INTRODUCTION
The financing of acquisitions involving Dutch companies has come under increased scrutiny in the Netherlands in recent years. The Dutch Tax Authority ("D.T.A.") has challenged the ability of Dutch acquisition companies to deduct interest on intercompany loans deemed to be abusive. Article 10a of the Dutch Corporate Income Tax Act ("C.I.T.A.") denies interest expense deductions if the financing structure artificially erodes the Dutch tax base. If organizations circumvent the direct application of Article 10a, the D.T.A. has successfully invoked the principle of fraus legis to deny interest expense deductions. Fraus legis may be applied if an arrangement is contrary to the intent of the law and its decisive purpose is to obtain a tax benefit.
A 2023 Insights article discussed cases in which the D.T.A. challenged the deductibility of interest under Article 10a and fraus legis. 1 However, many grey areas and interpretative issues remained. In the period since the article was published, new developments regarding the denial of interest expense deductions on intercompany acquisition loans have emerged. This year, the Dutch Supreme Court, the Advocate General for the C.J.E.U., and the Advocate General of the Netherlands have issued opinions on three separate cases. This article reviews the opinions and their potential impact on Dutch acquisition financing. While the saga of Article 10a and fraus legis continues to unfold, taxpayers welcome the recent guidance as it provides further insight into this evolving area and the extent to which fraus legis may be applied.
ARTICLE 10A AND FRAUS LEGIS
The Netherlands applies many specific anti-abuse rules of Dutch tax law, including Article 10a of the Corporate Income Tax Act 1969. Article 10a denies a taxpayer interest expense deductions in respect of debts insofar as these debts are related to the acquisition or increase of an interest in an entity that is or becomes affiliated with the taxpayer.2 An acquired entity is considered affiliated with a taxpayer when (i) the taxpayer holds at least a one-third interest in the entity, (ii) the entity holds at least a one-third interest in the taxpayer, or (iii) a third-party holds at least a one-third interest in both the taxpayer and the acquired entity.3 As of 2017, the affiliated entity definition extends to a cooperating group, whereby the cooperating group's total interest taken together is at least one-third.4
Two exceptions exist to this rule. A deduction of interest is permitted where (i) the taxpayer demonstrates that the loan and transaction are based predominantly on business considerations or (ii) the interest income is taxed at a rate of at least 10% in the hands of the direct recipient or a direct or indirect shareholder of the recipient.5
A presumption exists that a loan and transaction entered into for the acquisition or expansion of an interest in an entity are predominantly based on business considerations when the target first becomes associated with the taxpayer after the acquisition or expansion. Nonetheless, the presumption does not apply if the loan is deemed to be a wholly artificial arrangement.
The D.T.A. has successfully applied Article 10a in combination with fraus legis to deny interest expense deductions on intercompany loans within typical acquisition structures. The Netherlands applies the common law doctrine fraus legis, which is akin to the E.U. G.A.A.R. Fraus legis allows tax consequences of certain arrangements to be ignored if (i) the decisive purpose for entering into an arrangement was to realize a tax benefit (considering the artificiality of an arrangement lacking a business motive) and (ii) the arrangement is contrary to the object and purpose of the law. Fraus legis can be applied only if no specific anti-abuse rule is applicable to challenge the bona fides of a transaction.
Fraus legis has been applied as a backstop to anti-abuse legislation, making for a win-win situation for the D.T.A. More specifically, in cases where Article 10a is inapplicable due to the entities involved not meeting the affiliation threshold (generally for arrangements preceding the 2017 cooperating group provision), the D.T.A. has applied fraus legis to sidestep the issue and deny interest expense deductions.
The extent to which fraus legis may be applied to deny interest expense deductions remains unsettled, as evidenced by the numerous cases litigated in Dutch courts over the years. However, new guidance has emerged in 2024, helping to clarify some of the blurred lines that define what is and is not considered abusive.
DUTCH SUPREME COURT OPINION
On March 22, 2024, the Dutch Supreme Court ruled on a case involving interest expense deductions and financing costs in a private equity acquisition.6 In this case, a Swedish private equity firm used a Dutch acquisition vehicle ("X B.V.") to purchase a Dutch company.
The investment fund initially consisted of four limited partnerships ("L.P.'s"), which were non-transparent for Dutch tax purposes. Each L.P. established a sub-fund in Guernsey. The sub-funds were subject to a 0% tax rate in Guernsey. Sub-fund 1 was the only sub-fund with an interest in X B.V. that exceeded the one-third affiliate threshold of Article 10a. A fifth L.P. and Gurnsey sub-fund were established one month before the acquisition was finalized in order to reduce L.P 1's interest in X B.V. to a level below the affiliate threshold. The limited partners in L.P. 1 were the same as those in L.P. 5. During the takeover, 15% of X B.V. shares were transferred to a family company of the sellers ("FamBV"). The acquisition was financed with a combination of debt and equity from the sub-funds and FamBV. The sub-fund financing originated from equity contributed to the L.P.'s by the limited partners.
On its tax return, X B.V. deducted only interest paid on the FamBV loan, designating the remaining interest expense as nondeductible on the basis of Article 10a. Following an audit, the D.T.A. challenged the deductibility of interest paid on the FamBV loan. X B.V. objected and took the position that the full amount of interest may be deducted, including the interest paid on the sub-fund loans that had originally been excluded on the tax return.
Both the district court and the appellate court allowed the deduction for interest paid on the FamBV loan since the lender did not belong to the private equity group, but disallowed the deduction for interest paid on the sub-fund loans. The courts acknowledged that Article 10a was not directly applicable since the affiliate threshold was not met between the sub-funds and X B.V. Nonetheless, they held that fraus legis applied to deny the interest expense deductions because the structure was set up to artificially circumvent Article 10a and pay zero tax on the interest income in Gurnsey. The loans were deemed to be an unbusinesslike diversion of equity.
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Footnotes
1. M. Bennett, "Anti-Abuse Developments: A New Normal in the Netherlands," Insights, Volume 10, No. 1, (January, 2023), page 52.
2. Article 10a(1)(c) C.I.T.A.
3. Article 10a(4) C.I.T.A.
4. Article 10a(6) C.I.T.A.
5. Article 10a(3) C.I.T.A.
6. Supreme Court, 21/01534, ECLI:NL:HR:2024:469 (March 22, 2024).
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