CJEU rules that Dutch interest deduction limitation rule is not in breach of EU law

Background

Article 10a CITA limits the deduction of interest payments on loans from related parties if the loan is connected with certain tainted transactions. In the Lexel case (C‑484/19), the CJEU ruled that a similar interest deduction limitation rule in Sweden was not compatible with EU law and seemed to imply that a loan concluded under at arm’s length conditions cannot be considered artificial. Following the Lexel case, the Dutch Supreme Court made a preliminary ruling request on the compatibility of Article 10a CITA with the EU treaty freedoms (case C-585/22). For a more detailed discussion of the Lexel case we refer to our EU Tax Alert.

In his Opinion, the Advocate General had concluded that Article 10a CITA in principle restricts the freedom of establishment, but that this restriction could be justified on grounds relating to the fight against tax avoidance (see also our Tax Flash).

Judgment

The CJEU found that, although Article 10a CITA restricts the freedom of establishment, such restriction can be justified because the legislation pursues combatting tax avoidance, as its application is limited to wholly artificial arrangements. Whether a given arrangement is ‘wholly artificial’ should be determined on the basis of objective and verifiable elements. The CJEU finds that one of these elements is whether the loan is contracted at arm’s length conditions. In that context, the CJEU emphasizes that the examination of compliance with arm’s length conditions must relate, inter alia, to the economic reality of the transactions. Determining the economic reality of the transactions requires an examination of the terms of the loan, such as the interest rate, but more so whether concluding the loan and entering into the related transactions correspond to what the companies would have agreed upon in absence of their relationship.

The CJEU concludes that EU law does not preclude national legislation to refuse the deduction of the whole interest of a loan that is devoid of economic justification and would have never been contracted, absent the intragroup relationship between the parties to the loan and the tax advantage sought. Even if the loan was at arm’s length and the interest rate did not exceed the amount that would have been agreed upon between independent parties.

With regard to the comparison with Lexel, the CJEU considers that Article 10a CITA is not similar with the Swedish interest deduction limitation rule in Lexel, as the purpose of the legislation is not the same. The CJEU reiterates that the specific objective of the Swedish interest deduction limitation rule was not to counter purely artificial arrangements, but counteracting aggressive tax planning, and the practical application was also not limited to artificial arrangements. Moreover, the CJEU clarifies that it cannot be inferred from its judgment in Lexel that transactions carried at arm’s length basis are inherently to be considered as not being artificial arrangements.

Contact

We will keep you updated on further developments. Should you have queries or need any assistance in discussions with the tax authorities on interest deduction, please contact your trusted adviser at Loyens & Loeff.