Supreme Court clarifies abuse of law doctrine and counterevidence anti-base erosion rules

In April 2017, the Dutch Supreme Court issued four rulings in ten cases on tax planning structures set up by the international banking group Credit Suisse. The rulings of the Dutch Supreme Court provide insights and clarification on the abuse of law doctrine, the counterevidence provisions in article 10a of the Dutch Corporate Income Tax Act (“CITA”) and the possibility to impose penalties.

Facts

An international banking group acquired “profit companies’’ from third parties. The profits, resulting from the sale of assets, were realized prior acquisition, but in the same financial year. As a result these companies had a Corporate Income Tax (“CIT”) liability. The companies acquired were included in the Dutch tax consolidation group (fiscal unity) and were provided with group financing (used for various purposes including acquisitions and equity contributions). As a result, the financing expenses incurred on these debts erased the CIT liability in the acquired entities. In addition, the income earned  by the acquired companies was tax exempt by virtue of the participation exemption. Both the seller and the buyer of the “profit companies” benefited from this transaction via a discount of the acquisition price.

The Dutch Supreme Court had to decide whether the interest deduction could be disallowed and whether penalties could be imposed.

Abuse of law doctrine

It should be noted that the similar structured finance transactions nowadays in general are no longer possible due to specific rules counteracting these structures.

The Supreme Court ruled that transactions in which the deduction of interest is created to be offset against pre-acquisition profits contravenes the spirit and intent of the law. The interest charge cannot be deducted on the basis of the abuse of law doctrine (fraus legis) to the extent that tax capacity was acquired. The abuse of law doctrine did not apply in one of the cases since in that case the profits were generated only after acquisition (i.e. the business assets were not yet disposed pre-acquisition).

Counterevidence interest deduction limitation

On the basis of article 10a CITA interest expenses are non-deductible when a loan obtained from a related entity is used for a tainted transaction (i.a. acquisition, equity contribution). The case at hand therefore falls within the scope of article 10a CITA. Article 10a CITA does, however, not apply if the taxpayer can demonstrate that (i) the interest is subject to a sufficient level of taxation (tax burden exception) or (ii) both the loan and transaction are predominantly inspired by business reasons (business reasons exception).

In the case at hand, the related party loan was in turn externally financed. Business reasons are considered to be present if the group loan is, in turn, externally financed, provided that the loan conditions are parallel. The Supreme Court now ruled that if not all conditions of these loans are exactly mirrored (repayment schedule, terms and loan volume) the required parallel can also be demonstrated if there is a direct link between the intercompany financing and the third party loan. This viewpoint of the Supreme Court is a welcome clarification on the scope of the business reasons exception in case of a parallel debt.

Penalties

The Supreme Court further ruled that no penalties could be imposed since the taxpayer took a plausible position in his tax return which was based on objective criteria. That the structure could be regarded as “aggressive” was not an argument that the position as reported in the tax return was not plausible.

In general the type of transaction in this case are under today’s legislation invalid. In 2011, a specific rule was introduced targeting the use of fiscal losses incurred in the same year under a new shareholder. However, the decision of the Supreme Court is important since it provides important guidance on the scope of the abuse of law doctrine and the business reasons exception of article 10a CITA in case of a parallel external debt.