Opinion Advocate General of Dutch Supreme Court on scope Dutch base erosion rules (article 10a CITA)

Recently the Advocate General (“AG”) rendered its opinion on the Dutch interest deduction limitation rule of article 10a CITA. According to the AG article 10a CITA is also applicable in case of a group debt that is indirectly financed with external debt if the group debt and the external debt are not almost identical.

General
In the Netherlands interest on debt is in principle deductible from the taxable profit. Dutch base erosion rules (article 10a Dutch corporate income tax Act: “CITA”) however stipulate that interest charges on related party debt are not deductible if the debt is connected with certain acquisitions, capital contributions or dividend distributions (i.e. tainted transactions). A rebuttal rule applies if the taxpayer can demonstrate that business reasons predominantly underlie the transaction and the debt obligation connected therewith (“business reasons exception”) or if the interest is (indirectly) subject to a ‘reasonable’ levy of tax (“reasonable taxation exception”). However, the latter exception is not a safe haven if the tax authorities can successfully argue that the loan or the transaction is not predominantly driven by sound business reasons.  

As a general rule, a company is related if the company owns at least one third of the taxpayer. As of 2017 a company is also related if that company belongs to a collaborating group that together owns one third or more in the taxpayer.

According to the parliamentary history and Decree BLKB2013/110M the business reasons exception is in principle met if the related party loan is indirectly financed with external debt provided that the related loan has similar conditions as the external loan (e.g. maturity and repayment schedule). This effectively means that the business reasons exception (for the transaction and the loan obtained) is actually replaced by a single test (“parallel debt exception”).

Facts
In the case at hand the taxpayer borrowed funds from a related entity to make a capital contribution. The tax authorities applied article 10a CITA and denied the deduction of interest. The taxpayer argued that article 10a CITA should not apply since the lender financed the tainted loan with an external loan.  The Dutch Court of appeal ruled that article 10a CITA does not apply since there is a sufficient link between the group debt and the external third party financing of this group debt.

Conclusion AG
The AG concluded, based on parliamentary proceedings, case law and the Decree, that an article 10a CITA loan that is indirectly funded with external debt is out of scope of article 10a CITA in case there is a ‘strong parallel’ between the external loan and the group loan. Therefore, the related taxpayer needs to be a perfect ‘pass-through’ entity whereby the loan conditions are perfectly mirrored. The AG therefore concluded that the Court of Appeal did not apply the parallel debt exception correctly.

Remarks
The Dutch Supreme Court recently ruled that the reasonable taxation exception may also be applied at the level of the (in)direct creditor since this is a material test, rather than formal test. If the same interpretation would be applied in this case, the safe harbour for debt indirectly financed with an external loan does not seem to require a perfect parallel between the related party loan and the external debt.

It will be interesting to see whether the Supreme Court will follow the conclusion of the AG on the interpretation and scope of the parallel debt exception. If that is the case, it may be prudent to verify whether the conditions of the external loan match the loan taken up for the tainted transaction in all cases where a taxpayer relies on the parallel debt exception.