On 22 February, the European Court of Justice ruling The ruling was handed down in proceedings centred on the Dutch tax unity regime, and in particular the interest deduction. The Court of Appeal concluded that the Netherlands treats Dutch and foreign subsidiaries differently. This distinction unfairly discriminates against foreign subsidiaries.
As a result of the judgement, foreign subsidiaries could henceforth be eligible for the benefits of certain elements of the fiscal unity regime. As this would represent a financial loss for the Dutch Exchequer, urgent amendments to the legislation were introduced.
The tax group
In the Netherlands, companies may form a fiscal unity for the purposes of corporation tax if, amongst other things, the parent company holds at least 95% of the shares in the subsidiary. In addition, it is important that the companies have the same financial years and profit determination rules, and are actually established in the Netherlands. A tax unit has both tax advantages and disadvantages. For further information on this subject, please refer to this article.
Interest deduction
Within a fiscal unit, interest on intercompany loans is offset. If a parent company grants a loan to its subsidiary and receives interest on it, this interest is treated as income for the parent company and as an expense for the subsidiary. As a tax group is treated as a single taxpayer, the interest expenses and income are offset against each other.
Dutch legislation also contains provisions regarding restrictions on interest deductions. The aim of these provisions is to prevent profit shifting. When determining profit, no interest may be deducted that:
- is (in)directly owed to an associated entity and;
- relates to a tainted transaction. Legal acts classified as tainted transactions include a dividend payment, a capital contribution, the acquisition of a shareholding and the increase of a shareholding in a subsidiary.
The interest deduction restriction does not apply if either of the two rebuttal schemes is met:
- if it is demonstrated that the debt and the related legal act are based predominantly on commercial considerations;
- if it can be demonstrated that, on balance, the interest is subject to taxation that is reasonable by Dutch standards in the hands of the person to whom the interest is payable.
The judgment
In this case, a Dutch subsidiary had borrowed money from its foreign parent company to purchase a shareholding. The subsidiary had claimed the interest on the loan as a tax deduction. This interest deduction was disallowed by the tax inspector because the interest deduction restriction applied. In domestic situations, this could have been resolved by forming a fiscal unity. However, a tax unit with a company established outside the Netherlands is not possible.
The key question during the proceedings before the European Court was whether the taxpayer was eligible for this aspect of the fiscal unity regime. The Court ruled that this must be possible, as otherwise it would constitute discrimination. Domestic companies are favoured over companies established outside the Netherlands.
This ‘per-item’ approach adopted by the court would have major budgetary implications for the Dutch Treasury. The Dutch tax authorities would have to allow interest deductions on a large scale. For this reason, remedial legislation has been introduced. The emergency remedial measures will apply retroactively from 25 October 2017, 11:00.
Emergency repair
As a result of the amending legislation, the interest deduction restriction will also apply to purely domestic tax entities. It is expected that, as a result, the consequences for these purely domestic tax entities will remain limited, due to the rebuttal rules. Some of the benefits associated with the current tax entity regime will inevitably be lost as a result of the Court of Appeal’s judgement.