Simplified outline of the cases
Both cases concern international private equity funds that acquired a target company in the Netherlands. In both cases, the fund vehicles structured their investment in the Dutch target company through one or more Luxemburg holding companies (LuxCo) and one or more Dutch acquisition holdings (Dutch HoldCo). To finance the acquisition, LuxCo issued preferred equity certificates to the fund vehicles (and some co-investors) and used the proceeds to fund Dutch HoldCo with equity and shareholder loans. Dutch HoldCo acquired all shares in the Dutch target company.
As from closing, Dutch HoldCo formed a Dutch fiscal unity (i.e., a corporate tax group) with the Dutch target company. As a result, interest payments on the shareholder loans granted to Dutch HoldCo could be offset against operational profits of the acquired Dutch target company.
Specific interest deduction limitation rules to prevent base erosion
According to article 10a of the Corporate Income Tax Act (CITA), interest payments are in principle non-deductible if the loans are taken up from related parties and the relevant debt is connected with, inter alia, a third-party acquisition. Two entities are related if one entity holds an (indirect) interest of at least one-third in the other entity. If a loan is within scope of article 10a CITA, the interest can still be deducted if the taxpayer demonstrates that, inter alia, business reasons underly the loan and the related transaction. With respect to third-party acquisitions this is the case if the funds have not been re-routed within a group in a non-commercial manner.
The Supreme Court ruled that the funds used for the acquisition were not rerouted within a group in a non-commercial manner since the funds were obtained by LuxCo from the funds and indirectly the fund investors, who were not related with Dutch HoldCo within the meaning of article 10a CITA (i.e. none of the funds and/or fund investors held an interest of one-third in Dutch HoldCo). Hence, the interest deduction was not denied by article 10a CITA.
In 2017 the concept of a cooperative group (akin an acting together principle) was introduced in article 10a CITA. Any interests of a cooperative group should be aggregated for the related party test. However, both cases concerned tax years prior to 2017, for which the Supreme Court now explicitly confirms that such acting together principles did not apply yet. For tax years as from 2017 the outcome could be different if the funds and/or fund investors should be considered a cooperative group in relation to their (indirect) investment in the Dutch HoldCo.
Abuse of law doctrine
In both cases, the Dutch tax authorities took the position that, in case article 10a CITA would not apply, the deduction of interest should be denied based on the abuse of law doctrine (fraus legis). The Dutch Supreme Court referred the cases to the Courts of Appeal to rule on this argument. We refer to our previous publication on the Hunkemöller judgement for more information on this argument.
Further clarification non-businesslike loan doctrine
The Supreme Court also provided guidance on the non-businesslike loan doctrine. If a creditor runs a credit risk which independent parties would not have accepted in return for a fixed interest, such a loan is considered a non-businesslike loan. Write-offs on non-businesslike loans are not deductible for tax purposes. A loan being non-businesslike also affects the interest rate that is taken into account for tax purposes. The Supreme Court has ruled in the past that the interest rate on a non-businesslike loan is set at the rate that the debtor would have paid if it had attracted the loan from an independent third party under guarantee of the actual creditor, the so called “guarantee interest”.
From previous case law, it follows that in case the fair value of the “guarantee interest” accruing on a non-businesslike loan is below the nominal value, only such lower fair value of the interest should be included in the taxable profit of the creditor. From the Supreme Court ruling, it follows that the borrower can nevertheless deduct the nominal amount of the accrued “guarantee interest”, unless it is certain or almost certain that the interest does not need to be paid or will not be paid. A subsequent decrease in value of the accrued “guarantee interest” is not tax-deductible in the hands of the creditor, nor taxable at the level of the debtor.
Contact
We will keep you informed on further developments. Should you have any questions or need assistance in discussions with the tax authorities on interest deduction, please contact your trusted Loyens & Loeff adviser or a member of our interest deduction team mentioned below.