Tag: Business rationale

Test used in determining the economic substance of an arrangement/transaction. Artificial schemes which create circumstances under which no tax or minimal tax is levied may be disregarded if they do not have a “business rationaleâ€. See also lack of economic substance.

Germany vs “HQ Lender GmbH”, Januar 2022, Bundesfinanzhof, Case No IR 15/21

“HQ Lender GmbH” is the sole shareholder and at the same time the controlling company of A GmbH. The latter held 99.98% of the shares in B N.V., a corporation with its seat in Belgium. The remaining shares in B N.V. were held by HQ Lender GmbH itself. A GmbH maintained a clearing account for B N.V., which bore interest at 6% p.a. from 1 January 2004. No collateralisation was agreed in regards of the loan. In the year in dispute (2005), the interest rate on a working capital loan granted to the plaintiff by a bank was 3.14%. On 30 September 2005, A GmbH and B N.V. concluded a contract on a debt waiver against a debtor warrant (… €). The amount corresponded to the worthless part of the claims against B N.V. from the clearing account in the opinion of the parties to the contract. Although it was deducted from the balance sheet of A GmbH to reduce profits, the tax authorities neutralised the reduction in profits with regard to the lack of collateralisation of the claim in accordance with section 1 (1) of the German Income Tax Act (AStG) through an off-balance sheet addition. An appeal was filed by HQ Lender GmbH. Judgement of the BFH The BFH allowed the appeal of HQ Lender GmbH and referred the case back to the FG Düsseldorf. The FG has to determine whether there is a loan that can be recognized for tax purposes at all or whether this “clearing account” is more of an equity transfer by the shareholder. The distinction between loans occasioned by business and contributions occasioned by the company relationship is to be made on the basis of the totality of the objective circumstances. Individual criteria of the arm’s length comparison are not to be accorded the quality of indispensable prerequisites of the facts. The lack of collateral for a loan is one of the “conditions” within the meaning of § 1, para. 1 of the German Income Tax Act (AStG) which, when considered as a whole, can lead to the business relationship being unusual; the same applies to Article 9, para. 1 of the OECD Model Convention (here: Article 9 of the DTC-between Germany and Belgium 1967). Whether an unsecured intercompany loan is in conformity with the arm’s length principle in the context of an overall consideration of all circumstances of the individual case depends on whether a third party would also have granted the loan under the same conditions – if necessary, taking into account possible risk compensation. If an unsecured group loan would only have been granted at a higher interest rate than the one actually agreed, an income adjustment must be made primarily in the amount of this difference. In the context of arm’s length determinations, the granting of unsecured loans by third parties to the group parent company is not suitable to replace the assessment of the loan granted to a (subsidiary) company on the basis of the standard of an arm’s length granting of a loan. Click here for English translation Click here for other translation BFH-Urteil-I-R-15-21 ...

Germany vs “HQ Lender GmbH”, January 2022, Bundesfinanzhof, Case No IR 15/21

“HQ Lender GmbH” is the sole shareholder and at the same time the controlling company of A GmbH. The latter held 99.98% of the shares in B N.V., a corporation with its seat in Belgium. The remaining shares in B N.V. were held by HQ Lender GmbH itself. A GmbH maintained a clearing account for B N.V., which bore interest at 6% p.a. from 1 January 2004. No collateralisation was agreed in regards of the loan. In the year in dispute (2005), the interest rate on a working capital loan granted to the plaintiff by a bank was 3.14%. On 30 September 2005, A GmbH and B N.V. concluded a contract on a debt waiver against a debtor warrant (… €). The amount corresponded to the worthless part of the claims against B N.V. from the clearing account in the opinion of the parties to the contract. Although it was deducted from the balance sheet of A GmbH to reduce profits, the tax authorities neutralised the reduction in profits with regard to the lack of collateralisation of the claim in accordance with section 1 (1) of the German Income Tax Act (AStG) through an off-balance sheet addition. An appeal was filed by HQ Lender GmbH. Judgement of the BFH The BFH allowed the appeal of HQ Lender GmbH and referred the case back to the FG Düsseldorf. The FG has to determine whether there is a loan that can be recognized for tax purposes at all or whether this “clearing account” is more of an equity transfer by the shareholder. The distinction between loans occasioned by business and contributions occasioned by the company relationship is to be made on the basis of the totality of the objective circumstances. Individual criteria of the arm’s length comparison are not to be accorded the quality of indispensable prerequisites of the facts. The lack of collateral for a loan is one of the “conditions” within the meaning of § 1, para. 1 of the German Income Tax Act (AStG) which, when considered as a whole, can lead to the business relationship being unusual; the same applies to Article 9, para. 1 of the OECD Model Convention (here: Article 9 of the DTC-between Germany and Belgium 1967). Whether an unsecured intercompany loan is in conformity with the arm’s length principle in the context of an overall consideration of all circumstances of the individual case depends on whether a third party would also have granted the loan under the same conditions – if necessary, taking into account possible risk compensation. If an unsecured group loan would only have been granted at a higher interest rate than the one actually agreed, an income adjustment must be made primarily in the amount of this difference. In the context of arm’s length determinations, the granting of unsecured loans by third parties to the group parent company is not suitable to replace the assessment of the loan granted to a (subsidiary) company on the basis of the standard of an arm’s length granting of a loan. Click here for English translation Click here for other translation BFH-Urteil-I-R-15-21 ...

Portugal vs “GAAR S.A.”, January 2022, Supremo Tribunal Administrativo, Case No : JSTA000P28772

“GAAR S.A” is a holding company with a share capital of EUR 55,000.00. In 2010, “GAAR S.A” was in a situation of excess equity capital resulting from an accumulation of reserves (EUR 402,539.16 of legal reserves and EUR 16,527,875.72 of other reserves). The Board of Directors, made up of three shareholders – B………… (holder of 21,420 shares, corresponding to 42.84% of the share capital), C………… (holder of a further 21,420 shares, corresponding to 42.84% of the share capital) and D………… (holder of 7. 160 shares, corresponding to the remaining 14.32% of the share capital) – decided to “release this excess of capital” and, following this resolution, the shareholders decided: i) on 22.02.2010 to redeem 30,000 shares, with a share capital reduction, at a price of EUR 500.00 each, with a subsequent share capital increase of EUR 33. 000.00, by means of incorporation of legal reserves, and the share capital of the appellant will be made up of 20,000 shares at the nominal value of €2.75 each; and ii) on 07.05.2010, to cancel 10,000 shares, with a capital reduction, at the price of €1. 000.00 each, with a subsequent share capital increase of 27,500.00 Euros, by means of incorporation of legal reserves, and the share capital of the appellant is now composed of 10,000 shares at a nominal value of 5.50 Euros each (items E and F of the facts). As a result of this arrangements, payments were made to the shareholders in 2010, 2011 and 2012, with only the payment made on 4 September 2012 being under consideration here. On that date, cheques were issued for the following amounts: B………… – €214,200.00; C………… – €214,200.00; and D………… – €71,600.00. Payments which, according to “GAAR S.A”, since they constitute exempt capital gains, were not subject to taxation, that is, no deduction at source was made. Following an inspection the tax authorities decided, to disregard the arrangement, claiming that it had been “set up” by the respective shareholders with the aim of obtaining a tax advantage (whilst completely ignoring the economic substance of the arrangement). In short, the tax authorities considered that the transactions were carried out in order to allow “GAAR S.A” to distribute dividends under the “guise” of share redemption, thus avoiding the tax to which they would be subject. An appeal filed by “GAAR S.A.” with the Administrative Court was dismissed. An appeal was then filed with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Supreme Administrative Court dismissed the appeal and found that “GAAR S.A.” was liable for the payment of the tax which was not withheld at source and which should have been, we also consider that there is no error in the judgment under appeal in concluding that “at least in terms of negligence, it seems to us that the award of compensatory interest is, in cases such as the present, the natural consequence of the verification of the abuse, especially given the environmental and intellectual elements, demonstrating that there was a deliberate intention to avoid the due withholding tax” According to the court the tax authorities does not have to prove an “abusive” intention of the taxpayer. The tax authorities is not required to prove that the taxpayer opted for the construction leading to the tax saving in order to intentionally avoid the solution which would be subject to taxation. It is sufficient for the tax authorities to prove that the operation carried out does not have a rational business purpose and that, for this reason, its intentionality is exhausted in the tax saving to which it leads. Having provided this proof, the requirements of article 38(2) of the LGT should be considered to have been met. When the application of the GAAR results in the disregard of a construction and its replacement by an operation whose legal regulation would impose the practice of a definitive withholding tax act, it is the person who comes to be qualified as the substitute (in the light of the application of the GAAR) who is primarily liable for this tax obligation whenever the advantage that the third party obtains results from an operation carried out by him and it is possible to conclude, that he was the beneficiary of the operation. It is also possible to conclude, under the procedure set out in Article 63 of the CPPT, that the third party had a legal obligation to be aware of the alternative legal transaction that comes to be qualified as legally owed as a result of the disregard of the transaction carried out. Click here for English translation Click here for other translation Supremo Tribunal Administrativo 02507-15 ...

Spain vs SGL Carbon Holding, September 2021, Tribunal Supremo, Case No 1151/2021 ECLI:EN:TS:2021:3572

A Spanish subsidiary – SGL Carbon Holding SL – had significant financial expenses derived from an intra-group loan granted by the parent company for the acquisition of shares in companies of the same group. The taxpayer argued that the intra-group acquisition and debt helped to redistribute the funds of the Group and that Spanish subsidiary was less leveraged than the Group as a whole. The Spanish tax authorities found the transactions lacked any business rationale other than tax avoidance and therefor disallowed the interest deductions. The Court of appeal upheld the decision of the tax authorities. The court found that the transaction lacked any business rationale and was “fraud of law” only intended to avoid taxation. The Court also denied the company access to MAP on the grounds that Spanish legislation determines: The decision was appealed by SGL Carbon to the Supreme Court. Judgement of the Supreme Court The Supreme Court dismissed the appeal of SGL CARBON and upheld the judgment. Click here for English translation Click here for other translation Spain STS_3572_2021 ...

Netherlands vs X B.V., December 2020, Supreme Court (Preliminary ruling by the Advocate General), Case No 20/02096 ECLI:NL:PHR:2020:1198

This case concerns a private equity takeover structure with apparently an intended international mismatch, i.e. a deduction/no inclusion of the remuneration on the provision of funds. The case was (primarily) decided by the Court of Appeal on the basis of non-business loan case law. The facts are as follows: A private equity fund [A] raised LP equity capital from (institutional) investors in its subfund [B] and then channelled it into two (sub)funds configured in the Cayman Islands, Fund [C] and [D] Fund. Participating in those two Funds were LPs in which the limited partners were the external equity investors and the general partners were Jersey-based [A] entities and/or executives. The equity raised in [A] was used for leveraged, debt-financed acquisitions of European targets to be sold at a capital gain after five to seven years, after optimising their EBITDA. One of these European targets was the Dutch [F] group. The equity used in its acquisition was provided not only by the [A] funds (approximately € 401 m), but also (for a total of approximately € 284 m) by (i) the management of the [F] group, (ii) the selling party [E] and (iii) co-investors not affiliated with [A]. 1.4 The equity raised in the [A] funds was converted into hybrid, but under Luxembourg law, debt in the form of preferred equity shares: A-PECs (€ 49 m) and B-PECs (€ 636 m), issued by the Luxembourg mother ( [G] ) of the interested party. G] has contributed € 43 million to the interested party as capital and has also lent or on-lent it approximately € 635 million as a shareholder loan (SHL). The interested party has not provided [G] with any securities and owes [G] over 15% interest per year on the SHL. This interest is not paid, but credited. The SHL and the credited interest are subordinated to, in particular, the claims of a syndicate of banks that lent € 640 million to the target in order to pay off existing debts. That syndicate has demanded securities and has stipulated that the SHL plus credited interest may not be repaid before the banks have been paid in full. The tax authority considers the SHL as (disguised) equity of the interested party because according to him it differs economically hardly or not at all from the risk-bearing equity (participation loan) c.q. because this SHL is unthinkable within the OECD transfer pricing rules and within the conceptual framework of a reasonable thinking entrepreneur. He therefore considers the interest of € 45,256,000 not deductible. In the alternative, etc., he is of the opinion that the loan is not business-like, that Article 10a prevents deduction or that the interested party and its financiers have acted in fraudem legis. In any case he considers the interest not deductible. According to the Court of Appeal, the SHL is a loan in civil law and not a sham, and is not a participation loan in tax law, because its term is not indefinite, meaningless or longer than 50 years. However, the Court of Appeal considers the loan to be non-business because no securities have been stipulated, the high interest is added, it already seems impossible after a short time to repay the loan including the added interest without selling the target, and the resulting non-business risk of default cannot be compensated with an (even) higher interest without making the loan profitable. Since the interested party’s mother/creditress ([G] ) is just as unacceptable as a guarantor as the interested party himself, your guarantor analogy ex HR BNB 2012/37 cannot be applied. Therefore, the Court of Appeal has instead imputed the interest on a ten-year government bond (2.5%) as business interest, leading to an interest of € 7,435,594 in the year of dispute. It is not in dispute that 35,5% of this (€2,639,636) is deductible because 35,5% of the SHL was used for transactions not contaminated (pursuant to Section 10a Vpb Act). The remaining €4,795,958 is attributable to the contaminated financing of the contaminated acquisition of the [F] Group. The Court of Appeal then examined whether the deduction of the remaining € 4,795,958 would be contrary to Article 10a of the Dutch Corporate Income Tax Act or fraus legis. Since both the transaction and the loan are tainted (Article 10a Corporate Income Tax Act), the interested party must, according to paragraph 3 of that provision, either demonstrate business motives for both, or demonstrate a reasonable levy or third-party debt parallelism with the creditor. According to the Court of Appeal, it did not succeed in doing so for the SHL, among other things because it shrouded the financing structure behind [G], in particular that in the Cayman Islands and Jersey, ‘in a fog of mystery,’ which fog of mystery remains at its evidential risk. On the basis of the facts which have been established, including the circumstances that (i) the [A] funds set up in the Cayman Islands administered the capital made available to them as equity, (ii) all LPs participating in those funds there were referred to as ‘[A] ‘ in their names, (iii) all those LPs had the same general partners employed by [A] in Jersey, and (iv) the notification to the European Commission stated that the Luxembourg-based [H] was acquiring full control of the [F] group, the Court formed the view that the PECs to [G] had been provided by the [A] group through the Cayman Islands out of equity initially contributed to [B] LP by the ultimate investors, and that that equity had been double-hybridised through the Cayman Islands, Jersey and Luxembourg for anti-tax reasons. The interested party, on whom the counter-evidence of the arm’s length nature of the acquisition financing structure rested, did not rebut that presumption, nor did it substantiate a third-party debt parallelism or a reasonable levy on the creditor, since (i) the SHL and the B-PECs are not entirely parallel and the interest rate difference, although small, increases exponentially through the compound interest, (ii) the SHL is co-financed by A-PECs, whose interest rate ...

India vs. M/s Redington (India) Limited, December 2020, High Court of Madras, Case No. T.C.A.Nos.590 & 591 of 2019

Redington India Limited (RIL) established a wholly-owned subsidiary Redington Gulf (RG) in the Jebel Ali Free Zone of the UAE in 2004. The subsidiary was responsible for the Redington group’s business in the Middle East and Africa. Four years later in July 2008, RIL set up a wholly-owned subsidiary company in Mauritius, RM. In turn, this company set up its wholly-owned subsidiary in the Cayman Islands (RC) – a step-down subsidiary of RIL. On 13 November 2008, RIL transferred its entire shareholding in RG to RC without consideration, and within a week after the transfer, a 27% shareholding in RC was sold by RG to a private equity fund Investcorp, headquartered in Cayman Islands for a price of Rs.325.78 Crores. RIL claimed that the transfer of its shares in RG to RC was a gift and therefore, exempt from capital gains taxation in India. It was also claimed that transfer pricing provisions were not applicable as income was exempt from tax. The Indian tax authorities disagreed and found that the transfer of shares was a taxable transaction, as the three defining requirements of a gift were not met – that the transfer should be (i) voluntary, (ii) without consideration and that (iii) the property so transferred should be accepted by the donee. The tax authorities also relied on the documents for the transfer of shares, the CFO statement, and the law dealing with the transfer of property. The arm’s length price was determined by the tax authorities using the comparable uncontrolled price method – referring to the pricing of the shares transferred to Investcorp. In the tax assessment, the authorities had also denied deductions for trademark fees paid by RIL to a Singapore subsidiary for the use of the “Redington” name. The tax authorities had also imputed a fee for RIL providing guarantees in favour of its subsidiaries. RIL disagreed with the assessment and brought the case before the Dispute Resolution Panel (DRP) who ruled in favour of the tax authorities. The case was then brought before the Income Tax Appellate Tribunal (ITAT) who ruled in favour of RIL. ITAT’s ruling was then brought before the High Court by the tax authorities. The decision of the High Court The High Court ruled that transfer of shares in RG by RIL to its step-down subsidiary (RC) as part of corporate restructuring could not be qualified as a gift. Extraneous considerations had compelled RIL to make the transfer of shares, thereby rendering the transfer involuntary. The entire transaction was structured to accommodate a third party-investor, who had put certain conditions even prior to effecting the transfer. According to the court, the transfer of shares was a circular transaction put in place to avoid payment of taxes. “Thus, if the chain of events is considered, it is evidently clear that the incorporation of the company in Mauritius and Cayman Islands just before the transfer of shares is undoubtedly a means to avoid taxation in India and the said two companies have been used as conduits to avoid income tax†observed the Court. The High Court also disallowed deductions for trademark fees paid by RIL to a Singapore subsidiary. The court stated it was illogical for a subsidiary company to claim Trademark fee from its parent company (RIL), especially when there was no documentation to show that the subsidiary was the owner of the trademark. It was also noted that RIL had been using the trademark in question since 1993 – long before the subsidiary in Singapore was established in 2005. Regarding the guarantees, the Court concluded these were financial services provided by RIL to it’s subsidiaries for which a remuneration (fee/commission) was required. India vs Ms Redington (India) Limited 10 Dec 2020 Madras High Court FY 09 10 ...

Belgium vs Fortum Project Finance, May 2019, Court of Appeal in Antwerp, Case No F.16.0053.N

Fortum Project Finance (Fortum PF’) is a Belgian company, founded in 2008 by Fortum OYI, a Finnish company, and Fortum Holding bv, a Dutch company. The establishment of Fortum PF was part of an acquisition that the Finnish company Fortum OYI, through its Swedish subsidiary Fortum 1AB, had in mind in Russia. However, the financing of this Russian acquisition did not go directly through Sweden but through Fortum PF in Belgium. Two virtually identical loan contracts were drawn up simultaneously on 19 March 2008. First, Fortum OYI granted credit facilities of EUR 3,000,000,000 to Fortum PF and with a second loan, Fortum PF ‘passed on’ the same amount to Fortum 1AB of Sweden. The funds, intended for the acquisition in Russia, did not pass through Belgium but went directly to Russia. 10 days later, capital increases were made to Fortum PF, with the Finnish company Fortum OYI contributing part of its loan to Fortum PF. In this way, a total of 2,389,196,655.06 euros of capital was created. According to the Belgian tax authorities, the interest received by Fortum PF from Fortum 1AB was not obtained under normal economic circumstances, but only for the purpose of obtaining tax deduction. Consequently, the interest had to be regarded as an abnormal and gratuitous advantage, and the deduction for risk capital pursuant to Article 207, second(1) of the Belgian Income Tax Code 92 denied. The deduction for risk capital amounting to EUR 69,749,709.95 was rejected. Fortum PF had disputed this and won the case before the Court of First Instance. The Court of Appeal in Antwerp considered it important that the applicability of article 207 ITC 92 for the deduction of risk capital did not simply mean that the case law of the Court of Cassation on the recovery of losses after profit shifts could be extended to the present case as argued by the tax authorities. The Court of Appeal elaborated that, while the Court’s interpretation of the concept of “abnormal and gratuitous advantages” is justified in the light of the ratio legis of Article 79 ITC 92 as regards combating the compensation of previous losses, this is not the case in the light of the ratio legis of the deduction for risk capital, i.e. the elimination of the economically unjustified discrimination between financing by debt capital and financing by risk capital; as a result, the concept of abnormal and gratuitous advantages had to be interpreted narrowly, taking into account the operation which would have conferred the advantage, without taking into account an overly broad context. The Court of Appeal in its judgment ruled that there were no abnormal transactions. The Court examined whether both the establishment of Fortum PF, the granting by Fortum OYI of a loan to Fortum PF, the granting by Fortum PF of a loan to Fortum 1 AB, the contribution by Fortum OYT of its claim to the capital of Fortum PF and the granting by Fortum OYI of interest to Fortum PF should be considered unusual in the economic circumstances in question. According to the Court of Appeal the creation of Fortum PF could not be considered abnormal simply because a financing company already existed within the group; furthermore, the view that Fortum PF did not have any economic activity in Belgium cannot be accepted, since the granting of a loan and its management implies an activity and that activity cannot be ignored. In addition, the fact that Fortum PF possesses few assets and would call on the staff of another company via a payroll location cannot be considered abnormal either, since it is inherent to a financing company that it needs assets and staff only to a limited extent for its activities. Furthermore, the fact that the company would not have engaged in any activities other than the management of the loan to Fortum 1AB cannot be considered abnormal either, since it is a large loan and the administration should not be involved in assessing the quantity of a taxpayer’s transactions; Nor can the fact that Fortum PF was involved in the financing operation be considered abnormal for the sole reason that the existing financing company could have been used or that Fortum OYI could have granted the loan directly to Fortum 1AB; furthermore, the conversion of Fortum OYI’s claim into capital cannot be considered abnormal; according to the Court of Appeal, this even corresponds to the objective pursued by the legislator in introducing the deduction for risk capital; in addition, the administration did not dispute that the interest granted by Fortum 1AB to Fortum PF was in line with the market and therefore not abnormal; in short, the whole construction cannot be considered abnormal for the simple reason that it was also motivated by tax considerations; moreover, it must be noted that the deduction for risk capital is regulated in a detailed manner in the law and provides for its own conditions to avoid abuse as well as a specific anti-abuse provision (Article 205ter, § 4 ITC 92). The Court of Appeal added that the administration adds a condition to the law when it states that the deduction for risk capital cannot be applied when it appears that the incorporation of a company in Belgium and the generation of income in it is done in order to apply the deduction for risk capital. Before the cassation, the Belgian State argued that the Court of Appeal had gone too far in its interpretation of the concept of abnormal and gratuitous advantages. The Belgian State thus defended in particular the “broad scope” of the anti-abuse provision of Articles 79 and 207 of ITC 92, including as regards the deduction of risk capital. Fortum had invoked a ground of inadmissibility of the Belgian State’s plea. According to Fortum, the Court of Appeal had established and explained that all the transactions in question were economically justified and not artificial. The plaintiff’s criticism to cassation was directed entirely against the ‘strict’ interpretation of the concept of abnormal and gratuitous advantage, the ...

Spain vs SGL Carbon Holding, April 2019, Audiencia Nacional, Case No ES:AN:2019:1885

A Spanish subsidiary – SGL Carbon Holding SL – had significant financial expenses derived from an intra-group loan granted by the parent company for the acquisition of shares in companies of the same group. The taxpayer argued that the intra-group acquisition and debt helped to redistribute the funds of the Group and that Spanish subsidiary was less leveraged than the Group as a whole. The Spanish tax authorities found the transactions lacked any business rationale other than tax avoidance and therefor disallowed the interest deductions. The Court held in favor of the authorities. The court found that the transaction lacked any business rationale and was “fraud of law” only intended to avoid taxation. The Court also denied the company access to MAP on the grounds that Spanish legislation determines: Article 8 Reglamento MAP: Mutual agreement procedure may be denied, amongst other, in the following cases: … (d) Where it is known that the taxpayer’s conduct was intended to avoid taxation in one of the jurisdictions involved. (…) Click here for translation Spain vs SGL Carbon Holding April 22 2019 1885 ...

Spain vs ICL ESPAÑA, S.A. (Akzo Nobel), March 2018, Audiencia Nacional, Case No 1307/2018 ECLI:ES:AN:2018:1307

ICL ESPAÑA, S.A., ICL Packaging Coatings, S.A., were members of the Tax Consolidation Group and obtained extraordinary profits in the financial years 2000, 2001 and 2002. (AKZO NOBEL is the successor of ICL ESPAÑA, as well as of the subsidiary ICL PACKAGING.) On 26 June 2002, ICL ESPAÑA, S.A. acquired from ICL Omicron BV (which was the sole shareholder of ICL ESPAÑA, S.A. and of Elotex AG and Claviag AG) 45.40% of the shares in the Swiss company, Elotex AG, and 100% of the shares in the Swiss company of Claviag AG. The acquisition was carried out by means of a sale and purchase transaction, the price of which was 164.90 million euros, of which ICL ESPAÑA, S.A. paid 134.90 million euros with financing granted by ICL Finance, PLC (a company of the multinational ICL group) and the rest, i.e. 30 million euros, with its own funds. On 19 September 2002, ICL Omicron BV contributed 54.6% of the shares of Elotex AG to ICL ESPAÑA, S.A., in a capital increase of ICL ESPAÑA, S.A. with a share premium, so that ICL ESPAÑA, S.A. became the holder of 100% of the share capital of Elotex AG. The loan of 134,922,000 € was obtained from the British entity, ICL FINANCE PLC, also belonging to the worldwide ICL group, to finance the acquisition of the shares of ELOTEX AG. To pay off the loan, the entity subsequently obtained a new loan of €75,000,000. The financial burden derived from this loan was considered by ICL ESPAÑA as an accounting and tax expense in the years audited, in which for this concept it deducted the following amounts from its taxable base – and consequently from that of the Group: FY 2005 2,710,414.29, FY 2006 2,200,935.72, FY 2007 4,261,365.20 and FY 2008 4.489.437,48. During the FY under review, ICL ESPAÑA SA has considered as a deductible expense for corporate tax purposes, the interest corresponding to loans obtained by the entity from other companies of the group not resident in Spain. The financing has been used for the acquisition of shares in non-resident group companies, which were already part of the group prior to the change of ownership. The amounts obtained for the acquisition of shares was recorded in the groups cash pooling accounts, the entity stating that “it should be understood that the payments relating to the repayment of this loan have not been made in accordance with a specific payment schedule but rather that the principal of the operation has been reduced through the income made by Id ESPAÑA SA from the cash available at any given time”. Similarly, as regards the interest accrued on the debit position of ICL ESPAÑA SA, the entity stated that “the interest payments associated with them have not been made according to a specific schedule, but have been paid through the income recorded by ICL ESPAÑA SA in the aforementioned cash pooling account, in the manner of a credit policy contract, according to the cash available at any given time”. The Spanish tax authorities found the above transactions lacked any business rationale other than tax avoidance and therefor disallowed the interest deductions for tax purposes. This decision was appealed to the National Court. Judgement of the National Court The Court partially allowed the appeal. Excerpts “It follows from the above: 1.- The purchase and sale of securities financed with the loan granted by one of the group companies did not involve a restructuring of the group itself. The administration claims that the transfer of 100% ownership of the shares of both Swiss companies is in all respects formal. And it is true that no restructuring of the group can be seen as a consequence of the operation, nor is this alleged by the plaintiff. 2.- There are no relevant legal or economic effects apart from the tax savings in the operation followed, since, as we have pointed out, we are dealing with a merely formal operation, with no substantive effect on the structure and organisation of the Group. 3.- The taxation in the UK of the interest on the loan does not affect the correct application of Spanish tax legislation, since, if there is no right to deduct the interest generated by the loan, this is not altered by the fact that such interest has been taxed in another country. It is clear that the Spanish authorities cannot make a bilateral adjustment in respect of the amounts paid in the United Kingdom for the taxation of the interest received. For this purpose, provision is made for the mutual agreement procedure under Article 24 of the Convention between the Kingdom of Spain and the United Kingdom of Great Britain and Northern Ireland for the avoidance of double taxation and the prevention of fiscal evasion in relation to taxes on income and on capital and its Protocol, done at London on 14 March 2013 (and in the same terms the previous Instrument of Ratification by Spain of the Convention between Spain and the United Kingdom of Great Britain and Northern Ireland for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion in respect of Taxes on Income and on Capital, done at London on 21 October 1975, Article 26 ).” “For these reasons, we share the appellant’s approach and we understand that the non-compliance with the reinvestment takes place in the financial year 2004 (as the start of the calculation of the three-year period is determined by the deed of sale dated 29 June 2001), and that therefore the regularisation on this point should be annulled because it corresponds to a financial year not covered by the inspection.” “Therefore, and in the absence of the appropriate rectification, this tax expense would be double-counted, firstly because it was considered as a tax expense in 1992 and 1999, and secondly because it was included in seventh parts – in 2003 and in the six subsequent years – only for an amount lower than the amount due, taking into account the proven ...

Nederlands vs. Corp, January 2014, Lower Court, Case nr. AWB11/3717, 11/3718, 11/3719, 11/3720, 11/3721

The case involved a Dutch mutual insurance company, DutchCo, which paid surpluses from the insurance activity back to the participating members in the form of premium restitution. Prior to 2002, DutchCo reinsured the majority of its risks with external reinsurers via an external reinsurance broker. DutchCo kept a small part of the risks for its own account. In 2001, DutchCo established a subsidiary in Switzerland, Captive, to act as a captive reinsurance provider. DutchCo stated that the business rationale to establish Captive goes back to “9/11.†The resulting worldwide turmoil significantly impacted the reinsurance market. In an extremely nervous market, premiums increased and conditions were sharpened. From 2002 onward, all the reinsurance contracts of DutchCo were concluded with Captive (in exchange for payment of premiums), whereby Captive reinsured a vast majority of these risks with external reinsurers and kept a limited part of the risk for itself. As mentioned above, Captive did not employ any personnel, but made use of the services of M GmbH in the person of the owner/director of M GmbH (on average two days a week), an external Swiss reinsurance broker on whose office address Captive was located. In this respect, Captive was charged an amount of about €150,000 annually. The Dutch tax inspector argued that the reinsurance agreements with Captive were not concluded under the same conditions as with third parties. As a result, the tax inspector increased DutchCo’s taxable profit for the 2005-2008 years equal to the premiums paid to Captive by DutchCo after deducting the cost plus remuneration for Captive (i.e. the service fees paid to M GmbH with a mark-up of 10% in 2005 and 11% in the 2006-2008 years). In addition to the tax assessments, the tax inspector levied penalties equal to 50% of the income adjustment (i.e., taxes as a result of adjustments due to profit shifting to Captive). The Court stated that the conditions of the reinsurance agreements between DutchCo and Captive should be evaluated as if it would have been agreed between independent parties. In this respect, reference was made to the arm’s length principle as codified in Article 8b of the Dutch Corporate Income Tax Act 1969 (Article 8b). The Court considered it plausible that the level of the premiums paid by DutchCo to Captive and the policy of Captive regarding whether to reinsure the risks with third parties were determined by DutchCo itself. The Court also held that the tax inspector made it sufficiently plausible that the conditions of the agreement between DutchCo and Captive deviate from the conditions that would have been agreed between independent parties. Reference is made to the considerations of the expert. Next, the profits of DutchCo should be determined as if the deviating conditions would not have been agreed to (based on Article 8b of the Corporate Income Tax Act). Taking into account the limited activities and lack of policy determination by Captive, the Court argued that an annual return on equity (including the accumulated non-arm’s length premiums from the past) of 7.5% for Captive is reasonable in addition to a cost plus mark-up of 10% or 11% as set by the tax inspector. Hence, the Court lowered the adjustment to DutchCo’s taxable income as assessed by the tax inspector. The Court also adjusted the proposed penalties of the tax inspector to an annual penalty of €125,000 for the relevant years (about 25% of the additional corporate income tax). The Court believed that DutchCo intended to withdraw a considerable part of its profits from taxation in The Netherlands by setting up the structure with Captive and the excessive level of premiums paid to Captive. Click here for other translation Nederlands-vs-Corp-January-2014-Lower-Court-AWB11-3717 ...

Netherlands vs Corp, 2011, Dutch Supreme Court, Case nr. 08/05323 (10/05161, 10/04588)

In this case, the Dutch Supreme Court further outlined the Dutch perspective on the distinction between debt and equity in its already infamous judgments on the so-called extreme default risk loan (EDR loan) L sold a securities portfolio to B for EUR 5.3 million against B’s acknowledgement of debt to L for the same amount. The debt was then converted into a 10 year loan with  an interest rate of 5% and a pledge on the portfolio. Both L and B were then moved to the Netherlands Antilles. Later on L deducted a EUR 1.2 mill. loss on the loan to B due to a decrease in value of the securities portfolio. The Dutch Tax Authorities disallowed the deduction based on the argument, that the loan was not a business motivated loan. The Dutch Supreme Court ruled that in principle civil law arrangement is decisive in regard to taxation. However there are exceptions in which a civil law loan arrangement can be disregarded. A non-business motivated loan is defined as an intercompany loan that carries an interest rate which – given the terms and conditions of the loan – is not at arm’s length, and which a third party would not have granted given the risk involved. In such cases, any losses arising from the loan are not deductible for Dutch corporate tax purposes. But at the same time, the lender still has to report an arm’s length interest which equals the interest that the borrower would have paid in case it had borrowed from a third party with a guarantee from the lender. Click here for translation Netherland-vs-Corp-25-November-2011-Supreme-Court-case-nr-08-05323 ...

Nederlands vs. Corp, July 2011, Lower Court AWB 08/9105

X is the holding company of the so-called A-group, which is a recreation company driven. The activities in X was taking out cancellation insurance. Within the group an Irish company was established. Between X and an insurer, that insurer and a reinsurer and the reinsurer and the Irish company several contracts were concluded with regard to the cancellation activities. The court considers that the tax administration has proved that X has let on un-businesslike grounds earnings miss in favor of the Irish company. Click here for other translation Nederlands-vs-Corp-July-2011-Lower-Court-Case-nr-AWB-08-9105 ...

Netherlands vs Shoe Corp, June 2007, District Court, Case nr. 05/1352, VSN June 2, 2007

This case is about a IP sale-and-license-back arrangement. The taxpayer acquired the shares in BV Z (holding). BV Z owns the shares in BV A and BV B (the three BVs form a fiscal unity under the CITA). BV A produces and sells shoes. In 1993, under a self-proclaimed protection clause, BV A sells the trademark of the shoes to BV C, which is also part of the fiscal unity. The protection clause was supposedly intended to protect the trademark in case of default of BV A. Taxpayer had created BV C prior to the sale of the trademark. In 1994, the taxpayer entered into a licensing agreement with BV C: the taxpayer pays NLG 2 to BV C per pair of shoes sold. Next, BV C is then moved to the Netherlands Antilles, which results in the end of the fiscal unity as of January 1, 1994. The roundtrip arrangement, the sale of an intangible and the subsequent payment of licensing fees, is now complete. In 1999 the royalty for use of the trademark was increased from fl. 2 per pair of shoes to fl. 2.50 per pair, resulting in annual royalty payments of fl. 300.000 from A BV to B BV. The Court disallowed tax deductions for the royalty payments. The payments were not proven to be at arm’s length. B BV had no employees to manage the trademarks. There were no business reasons for the transactions, only a tax motive. Hence the sale-and-license back arrangement was disregarded for tax purposes. Also, the licensing agreement were not found to produce effective protection of the brand and was therefore also considered part of a tax planning plan. Taxpayers often seek to maximise differences in tax rates through selling intangibles to a low- tax country and subsequently paying royalties to this country for the use of these intangibles, thereby decreasing the tax-base in the high-tax country. The arm’s length principle requires taxpayers to have valid business purposes for such transactions and requires them to make sure that the royalties are justified – why would an independent company pay royalties to a foreign company for an intangible it previously owned?’ To adress such situations a decree was issued in the Netherlands on August 11, 2004. The decree provided additional rules for transfers of intangibles when the value is uncertain at the time of the transaction (HTVI). It refers to situations in which an intangible is being transferred to a foreign group company and where this company furthermore licenses the intangible back to the transferor and/or related Dutch companies of this company. In these situations a price adjustment clause is deemed to have been entered. The deemed price adjustment clause prevents a sale at a very low price with a consequent high royalty fee to drain the Dutch tax base. Through the price adjustment clause the Dutch tax authorities are guaranteed a fair price for the sale of the intangible. Click here for translation Netherlands-vs-Corp-Maj-2007-IP-sale-and-license-back ...

US vs Proctor & Gamble Co, April1992, Court of Appeal (6th Cir.), Case No 961 F.2d 1255

Proctor & Gamble is engaged in the business of manufacturing and marketing of consumer and industrial products. Proctor & Gamble operates through domestic (US) and foreign subsidiaries and affiliates. Proctor & Gamble owned all the stock of Procter & Gamble A.G. (AG), a Swiss corporation. AG was engaged in marketing Proctor & Gamble’s products, generally in countries in which Proctor & Gamble did not have a marketing subsidiary or affiliate. Proctor & Gamble and AG were parties to a License and Service Agreement, known as a package fee agreement, under which AG paid royalties to Proctor & Gamble for the nonexclusive use by AG and its subsidiaries of Proctor & Gamble’s patents, trademarks, tradenames, knowledge, research and assistance in manufacturing, general administration, finance, buying, marketing and distribution. The royalties payable to Proctor & Gamble were based primarily on the net sales of Proctor & Gamble’s products by AG and its subsidiaries. AG entered into agreements similar to package fee agreements with its subsidiaries. In 1967, Proctor & Gamble made preparations to organize a wholly-owned subsidiary in Spain to manufacture and sell its products in that country. Spanish laws in effect at that time closely regulated foreign investment in Spanish companies. The Spanish Law of Monetary Crimes of November 24, 1938, in effect through 1979, regulated payments from Spanish entities to residents of foreign countries. This law required governmental authorization prior to payment of pesetas to residents of foreign countries. Making such payments without governmental authorization constituted a crime. Decree 16/1959 provided that if investment of foreign capital in a Spanish company was deemed economically preferential to Spain, a Spanish company could transfer in pesetas “the benefits obtained by the foreign capital.” Proctor & Gamble requested authorization to organize Proctor & Gamble Espana S.A. (Espana) and to own, either directly or through a wholly-owned subsidiary, 100 percent of the capital stock of Espana. Proctor & Gamble stated that its 100 percent ownership of Espana would allow Espana immediate access to additional foreign investment, and that Proctor & Gamble was in the best position to bear the risk associated with the mass production of consumer products. Proctor & Gamble also indicated that 100 percent ownership would allow Proctor & Gamble to preserve the confidentiality of its technology. As part of its application, Proctor & Gamble estimated annual requirements for pesetas for the first five years of Espana’s existence. Among the items listed was an annual amount of 7,425,000 pesetas for royalty and technical assistance payments. Under Spanish regulations, prior authorization of the Spanish Council of Ministers was required in order for foreign ownership of the capital of a Spanish corporation to exceed fifty percent. The Spanish government approved Proctor & Gamble’s application for 100 percent ownership in Espana by a letter dated January 27, 1968. The letter expressly stated that Espana could not, however, pay any amounts for royalties or technical assistance. For reasons that are unclear in the record, it was determined that AG, rather than Proctor & Gamble, would hold 100 percent interest in Espana. From 1969 through 1979, Espana filed several applications with the Spanish government seeking to increase its capital from the amount originally approved. The first such application was approved in 1970. The letter granting the increase in capital again stated that Espana “will not pay any amount whatsoever in the concept of fees, patents, royalties and/or technical assistance to the investing firm or to any of its affiliates, unless with the approval of the Administration.” All future applications for capital increases that were approved contained the same prohibition. In 1973, the Spanish government issued Decree 2343/1973, which governed technology agreements between Spanish entities and foreign entities. In order to obtain permission to transfer currency abroad under a technology agreement, the agreement had to be recorded with the Spanish Ministry of Industry. Under the rules for recording technology agreements, when a foreign entity assigning the technology held more than 50 percent of the Spanish entity’s capital, a request for registration of a technology agreement was to be looked upon unfavorably. In cases where foreign investment in the Spanish entity was less than 50 percent, authorization for payment of royalties could be obtained. In 1976, the Spanish government issued Decree 3099/1976, which was designed to promote foreign investment. Foreign investment greater than 50 percent of capital in Spanish entities was generally permitted, but was conditioned upon the Spanish company making no payments to the foreign investor, its subsidiaries or its affiliates for the transfer of technology. Espana did not pay a package fee for royalties or technology to AG during the years at issue. Espana received permission on three occasions to pay Proctor & Gamble for specific engineering services contracts. The Spanish Foreign Investments Office clarified that payment for these contracts was not within the general prohibition against royalties and technical assistance payments. Espana never sought formal relief from the Spanish government from the prohibition against package fees. In 1985, consistent with its membership in the European Economic Community, in Decree 1042/1985 Spain liberalized its system of authorization of foreign investment. In light of these changes, Espana filed an application for removal of the prohibition against royalty payments. This application was approved, as was Espana’s application to pay package fees retroactive to July 1, 1987. Espana first paid a dividend to AG during the fiscal year ended June 30, 1987. The Commissioner determined that a royalty of two percent of Espana’s net sales should be allocated to AG as royalty payments under section 482 for 1978 and 1979 in order to reflect AG’s income. The Commissioner increased AG’s income by $1,232,653 in 1978 and by $1,795,005 in 1979 and issued Proctor & Gamble a notice of deficiency.1 Proctor & Gamble filed a petition in the Tax Court seeking review of the deficiencies. The Tax Court held that the Commissioner’s allocation of income was unwarranted and that there was no deficiency. The court concluded that allocation of income under section 482 was not proper in this case because Spanish ...

US vs Proctor & Gamble, September 1990, US Tax Court, Opinion No. 16521-84.

Proctor & Gamble is an US corporation engaged in the business of manufacturing and marketing of consumer and industrial products. Proctor & Gamble operates through domestic and foreign subsidiaries and affiliates. Proctor & Gamble owned all the stock of Procter & Gamble A.G. (AG), a Swiss corporation. AG was engaged in marketing Proctor & Gamble’s products, generally in countries in which Proctor & Gamble did not have a marketing subsidiary or affiliate. Proctor & Gamble and AG were parties to a License and Service Agreement, known as a package fee agreement, under which AG paid royalties to Proctor & Gamble for the nonexclusive use by AG and its subsidiaries of Proctor & Gamble’s patents, trademarks, tradenames, knowledge, research and assistance in manufacturing, general administration, finance, buying, marketing and distribution. The royalties payable to Proctor & Gamble were based primarily on the net sales of Proctor & Gamble’s products by AG and its subsidiaries. AG entered into agreements similar to package fee agreements with its subsidiaries. In 1967, Proctor & Gamble made preparations to organize a wholly-owned subsidiary in Spain to manufacture and sell its products in that country. Spanish laws in effect at that time closely regulated foreign investment in Spanish companies. The Spanish Law of Monetary Crimes of November 24, 1938, in effect through 1979, regulated payments from Spanish entities to residents of foreign countries. This law required governmental authorization prior to payment of pesetas to residents of foreign countries. Making such payments without governmental authorization constituted a crime. Decree 16/1959 provided that if investment of foreign capital in a Spanish company was deemed economically preferential to Spain, a Spanish company could transfer in pesetas “the benefits obtained by the foreign capital.” Proctor & Gamble requested authorization to organize Proctor & Gamble Espana S.A. (Espana) and to own, either directly or through a wholly-owned subsidiary, 100 percent of the capital stock of Espana. Proctor & Gamble stated that its 100 percent ownership of Espana would allow Espana immediate access to additional foreign investment, and that Proctor & Gamble was in the best position to bear the risk associated with the mass production of consumer products. Proctor & Gamble also indicated that 100 percent ownership would allow Proctor & Gamble to preserve the confidentiality of its technology. As part of its application, Proctor & Gamble estimated annual requirements for pesetas for the first five years of Espana’s existence. Among the items listed was an annual amount of 7,425,000 pesetas for royalty and technical assistance payments. Under Spanish regulations, prior authorization of the Spanish Council of Ministers was required in order for foreign ownership of the capital of a Spanish corporation to exceed fifty percent. The Spanish government approved Proctor & Gamble’s application for 100 percent ownership in Espana by a letter dated January 27, 1968. The letter expressly stated that Espana could not, however, pay any amounts for royalties or technical assistance. For reasons that are unclear in the record, it was determined that AG, rather than Proctor & Gamble, would hold 100 percent interest in Espana. From 1969 through 1979, Espana filed several applications with the Spanish government seeking to increase its capital from the amount originally approved. The first such application was approved in 1970. The letter granting the increase in capital again stated that Espana “will not pay any amount whatsoever in the concept of fees, patents, royalties and/or technical assistance to the investing firm or to any of its affiliates, unless with the approval of the Administration.” All future applications for capital increases that were approved contained the same prohibition. In 1973, the Spanish government issued Decree 2343/1973, which governed technology agreements between Spanish entities and foreign entities. In order to obtain permission to transfer currency abroad under a technology agreement, the agreement had to be recorded with the Spanish Ministry of Industry. Under the rules for recording technology agreements, when a foreign entity assigning the technology held more than 50 percent of the Spanish entity’s capital, a request for registration of a technology agreement was to be looked upon unfavorably. In cases where foreign investment in the Spanish entity was less than 50 percent, authorization for payment of royalties could be obtained. In 1976, the Spanish government issued Decree 3099/1976, which was designed to promote foreign investment. Foreign investment greater than 50 percent of capital in Spanish entities was generally permitted, but was conditioned upon the Spanish company making no payments to the foreign investor, its subsidiaries or its affiliates for the transfer of technology. Espana did not pay a package fee for royalties or technology to AG during the years at issue. Espana received permission on three occasions to pay Proctor & Gamble for specific engineering services contracts. The Spanish Foreign Investments Office clarified that payment for these contracts was not within the general prohibition against royalties and technical assistance payments. Espana never sought formal relief from the Spanish government from the prohibition against package fees. In 1985, consistent with its membership in the European Economic Community, in Decree 1042/1985 Spain liberalized its system of authorization of foreign investment. In light of these changes, Espana filed an application for removal of the prohibition against royalty payments. This application was approved, as was Espana’s application to pay package fees retroactive to July 1, 1987. Espana first paid a dividend to AG during the fiscal year ended June 30, 1987. The Commissioner determined that a royalty of two percent of Espana’s net sales should be allocated to AG as royalty payments under section 482 for 1978 and 1979 in order to reflect AG’s income. The Commissioner increased AG’s income by $1,232,653 in 1978 and by $1,795,005 in 1979 and issued Proctor & Gamble a notice of deficiency.1 Proctor & Gamble filed a petition in the Tax Court seeking review of the deficiencies. Decision of the Tax Court The Tax Court held that the Commissioner’s allocation of income was unwarranted and that there was no deficiency. The court concluded that allocation of income under section 482 was ...

Belgium vs SA Etablissements Brepols, June 1961, Court Cassation,

SA Etablissements Brepols, which had a profitable commercial activity in Belgium, transferred its entire activity to an new company, the SA Usines Brepols. At the same time, a loan was granted to the new company. The interest charge on that loan was so high that almost all of the profits of SA Usines Brepols were used to finance the loan and therefore no taxes were paid. However, S.A. Etablissements Brepols was taxed on the interest received, which at the time was at a reduced rate in Belgium. The tax administration considered that the taxpayer had only entered into the transactions for the main purpose of reducing the tax burden and disallowed the reduced taxation. The Court of Appeal agreed and held that the agreements concluded between the parties constituted evasion of the law. The Belgian Supreme court overturned the decision in its judgment of 6 June 1961 and stated the following: “There is no simulation prohibited in the field of taxation, nor does it prohibit fraudulent tax practices, when, in order to benefit from a more favorable tax regime, the parties, using the freedom of conventions, without violating any legal obligation, establish acts of which they accept all the consequences, even if the form they give them is not the most normal”. Click here for Translation Belgium vs Brepols 1961-4fr ...