CJEU applies ‘per element’ approach to the Netherlands and rules that Dutch fiscal unity regime infringes the freedom of establishment

On 22 February 2018, the Court of Justice of the European Union (CJEU) issued its judgement in the joined cases C‐398/16 and C‐399/16 X BV & X NV versus the Dutch State Secretary of the Ministry of Finance (Staatssecretaris van Financiën). These cases were referred to the CJEU in July 2016 and deal with the ‘per element’ approach, as established by the CJEU in C‐386/14 Groupe Steria, for the Dutch fiscal unity regime, in particular concerning interest deductibility and currency losses. In its judgement, the CJEU followed the conclusions of the Advocate General (AG) of 25 October 2017.

Case C‐398/16 (interest deductibility)

The first case deals with the non-deductibility of interest on a loan received by a Dutch company from a related Swedish company to make a capital contribution in a non-resident subsidiary. Under the Dutch anti-base erosion provisions (Article 10a of the Corporate Income Tax Act), the interest expense may be disallowed if the loan is used for certain tainted transactions, such as a capital contribution. Within a domestic fiscal unity, the capital contribution would not be visible and as a result, the rule would not be applicable such that the interest would in essence  be tax deductible. The taxpayer argued that if it had been permitted to form a fiscal unity with its non-resident EU subsidiary, it could have deducted the interest on the loan. Since the possibility to enter in a fiscal unity is only reserved for Dutch resident companies (and PEs of non-residents), the taxpayer argued that the freedom of establishment was restricted due to the non-deductibility of interest as investing in a non-resident subsidiary was less attractive than in a Dutch subsidiary.

In line with the CJEU’s judgments in X Holding and Groupe Steria, the CJEU now ruled that the two situations were objectively comparable as they concerned the financial costs borne by the parent company related to its shareholding in a subsidiary, regardless whether or not there is a fiscal unity. Further, in line with the AG, the CJEU concluded that the two comparable situations were treated differently resulting in a restriction of the fundamental freedoms. The Netherlands’ justifications regarding the need to maintain the coherence of the fiscal unity regime and the need to prevent tax evasion were not accepted by the CJEU. The CJEU ruled thus in favor of the taxpayer and as a result, the Dutch tax consolidation regime, in combination with the interest deductibility, is in breach with EU law.

Case C-399/16 (currency losses)

This case concerned a Dutch company, part of a Dutch fiscal unity, holding the shares in a UK subsidiary. These shares were subsequently contributed to another UK subsidiary. Upon contribution, the Dutch company incurred a currency loss on its contributed UK subsidiary. The Dutch tax authorities denied the deduction of the currency loss under the participation exemption rules. Under the participation exemption, the benefits derived from a subsidiary and the transaction costs upon transfer of that subsidiary are tax exempt. The taxpayer claimed that if it had been permitted to form a fiscal unity with its UK subsidiary, it would have been able to deduct the currency loss incurred. This because the participation exemption rules are not applicable between entities included in the same fiscal unity. Since the possibility to enter in a fiscal unity is only reserved for Dutch resident companies (and PEs of non-residents), the taxpayer argued that the freedom of establishment was restricted due to the participation exemption.

In this case, the CJEU ruled that the two situations were not comparable, as a Dutch parent company cannot deduct a currency loss on an investment in an EU subsidiary except for very particular cases. However, according to the CJEU , even in such a particular event, the Dutch participation exemption is neutral, meaning that losses cannot be taken into account, irrespective whether or not this is the result of a currency loss or for another reason.

Takeaway

This judgement has a major impact on the Dutch tax consolidation regime. Immediately after the conclusions of the AG, the Dutch Government announced emergency response measures under which certain provisions within the Corporate Income Tax Act and the Dividend Withholding Tax Act will apply within a fiscal unity, as if such fiscal unity was not present.

Immediately after the CJEU judgement, the Dutch State Secretary of Finance announced that new legislation will be proposed to implement the emergency response measures retroactively as of 25 October 2017 11:00 am. Further, the Dutch fiscal unity regime will, within a foreseeable period, be replaced by a company tax group regime that is considered future-proof.

We will of course keep you informed on these developments.