The Court of Justice of the European Union (CJEU) issued a judgement on 4 October 2024 regarding Dutch interest deduction limits and freedom of establishment (Article 49 TFEU), based on a request from the Netherlands’ Supreme Court.

The Supreme Court requested a preliminary ruling on the interest deduction limitation in Article 10a of the Corporate Income Tax Act. This rule involves related party financing for acquiring an entity that becomes a related party after the acquisition. In these situations, interest on related party financing is deductible only if specific conditions are fulfilled, such as the financing and the acquisition are driven by commercial considerations.

A release on the judgement elaborated that the Dutch legislation introduces a disparity in treatment, which could discourage the exercise of the freedom of establishment.

The release states that X is a company incorporated under Netherlands law and belongs to a multinational group of companies. That group includes, inter alia, companies A and C, both established in Belgium. A is the sole shareholder of X and the majority shareholder of C. In 2000, X acquired the majority of the shares in a company incorporated under Netherlands laws, in which A acquired the remaining shares. X financed that acquisition by means of loans contracted with C, which used for that purpose own funds obtained through a capital contribution made by A.

In the corporation tax assessment notice addressed to X for 2007, the Netherlands State Secretary for Finance refused to deduct the interest paid by that company to C.

X challenged that refusal before the Netherlands courts, the last of which being the Supreme Court of the Netherlands. The referring court notes that the legislation at issue establishes a presumption that interest paid in respect of intra-group loan debts constitutes or forms part of wholly artificial arrangements.

Nevertheless, the Supreme Court asks whether that legislation is compatible, inter alia, with the freedom of establishment, since that legislation is capable of placing cross-border situations at a disadvantage.

In its judgement, the Court of Justice finds that the Netherlands legislation does in fact entail a difference in treatment which may have a deterrent effect on the exercise of the freedom of establishment.

However, that legislation pursues the legitimate objective of combating tax fraud and tax evasion. It seeks to prevent a group’s own funds from being presented, in a contrived manner, as being funds borrowed by a Netherlands entity of that group and the interest on that loan from being deducted from the taxable profit in the Netherlands.

That objective also applies to cases where, as in the present case, an entity becomes an entity related to the same taxpayer only following the acquisition or increase of a shareholding.

The Court also states that the presumption of a wholly artificial arrangement may be rebutted by the taxpayer. In that context, the Court emphasises that the examination of compliance with arm’s length conditions must relate, inter alia, to the economic reality of the transactions. Where the artificial nature of a given transaction results from an exceptionally high rate of interest on such a loan, which, moreover, reflects economic reality, the principle of proportionality requires the deduction of the proportion of interest paid, which exceeds the normal market rate.

By contrast, where the loan is, in itself, devoid of economic justification and, but for the relationship between the companies and the tax advantage sought, would never have been contracted, it is consistent with the principle of proportionality to refuse the deduction of the whole interest.