On July 8, 2016 the Supreme Court rendered two important judgments for corporate income tax purposes. One case concerned the limitation on the deduction of interest (profit shifting, Section 10a Corporate Income Tax Act 1969 (“CITA”)), while the other concerned foreign exchange losses on EU participations. The ‘per element approach’ was a factor in both cases. Under this approach, the situation where there are subsidiaries resident elsewhere in the EU, but where no cross-border fiscal unity is possible, is nevertheless compared to the situation where this would be possible. If the fiscal unity would have offered a benefit for a certain element, then the taxpayers should have the option to claim the benefits of the separate elements of the fiscal unity.
In 2011, the Supreme Court rejected the per element approach, however. In response to the judgment rendered by the Court of Justice of the European Union (CJEU) in the Groupe Steria case – see our memorandum of September 2, 2015 – the Supreme Court is no longer sure about this and has requested preliminary rulings from the CJEU. Both cases are addressed below.
Foreign exchange losses on a UK participation
This case concerned a Dutch parent company of a fiscal unity, which held direct and indirect participations, some of which were established in the UK. An interest in the Dutch company was held via this UK branch. Internal reorganizations took place in 2008 and 2009, which also involved intercompany debt. After the reorganizations, the Dutch company was held directly by the fiscal unity, while the UK branch was held indirectly via a Luxembourg company. As a result of the reorganizations a foreign exchange loss was incurred on the capital invested in the UK branch. The application of the participation exemption means that such foreign exchange losses are, in principle, non-deductible. The question that arose was whether EU law would nevertheless require their deduction.
The District Court of The Hague ruled in favor of the tax inspector, while the Court of Appeals of The Hague ruled in favor of the taxpayer. The Supreme Court noted that the conclusion in the Groupe Steria judgment was that each element of a group rule must be assessed as to whether missing out on them in a cross-border situation forms a restriction on the freedom of establishment. The Supreme Court concluded that if the directly held UK company had been able to be included in a fiscal unity, the profit of that company would be attributed to the parent company, but a profit exemption would subsequently be granted by way of the exemption method applicable to permanent establishments. That would have allowed foreign exchange losses to be deducted, although the scale of the losses would have differed from that argued by the taxpayer in this case. After the Supreme Court presents it arguments for concluding that this does not involve the unequal treatment of objectively comparable cases, by referring, for example, to the X AB judgment (see our memorandum of June 11, 2015), it nonetheless goes on to deal with the question whether a justification ground is present if the cases are the same. In this respect, the Court addressed the consistency of the fiscal unity rules and indicated that the per element approach may result in taxpayers being able to retroactively claim the consequences of the fiscal unity and also only the benefits thereof, while domestic companies must submit a request in advance and are also subject to the disadvantages of the regime.
The Supreme Court ultimately concluded that it is not beyond reasonable doubt whether the taxpayer is justified in invoking the Groupe Steria. It has therefore requested a preliminary ruling from the CJEU. Essentially, the questions posed to the CJEU are:
- Does the EU freedom of establishment require that foreign exchange losses incurred on the capital invested in an EU subsidiary be deducted if this is also permitted in domestic situations?
- If so, then i) for the purposes of determining the foreign exchange loss, do indirectly held subsidiaries have to be included in the deemed fiscal unity, and ii) do the foreign exchange results from earlier years also have to be taken into account?
Profit shifting (Section 10a CITA)
The other case concerned the refusal of an interest deduction. In simplified form, the case involved a Dutch company that borrowed from the Swedish top holding company of a group of which it was a member and then used the borrowed funds to make a share contribution in an Italian subsidiary, who in its turn used these funds to delist another Italian group company. In dispute was firstly the application of Section 10a CITA, given that this involved a loan from a related entity for the purposes of making a contribution in a related entity. An issue in dispute was whether the Court of Appeals of Den Bosch was right in ruling that the loan and contribution were not business-motivated. Although this does not relate to the per element approach, some important conclusions are listed below:
- In principle, a taxpayer is free to choose how it wishes to finance a company in which it participates, i.e. with debt or equity.
- A group is also free to contribute its economic interests into a company established in the Netherlands. The business motivation of electing to ‘hang a participation under the Netherlands’ is thus not assessed for the purposes of Section 10a CITA.
- The ‘compensatory tax’ test, providing evidence to prove that the corresponding interest income is subject to a fair tax (at least 10%), occurs at the ‘actual financier’, that is the ultimate creditor, if the funds are borrowed to, and onlent by, an interposed company.
- Section 10a CITA is not, in itself, contrary to EU law.
- A contribution within the fiscal unity is not a tainted transaction for the purposes of Section 10a CITA.
So although Section 10a CITA is not, in itself, contrary to EU law, the Supreme Court considers that that may not be the case, given the overlap with the fiscal unity regime (the per element approach). After all, if, in the present case, the Italian subsidiary had been established in the Netherlands, it could have been included in a fiscal unity with the Dutch company, in which case the contribution would not be a tainted transaction. The Supreme Court has therefore also requested a preliminary ruling from the CJEU in this case. The question posed to the CJEU is, in short, whether Section 10a CITA violates the freedom of establishment in those cases where the application of the provision in national situations would be avoided by setting up a fiscal unity.
After the earlier negative judgments by the Supreme Court and the favorable judgments by the CJEU, in particular, in the Groupe Steria case, the requests for preliminary rulings mark an important new stage for the per element approach. Also of importance is the fact that this involves a difference in treatment directly resulting from the consolidation within a fiscal unity or group. With regard to the possible deduction of foreign exchange losses on EU subsidiaries, we note that there is still much uncertainty about the scale thereof.
In response to the Supreme Court’s requests for preliminary rulings, taxpayers would therefore be well-advised to further analyze not only the above positive consequences (deduction of interest, deduction of foreign exchange losses incurred on EU subsidiaries), but also any other positive consequences that could arise in the case of a deemed consolidation of a parent and/or subsidiaries that are established in the EU/EER. For example, the deduction of participation interest (Section 13l CITA), the unlimited set off of holding company losses (Section 20(4) through (6) CITA) and tax-neutral intragroup transactions.
During the ongoing parliamentary debates in the Lower House on the bill on the Fiscal Unity Amendment Act (see our memorandum of October 21, 2015, which addressed that bill), the Deputy Minister of Finance recently noted that if the judgment in the Groupe Steria case or any other CJEU case law were to have further implications for the fiscal unity regime, then these implications will need to be reviewed with an eye to any changes that may be needed and what their budgetary effects will be. The Deputy Minister had previously indicated that clarity would possibly only be obtained through further case law. Based on these statements, the Deputy Minister is obviously going to await the preliminary rulings from the CJEU – and possibly the final judgments from the Supreme Court – before any changes are made to the Dutch fiscal unity regime. The judgments rendered on July 8, 2016 have in any case brought the clarity hoped for by the Deputy Minister and in practice a step closer.