Court of Appeal rules: interest deduction is abuse of law
05/06/19
The Amsterdam Court of Appeal does not refuse the interest deduction on a shareholder loan by means of the interest limitation rules for base erosion but by means of abuse of law.
The ruling concerns a structure in which a number of institutional investors took over the Dutch X-group through funds, managed by a private equity firm in 2011. The institutional investors had provided funds to French entities. The French entities used the funds to provide capital indirectly to the Dutch holding entity, which acquired the shares of the Dutch X-group from a third party. The remaining funds were onlent to the Dutch holding entity as a convertible loan.
What does this mean for you?
It is apparent from the facts presented to the Amsterdam Court of Appeal, that Private Equity structures as the one the taxpayer was involved with, are not unusual. However, the way in which the financing of this acquisition has been structured, could not be endorsed by the Amsterdam Court of Appeal.
For the Private Equity practice, it is therefore relevant to take notice of the considerations made by the Amsterdam Court of Appeal for their existing and new acquisition structure and corresponding financing structures. This case can still be submitted to the Supreme Court, which will then review the case. Whether this will happen will become clear in the coming weeks.
Background
The dispute submitted to the Amsterdam Court of Appeal concerned the deductibility, for Dutch corporation income tax purposes, of the interest on the convertible loans that the Dutch holding company owed to the French entities. From a Dutch tax perspective, interest was paid to French companies, but from a non-Dutch tax perspective, the French entities were fiscally transparent so that the interest received did not constitute taxable income for French corporate income tax purposes.
Various questions were referred to the Court, the first five of which were decided by the Court in favor of the taxpayer concerned:
- The convertible bonds must be regarded as a loan under civil law indeed, and not as a capital contribution (no "sham loan");
- The convertible bonds have not been entered into under such conditions that they actually function as shareholders' equity (Article 10 (1) (d) of CITA 1969);
- The interest on the convertible bonds can be regarded as businesslike;
- The statutory base erosion provisions with respect to interest (Article 10a of the CITA 1969) do not preclude deduction of the interest;
- The thin capitalisation rules do not apply (Article 10d of the CITA 1969).
However, the sixth question was decided by the Court to the detriment of the taxpayer:
In the present case, interest deduction can be refused by applying the abuse of law doctrine.
For a successful application of the abuse of law doctrine, two requirements must be met: the motive test and the purpose test.
Motive test
In its judgment, the Court of Appeal of Amsterdam ruled that the initial availability of equity to the French entities and the subsequent acquisition of the Dutch X-group using hybrid entities, hybrid financing and the interposing of Dutch companies resulted in an interest expense at the level of those Dutch companies that has the character of a so-called "diversion". In this way, capital that was available as equity for the acquisition of the Dutch X-group was converted into loans, the interest expenses of which were directly charged to the result of that group.
According to the Court, the loans and the interest burden have no function in this structure, other than creating a tax benefit. This method of financing therefore results from the motive to avoid Dutch corporate income tax.
Purpose test
The standard set by the Dutch legislator, means that interest on loans that - except for avoiding taxation - do not have a real business function, cannot be allowed to be deducted. In the opinion of the Amsterdam Court of Appeal, this standard has been violated in the present case.
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