002, then 44.47%), with the remainder listed on the Brussels Stock Exchange and held by the public (paragraph 4).
The group formed by B and A also includes C, a company established in Belgium which, between 1999 and 2010, had the status of a 'coordination centre' under Belgian tax law, benefitting from a flat-rate profit basis and no withholding tax on interest payments (paragraph 5). Shareholdings in C were held by A and B in varying proportions, with a small minority held by third parties.
In 2000, X BV acquired 72% of the shares in F, a Netherlands company, from third parties, while A acquired the remaining 28%. X BV financed its acquisition of the F shares by means of loans contracted with C, which in turn used funds obtained through a capital contribution from A (paragraph 6).
In the 2007 corporation tax assessment notice, the Netherlands tax authorities refused to allow X BV to deduct the interest paid to C (paragraph 7). X BV challenged that refusal before the rechtbank Gelderland and then the Gerechtshof Arnhem-Leeuwarden, which held, by judgment of 20 October 2020, that Articles 49, 56 and 63 TFEU did not preclude the limitation on interest deduction in Article 10a of the Law on Corporation Tax (paragraph 7).
Core dispute
X BV appealed on a point of law to the Hoge Raad der Nederlanden, which considered that Article 10a of the Law on Corporation Tax could disadvantage cross-border situations, since a resident related entity would generally satisfy the reasonable-taxation condition in Article 10a(3)(b), whereas a non-resident related entity would satisfy it less often, leaving only the commercial-considerations condition in Article 10a(3)(a) available (paragraph 8).
The referring court considered the restriction potentially justified by the need to combat tax fraud and avoidance, aimed at wholly artificial arrangements not reflecting economic reality, generating interest on loan debt contracted arbitrarily and without business reasons, even if the interest rate matched what independent undertakings would have agreed (paragraphs 9-10).
However, the Hoge Raad was uncertain in light of the judgment in Lexel (C-484/19), asking, first, whether transactions concluded on an arm's length basis can, for that reason alone, be excluded from classification as wholly artificial arrangements, and second, whether it matters that the Netherlands legislation, unlike that in Lexel, covers not only intra-group transfers but also acquisitions of previously unrelated external entities that become related as a result of the acquisition (paragraph 12). Three questions were referred concerning the compatibility of the full non-deductibility rule with Articles 49, 56 and 63 TFEU.
Court findings
The Court first determined that, since Article 10a(4) of the Law on Corporation Tax defines related entities by reference to holdings of at least 33.3%, capable of conferring definite influence, the legislation falls within the scope of freedom of establishment under Article 49 TFEU rather than Articles 56 or 63 TFEU (paragraphs 26-31).
On difference in treatment, the Court noted that Article 10a(3)(b), requiring reasonable taxation of at least 10% of the interest at the recipient's level, may in practice be met more easily by Netherlands-resident related entities than by entities established in Member States (such as Belgium in this case) offering favourable regimes, and it is for the referring court to verify whether taxation below 10% can occur domestically (paragraphs 41-45). The Court found this capable of constituting a difference in treatment liable to affect freedom of establishment (paragraph 46), and that the situations of domestic and cross-border interest recipients are objectively comparable for this purpose (paragraphs 48-52).
The Court accepted that the legislation pursues the overriding public interest objective of preventing tax fraud and avoidance, specifically targeting wholly artificial arrangements that redirect a group's own funds as artificial loan capital to erode the Netherlands tax base, and that this objective applies equally where the acquired entity only becomes related after the transaction (paragraphs 54-61).
On proportionality, the Court held that reliance on objective, verifiable criteria (a loan owed to a related entity used to acquire or extend an interest in an entity that becomes related), coupled with the taxpayer's opportunity to rebut the presumption under Article 10a(3)(a) or (b), does not exceed what is necessary (paragraphs 69-72). The Court clarified that its earlier judgment in Lexel (C-484/19) did not establish that arm's length loan terms automatically preclude a finding of a wholly artificial arrangement; the examination of arm's length conditions concerns not only the loan's terms but also the economic sense of the loan and related transactions, i.e. whether they would have been undertaken absent the special relationship (paragraphs 73-85). The Court distinguished Lexel on the basis that the Swedish legislation there was not limited to combating wholly artificial arrangements, whereas the Netherlands provision specifically targets such arrangements (paragraphs 79-84).
The Court further held that where the artificiality lies only in an excessive interest rate on an otherwise genuine loan, proportionality requires disallowing only the excess over the arm's length rate; but where the loan itself is devoid of economic justification and would never have been contracted absent the group relationship and tax advantage, full disallowance of the interest deduction is consistent with proportionality (paragraphs 86-88). The legislation was also found sufficiently clear, precise and predictable to satisfy legal certainty requirements (paragraphs 89-92).
Outcome
The Court ruled that Article 49 TFEU must be interpreted as not precluding national legislation under which, in determining a taxpayer's profits, the deduction of interest paid on a loan debt contracted with a related entity, relating to the acquisition or extension of an interest in another entity that becomes related as a result, is refused in full where the debt is considered to constitute, or form part of, a wholly artificial arrangement, even if the debt was incurred on an arm's length basis and the interest does not exceed what would have been agreed between independent undertakings (paragraph 93 and operative part).
Tp method highlighted
The judgment addresses the arm's length principle in the context of intra-group financing. It clarifies that compliance with arm's length terms (as to interest rate and loan conditions) does not by itself preclude a finding that a loan and related legal transaction constitute a wholly artificial arrangement, because the examination must also cover the economic validity of the loan and the related transactions, that is, whether they would have been entered into at all absent the special relationship between the parties (paragraphs 74-76, 84-85). The Court distinguishes between artificiality arising from an excessive interest rate (where proportionality requires disallowing only the excess over market rate) and artificiality arising from the loan itself lacking economic justification (where full disallowance of interest deduction is proportionate) (paragraphs 86-88). Reference is also made to Article 10a(3)(a) and (b) of the Law on Corporation Tax, which allow deduction where the loan and related transaction are predominantly based on commercial considerations, or where a reasonable tax (at least 10%) is levied on the interest at the recipient's level.
Major issues / areas of contention
- Whether national legislation refusing deduction of interest on an intra-group loan used to acquire a company that becomes related as a result constitutes a restriction on freedom of establishment under Article 49 TFEU.
- Whether such legislation falls to be assessed under Article 49 TFEU rather than Articles 56 or 63 TFEU, given that it concerns relationships within a group of companies capable of exerting definite influence.
- Whether the condition in Article 10a(3)(b) of the Law on Corporation Tax, requiring reasonable taxation of the interest at the recipient's level, produces indirect discrimination against cross-border situations.
- Whether the prevention of tax fraud and avoidance, specifically the combating of wholly artificial arrangements, can justify the restriction.
- Whether transactions concluded on an arm's length basis can, for that reason alone, be excluded from classification as wholly artificial arrangements, in light of the judgment in Lexel (C-484/19).
- Whether it matters that the Netherlands legislation covers not only transfers within an already-related group but also acquisitions of previously unrelated entities that become related as a result of the transaction.
- Whether a full, rather than partial, refusal to deduct the interest goes beyond what is necessary to attain the objective of preventing wholly artificial arrangements.
- Whether the legislation satisfies the requirements of legal certainty given its use of abstract concepts such as 'wholly artificial arrangement'.