Netherlands: Deduction of interest not limited in active group financing companies (Supreme Court decision)

A Supreme Court decision concerning interest deduction limitation of Section 10a Corporate Income Tax Act 1969

A Supreme Court decision concerning interest deduction limitation of Section 10a

The Dutch Supreme Court (Hoge Raad) on 3 March 2023 rendered a new judgment on the interest deduction limitation of Section 10a Corporate Income Tax Act 1969 (‘CITA 1969’).

The Supreme Court held, among other things, that if there is a business-motivated ”10a transaction,” the associated debt is, in principle, also business-motivated if the relevant funds were not diverted. With regard to this diversion of funds, the Supreme Court concluded that this cannot, in principle, be the case if the related debtor fulfills a pivotal financial function within the group. The Supreme Court has provided clarity and provided that the deduction of interest will not typically be limited in situations when there are active group financing companies.

The Supreme Court also addressed the fact that the tax inspector had argued that the deduction of interest in the present case would be contrary to the intent of Section 10a CITA 1969. The Supreme Court noted that if the taxpayer has convincingly demonstrated that the debt and associated transaction is primarily business-motivated (the double business motivation test), this rules out that the motive requirement for applying the doctrine of evasion of the law (fraus legis) has been met in respect of that debt and transaction. According to the Supreme Court, in that case the deduction of interest cannot be refused on the basis that this doctrine had been invoked by the tax inspector.

KPMG observation

The Supreme Court has made clear in this judgment that with regard to 10a transactions, if there is a business-motivated transaction, the associated debt is in principle business-motivated if the funds were not diverted through related entities. In practice—and also in the present judgment—the tax inspector contended that this principle only applies, in short, to external acquisitions.

A more important practical point is that the Supreme Court has clearly explained in this judgment how the doctrine of the diversion of funds relates to an entity that fulfills a pivotal financial function within the group; for which, in addition to the above points, it also appears to be relevant that the entity also raised funds from third parties.

In summary, according to the Supreme Court it cannot be said of an entity with such a pivotal function that there was an intra-group diversion of funds within the meaning of case law, and thus there is, in principle, a business-motivated debt. That is otherwise insofar as the entity only acted as a conduit for the provision of those funds. The obligation to furnish facts and the burden of proof for this exception rest on the tax inspector. These legal grounds are of crucial importance especially for entities or independent business units that fulfill a cash pool or inhouse banking function.

The grounds put forward by the Supreme Court as regards to the evasion of law (fraus legis) seem to follow from those grounds that if a taxpayer successfully invokes the double business motivation test—which means that the deduction of interest is not limited pursuant to Section 10a CITA 1969—this rules out that the motive requirement for applying the doctrine of evasion of law has been met in respect of that loan/debt and transaction. The question that arises is how these legal grounds relate to another Supreme Court judgment (ECLI:NL:HR:2022:1086, of 15 July 2022), that seems to imply the opposite: that the Supreme Court did not exclude the application of fraus legis in principle if the double business motivation test of Section10a(3)(a) CITA 1969 had been met. A possible explanation for this is that in the earlier proceedings it had also been stated that fraus legis must be applied to the part of the debt to which Section 10a CITA 1969 cannot be applied and to which the double business motivation test thus also did not apply.

Read a March 2023 report prepared by the KPMG member firm in the Netherlands

 

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