| Image Credits: “Supreme Court of the Netherlands, The Hague” by Bas Kijzers / Rijksvastgoedbedrijf
In a judgment of October 4, 2024, in Case C-585/22, the Court of Justice of the European Union (CJEU) has ruled that Dutch legislation limiting the deduction of interest paid on intra-group loans is compatible with EU law. This decision supports measures to combat tax fraud and evasion, even if such legislation might initially appear to restrict the freedom of establishment within the EU.
The case in question involved a Dutch company (X) that belongs to a multinational group, which includes two Belgian entities, A and C. In 2000, X acquired shares in a Netherlands-based company using funds borrowed from C, which had received capital contributions from A. When the Dutch tax authorities assessed X’s corporation tax for 2007, they refused to allow the deduction of the interest paid to C on the loan. The authorities argued that the transaction was part of an artificial arrangement designed to reduce taxable profits in the Netherlands.
NATIONAL LEGISLATION AND THE PRESUMPTION OF ARTIFICIALITY
The Dutch legislation at the center of this dispute creates a presumption that interest payments on intra-group loans are part of artificial arrangements aimed at tax avoidance. However, the Supreme Court of the Netherlands referred the case to the CJEU, questioning whether such legislation was compatible with the EU’s principle of freedom of establishment, as it could disadvantage cross-border transactions.
The CJEU acknowledged that Dutch law could lead to different treatment of domestic and cross-border situations, potentially discouraging companies from exercising their right to establish in other EU member states. However, the Court determined that the legislation serves a legitimate purpose: preventing companies from artificially presenting a group’s internal funds as borrowed capital to exploit tax deductions in the Netherlands.
COMBATING TAX FRAUD AND EVASION
The Court emphasized that the law aims to prevent tax fraud and evasion by ensuring that interest deductions are only allowed for genuine, economically justified loans. The Court noted that it is legitimate for a member state to prevent a multinational group from using intra-group loans to shift profits and avoid taxes.
The ruling clarified that the presumption of artificiality can be rebutted by the taxpayer if they can demonstrate that the loan reflects market conditions and has genuine economic substance. If the interest rate is excessively high and lacks economic justification, the legislation allows for the disallowance of the excessive portion of the interest. In cases where the loan itself lacks economic substance and is solely motivated by tax advantages, the deduction of the full amount of interest can be denied.
THE ROLE OF THE CJEU IN TAX CASES
This ruling highlights the role of the CJEU in interpreting EU law and its application in tax cases. While the CJEU does not decide the specific dispute, its interpretation is binding on national courts, ensuring that EU law is applied consistently across member states.
This judgment upholds the right of member states to implement tax measures that prevent abuse while ensuring that companies can challenge assumptions of artificial arrangements by providing evidence of genuine economic activity.
