CJEU: Article 10a Dutch CITA is compatible with EU laws

25/10/24

According to the Court of Justice of the EU (CJEU) in X BV (C-585/22), Article 10a Dutch Corporate Income Tax Act (CITA) is compatible with EU law. Although this Article introduces a difference in treatment between a domestic and a cross-border situation, such a difference is justified based on the need to combat tax fraud and tax evasion. In addition, the Court considered that Article 10a Dutch CITA is proportionate to this objective and took a position regarding the previously decided Lexel AB (C-484/19) case.

Furthermore, as per Court, where the artificial nature of a given transaction results from an exceptionally high rate of interest on such a loan which reflects economic reality, the principle of proportionality requires that an adjustment be made for the part of the interest paid on that loan which exceeds the usual market rate. Refusing any interest deduction would go beyond what is necessary to prevent wholly artificial arrangements.

By contrast, where the loan, in itself, is devoid of economic justification and, but for the relationship between the companies and the tax advantage sought, would never have been contracted, it is consistent with the principle of proportionality to refuse the deduction of the whole interest.

What does this mean for your organisation?

Following the CJEU judgement, it is clear the CJEU considers Article 10a of the Dutch CITA to be in line with EU law. Consequently, no legislative amendments are required by the Dutch legislator. Objections to tax assessments that include a Lexel AB argument are expected to be rejected by the tax authorities, and previously rejected objections will not need to be revisited.

It is clear for the CJEU that having market-conform conditions is not enough to guarantee the right to interest deduction. There must be a logical economic reason for the granting of the loan. It is up to the Dutch Supreme Court to interpret the judgement of X BV within the current framework of EU law, and Dutch tax law where the assessment of market conditions under the arm's length principle precedes the application of interest limitation rules.

The CJEU judgement in more detail

Fact of the case

The case concerned X, a company incorporated under Dutch law which belongs to a multinational group of companies. That group includes, inter alia, companies A and C, both established in Belgium. A is the sole shareholder of X and the majority shareholder of C. In 2000, X acquired the majority of the shares (78%) in F, a company incorporated under Dutch laws, in which A acquired the remaining shares. X financed that acquisition by means of loans contracted with C, which used for that purpose own funds obtained through a capital contribution made by A. In 2007, Dutch authorities refused to allow X to deduct interest paid to C. X challenged this, and in 2020, the Dutch Court of Appeal upheld the interest deduction limitation under Article 10a CITA as EU-law compliant. X appealed to the Dutch Supreme Court, which referred questions to the CJEU, seeking clarification based on the Lexel AB (C-484/19) case, where the CJEU ruled that transactions at arm's length are not abusive/wholly artificial.

The CJEU's argumentation

The case was decided based on the freedom of establishment. The CJEU ruled that although Article 10a of the Dutch CITA applies without distinction, it creates a difference in treatment that could affect the exercise of the freedom of establishment. This difference in treatment concerns objectively comparable situations, as the position of the Dutch debtor is the same regardless of whether the interest is paid to a Dutch or foreign creditor. However, the difference in treatment can be justified by the need to combat abuse. The CJEU referred to the Danish beneficial ownership cases (N Luxembourg 1 and Others) and the Dutch Groupe Steria cases (X and X (C‑398/16 and C‑399/16)). This justification applies even when the entity becomes affiliated with the taxpayer only after the acquisition or extension.

The Court considered Article 10a Dutch CITA to be proportionate to the objective pursued. Although this Article introduces a presumption of a wholly artificial arrangement, this presumption may be rebutted by the taxpayer by demonstrating that the conditions of Article 10a, paragraph 3, under (a) or (b), of the Dutch CITA have been met. In that regard, the CJEU ruled that Article 10a(3)(a) of the Dutch CITA concerns evidence regarding the reason for contracting loan and the related legal transaction and the objective elements characterizing that loan and that legal transaction, with the taxpayer having to demonstrate that they are justified by commercial considerations and that they could have been agreed in the absence of those specific relationships between entities. Assessing this approach, the CJEU ruled that the examination of compliance with market conditions concerns not only the terms of the loan agreement relating, in particular, to the amount or the interest rate, but also the economic logic of the loan in question and the legal transactions relating thereto.

Amount of interest deducted

As per the CJEU, the principle of proportionality requires that the refusal of the right to deduct be limited to the part of the interest paid on that loan which exceeds the amount that would have been agreed if there had been no special relationship between the parties.

However, where the loan itself lacks any economic justification and would never have been entered into if there had been no special relationship between the undertakings concerned and no tax advantage was sought, it is compatible with the principle of proportionality to refuse the deduction of interest in its entirety, since the tax authorities must disregard such a wholly artificial arrangement.

Article 10a Dutch CITA is in line with the principle of legal certainty

As per the CJEU, the use of abstract concepts in Article 10a CITA does not imply that the application of this Article is left entirely to the discretion of the tax authorities. Therefore, according to the CJEU, the principle of legal certainty has not been violated.

Addition of an economic reality test

In our view, the CJEU did not reverse Lexel AB as to the qualification of a loan as an artificial arrangement. On the contrary, the Court added an economic reality test, next to the condition that the loan should be agreed on market conform terms.

Although the case refers to an older version of article 10a CITA, the judgement is also relevant for the interpretation of the current version.