Following an audit of Sadepan Chimica S.R.L., the Italian tax authorities issued an assessment of additional taxable income relating to non-interest bearing loans and bonds granted by Sadepan Chimica S.R.L. to its subsidiaries. The tax authorities considered that, in the financing relationship between the subsidiaries and the foreign associates – Polena S.A., based in Luxembourg, and Sadepan Chimica N.V., based in Belgium – the former had applied interest rates that did not correspond to the arm’s length value referred to in Article 9, paragraph 3, of the Italian Income Tax Code. U.I.R. As a result, the authorities issued separate tax assessments for the year 2013 claiming the higher amounts of interest income, calculated by applying an average rate of 3.83% for loans and 5.32% for bonds. Not satisfied with the assessment, Sadepan Chimica S.R.L. filed an appeal. The Regional Tax Commission (C.t.r.) confirmed the assessments and Sadepan Chimica S.R.L. filed an appeal with the Supreme Court. In the appeal Sadepan Chimica S.R.L. and its subsidiaries stated that the C.t.r. judgment were ‘irrelevant’ for not having analysed the general and specific conditions in relation to which the loans had been granted, and in so far as it held that it was for the taxpayer to provide evidence that the agreed consideration corresponded ‘to the economic values that the market attributes to such transactions. First of all, they claimed that the rules on the allocation of the burden of proof have been infringed; secondly, they complained of the failure to assess the evidence; they also claimed that the Office had used as a reference a market rate extraneous to the case at hand in that it was applicable to the different case of loans from financial institutions to industrial companies whereas it should have sought a benchmark relating to intra-group loans of industrial companies. They added that they had submitted to the judge of the merits, in order to determine in concrete terms the conditions of the financing, a number of elements capable of justifying the deviation from the normal value and, precisely a) the legal subordination of the financing b) the duration, c) the absence of creditworthiness, d) the indirect exercise of the activity through the subsidiaries; that, nevertheless, the C.t.r. had not assessed the economic and commercial reasons deduced. Judgement of the Supreme Court The Court ruled in favour of Sadepan Chimica S.R.L. and annulled the judgment under appeal on the grounds that it had failed to take account of the specific circumstances (solvency problems of the subsidiaries) relating to the transactions carried out by the related parties. Excerpts (English translation) “In fact, it still remains that a non-interest-bearing financing, or financing at a non-market rate, cannot be criticised per se, since it is possible for the taxpayer to prove the economic reasons that led it to finance its investee in the specific manner adopted. The rationale of the legislation is to be found in the arm’s length principle set forth in Article 9 of the OECD Model Convention, which provides for the possibility of taxing profits arising from intra-group transactions that have been governed by terms different from those that would have been agreed upon between independent companies in comparable transactions carried out in the free market. It follows from this conceptual core that “the valuation ‘at arm’s length’ disregards the original capacity of the transaction to produce income and, therefore, any negotiating obligation of the parties relating to the payment of consideration (see OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, paragraph 1.2). It is, in fact, a matter of examining the economic substance of the transaction that has taken place and comparing it with similar transactions carried out, in comparable circumstances, in free market conditions between independent parties and assessing its compliance with these (Cass. 20/05/2021, no. 13850 Cass. 15/04/2016, no. 749) Moreover, it is not excluded that intra-group gratuitous financing may have legal standing where it can be demonstrated that the deviation from the arm’s length principle was due to commercial reasons within the group, connected to the role that the parent company assumes in support of the other companies in the group (Court of Cassation 20/05/2021, no. 13850).” “In the OECD report published on 11/02/2020, on financial transactions, it is reiterated (as already stated in the OECD Commentary to Article 9 of the Model Convention) that, in intercompany financing transactions, the proper application of the arm’s length principle is relevant not only in determining the market value of the interest rates applied, but also in assessing whether a financing transaction is actually to be considered a loan or, alternatively, an equity contribution. It is also emphasised that, in order to distinguish a loan from an equity injection, among other useful indicators, the obligation to pay interest is of independent relevance. With reference to Italy, however, based on the application practice of the Agenzia delle Entrate (Circular No. 6/E of 30 March 2016 on leveraged buy-outs), the requalification of debt (or part thereof) into an equity contribution should represent an exceptional measure. Moreover, it is not ruled out that intra-group free financing may have legal standing where it can be demonstrated that the deviation from the arm’s length principle was due to commercial reasons within the group, related to the role that the parent company plays in supporting the other group companies. The Revenue Agency itself, already in Circular No. 42/IIDD/1981, had specified that the appropriateness of a transfer pricing method must be assessed on a case-by-case basis. “9.6. That being stated, this Court has clarified that, the examination by the court of merit must be directed along two lines: first, it must verify whether or not the office has provided the proof, which is due to it, that the Italian parent company has carried out a financing transaction in favour of the foreign subsidiary, as a legitimate prerequisite for the recovery of the taxation of the interest income on the loan, on the basis of the market rate observable in relation to loans ...

SAS Blue Solutions manufactures electric batteries and accumulators for electric and hybrid vehicles and car-sharing systems. In FY 2012-2014 it granted a related party – Blue Solutions Canada – non-interest-bearing current account advances of EUR 42.9 million, EUR 43 million, and EUR 39 million. The French tax authorities considered that the failure to charge the interest on these advances was an indirect transfer of profit subject to withholding taxes and reintegrated the interest into the taxable income of Blue Solutions in France. Not satisfied with the resulting assessment an appeal was filed where SAS Blue Solutions. The company argued that the loans was granted interest free due to industrial and technological dependence on its Canadian subsidiary and that the distribution of profits was not hidden. Finally it argued that the treatment of the transactions in question was contrary to the freedom of movement of capital guaranteed by Article 63 of the Treaty on the Functioning of the European Union. Judgement of the Court The court dismissed the appeal of SAS Blue Solutions and upheld the assessment issued by tax authorities. Excerpts: “7. The applicant company maintains that it was in a situation of industrial and technological dependence on its Canadian subsidiary, its sole supplier of LMP (lithium metal polymer) batteries, without which it would not have been able to meet its own contractual commitments to its main customers. However, it has not been established, as the Minister maintains, that Blue Solutions was unable to obtain supplies from other companies and that its Canadian subsidiary held patents relating to the type of batteries marketed. Nor is it established that the Canadian company was not in a position to remunerate the advances granted, although it is not disputed that it paid interest in return for the advances granted by its former shareholder, SA Bolloré, before the tax years in dispute, a period during which its situation was even less favourable, and that it is clear from the opinion of the National Commission on Direct Taxes and Turnover Taxes that its turnover had been growing since 2011. Furthermore, SAS Blue Solutions was in a more fragile situation than its Canadian subsidiary, which was exacerbated by the waiver of interest on the advances granted to its subsidiary. Under these conditions, it did not establish that the advantages it had granted were justified by obtaining the necessary consideration. The administration was therefore justified in reintegrating the interest that should have paid for these advances into Blue Solutions’ taxable income in France.” “8. Finally, even though the waiver of interest was expressly stipulated by the parties in the current account advance agreement, it does not follow from the investigation that this benefit was recorded by Blue Solution in the accounts in a manner that made it possible to identify the purpose of the expenditure and its beneficiary, nor that this recording in itself reveals the liberality in question. This advantage was therefore of a hidden nature within the meaning of c. of Article 111 of the General Tax Code. 9. Thus, the administration was able to consider that the absence of invoicing of this interest constituted an indirect transfer of profits abroad within the meaning of the aforementioned provisions of Article 57 of the General Tax Code and that the interest that should have been paid fell into the category of hidden remuneration and benefits within the meaning of c. of Article 111 of the General Tax Code, which were liable to be subject to the withholding tax referred to in 2 of Article 119 bis of the same code.” “13. However, in the present case, the remuneration and benefits are subject to withholding tax in accordance with Article 111(c) of the General Tax Code, corresponding to the interest that should have been paid by Blue Solutions Canada in respect of the advances granted by Blue Solutions. The income of the non-resident company thus taxed in France does not correspond to that of an investment made in that country by the taxpayer in the context of the exercise of the freedom of movement of capital. The applicant company cannot therefore usefully argue that the legislative provisions applied to it in its capacity as debtor of the withholding tax levied on the income deemed to have been distributed to its subsidiary are contrary to the aforementioned provisions of Article 63(1) of the Treaty on the Functioning of the European Union since they cannot be regarded, in this case, as being such as to dissuade non-residents from making investments in a Member State or to dissuade residents of that Member State from making such investments in other States.” Click here for English translation Click here for other translation ...

Fibusa SAS is a holding company with holdings in four Romanian companies whose purpose is to develop wind power stations in Romania. In 2011, 2012, In 2011, 2012, 2013 and 2014, Fibusa granted these companies interest-free loans for a period of less than one year, renewable for the same period, with the possibility of repaying these loans at any time, for a total amount of almost 26 million euros in 2011, more than 33 million euros in 2012 and more than 35.5 million euros in 2013 and 2014, which were financed mainly by loans taken out by it. 2,086,730 for the year ended 2013 and €2,385,774 for the year ended 2014. Following an audit, an assessment of additional corporate income tax and corresponding penalties for the financial years 2011 – 2014 was issued by the tax authorities. The lack of interest on the loans was considered indirect transfers of profits abroad. Not satisfied with the assessment Fibusa filed an complaint which was rejected by the Administrative Court in December 2020. An appeal was then filed by Fibusa with the Administrative Court of Appeal. Judgement of the Court The court upheld the assessment but made adjustments to the applicable interest rate on the loans and thus the amounts of additional taxable income calculated by the tax authorities. Excerpts (Unofficial English translation) “8. Under the terms of Article 57 of the General Tax Code, which is applicable to corporation tax by virtue of Article 209 of the same Code: “For the purposes of calculating the income tax due by companies that are dependent on or control companies located outside France, profits indirectly transferred to the latter, either by way of an increase or decrease in purchase or sale prices, or by any other means, are incorporated into the results shown in the accounts (…)”. 9. These provisions establish, as soon as the administration establishes the existence of a link of dependence and a practice falling within the provisions of Article 57 of the General Tax Code, a presumption of indirect transfer of profits which can only be usefully challenged by the company liable to tax in France if it provides proof that the advantages it granted were justified by the obtaining of consideration.” “11. As the court held, in view of the relationship of dependence between the applicant company and its subsidiaries and its waiver of the right to receive interest in return for the advances granted, the presumption of indirect transfer of profits established by the provisions of Article 57 of the General Tax Code can be rebutted by Fibusa only if it proves that the advantages thus granted were justified by the obtaining of consideration.” “Although the applicant company refers to the situation of financial difficulty in which these companies found themselves, there is no evidence in the investigation to confirm the reality of these difficulties before 2014, the year in which the companies were admitted to insolvency proceedings under Romanian law. Furthermore, the accounting information produced by the applicant company, while showing investments made by those subsidiaries, also shows that they did not achieve any turnover and the information provided by the Romanian authorities indicates that the investments made are, for the most part, not related to wind farm projects and that the companies do not have any of the administrative authorisations required for such installations. In those circumstances, in the absence of any evidence to corroborate the reality of the activity of the beneficiary companies or of financial difficulties as from 2011, the applicant company, which invoked at first instance the financial difficulties of the subsidiaries and invokes on appeal the prospects of dividends which it expected to receive by granting the loans granted, does not justify any consideration for those interest-free loans. Thus, the administration was right to consider that the advantages granted by the applicant company to its subsidiaries constituted indirect transfers of profits.” “14. With regard to the sums borrowed by Fibusa to finance the advances granted to its subsidiaries, i.e. EUR 21 004 750 in 2011, EUR 26 309 187 in 2012, EUR 24 047 500 in 2013 and EUR 27 257 711 in 2014, it follows from what has been said above that it is appropriate to retain 1,188,828 in 2011, EUR 2,036,937 in 2012, EUR 2,418,713 in 2013 and EUR 1,594,425 in 2014, corresponding to the interest actually borne by Fibusa during each financial year in respect of the loans it took out. 15. With regard to the sums made available to Fibusa’s subsidiaries but not borrowed by it, namely EUR 4 981 250 in 2011, EUR 6 813 313 in 2012, EUR 11 487 500 in 2013 and EUR 8 332 789 in 2014, the applicant company relied at first instance on the rates of 4.25%, 3.75%, 3% and 2.4%, corresponding to the average interest rates for advances on securities applied by the Banque de France. It is not contested by the administration and there is nothing in the investigation to show that the rates of remuneration that the company could have obtained from a financial institution or similar body with which it would have placed sums of an equivalent amount under similar conditions would have been higher. In these circumstances, these rates should be retained and the company should be relieved of the amount of the taxes in dispute corresponding to the difference between the taxes to which it was subject and those resulting from the application of these rates to the sums of EUR 4,981,250 in 2011, EUR 6,813,313 in 2012, EUR 11,487,500 in 2013 and EUR 8,332,789 in 2014.” Click here for English translation Click here for other translation ...

Sapio Industrie Srl had granted an interest-free loan to its German subsidiary, which was in financial difficulties. The tax authorities issued an assessment in which an arm’s length interest rate was determined and added to Sapio Industrie’s taxable income on the basis of the Italian arm’s length principle. Sapio Industrie appealed and both the District Court and later the Regional Court (CTR) ruled in favour of the company and annulled the assessment. The tax authorities then appealed to the Supreme Court. Judgement of the Supreme Court The Supreme Court ruled in favour of the tax authorities, overturning the contested judgment of the Regional Court (CTR) and referring the case back to the Regional Court, in a different composition. Excerpts “(…)the ‘rationale’ of the legislation in question is to be found in the arm’s length principle set out in paragraph 1 of Art. 9 of the OECD Model Tax Convention, where it is provided that “(Where) the two (associated) enterprises, in their commercial or financial relations, are bound by conditions accepted or imposed other than those which would be agreed upon between independent companies, profits which, but for those conditions, would have been made by one of the enterprises, but which, by reason of those conditions, have not been made, may be included in the profits of that enterprise and taxed accordingly”; the tax authorities may therefore review the appropriateness – in line with the normal market value – of the transactions put in place potentially generating income components, regardless of the negotiating autonomy of the parties and of the contractual agreements established by the economic entities concerned; the possible unsuccessfulness of the financing agreed upon by the parties does not, per se, exclude the application of the provisions on the correct determination of intercompany transfer prices; In essence, in attempting to adjust profits by reference to the conditions that would have occurred between independent companies in comparable transactions and in comparable circumstances (i.e. in ‘comparable transactions between independent parties’), the arm’s length principle adopts an approach of treating the entities of a multinational group as operating as separate entities and not as indissociable subsets of a single group. Since, under the separate entity approach, the entities of a multinational group are treated as independent entities, the focus is on the nature of the transactions entered into between these entities and on whether the terms of these transactions differ from the terms that would have occurred in comparable transactions between independent parties” (thus “OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations”, paragraph B.l, n 1.6); Click here for English translation Click here for other translation ...

Cases may arise where one enterprise within a group, usually the parent company, makes a loan to another in order to help in overcoming financial difficulties and where from the start the lender waives, or defers, interest. Similarly, a parent company may agree to waive or defer interest on an outstanding loan in cases where a subsidiary has fallen into financial difficulties. If, in such circumstances, an unrelated lender would have been-led to act in -the same manner and such cases can arise – it could be generally accepted that interest on loans made in similar circumstances between associated enterprises could be waived or deferred ...

During its start-up years, an enterprise will frequently be in need of financial support, for example, from a parent company. Nevertheless, applying the arm’s length principle, most countries would not accept that an intra-group loan could be interest-free simply because the enterprise was in its start-up phase. It was concluded that, for tax purposes, interest should always be regarded as charged (even though eventually deferred) unless an unrelated lender would have waived the payment of the interest in the same circumstances ...