12 December 2024, the German Federal Ministry of Finance published updated administrative principles on transfer pricing 2024 (VWG VP 2024). The updates mainly concern the chapter on financial transactions, where paragraphs 3d and 3e have recently been added to the AStG. Paragraph 3d concerns the determination of arm’s length interest rates, group or stand-alone rating and whether capital should be treated as a loan or equity, and paragraph 3e concerns the treatment of financing arrangements, i.e. cash pools, hedging, etc. New guidance is also provided on the application of OECD Pillar 1 – Amount B. Click here for an unofficial English Translation ...

14 August 2024, the Federal Ministry of Finance sent revised administrative principles for transfer prices 2023 dated 6 June 2023 regarding the topic of intra-group financing, which, among other things, takes into account new paragraphs 3d and 3e in the German TP provisions. An opportunity to comment on the draft will be available until 6 September 2024. Paragraphs 3d and 3e were recently added to the German Foreign Tax Act (AStG). Paragraph 3d concerns the determination of arm’s length interest rates, group or stand-alone rating and whether capital should be treated as a loan or equity and paragraph 3e concerns the treatment of financing arrangements, i.e. cash pools, hedging, etc. Click here for an unofficial English Translation ...

ING Bank SPA received interest on a loan granted to a Dutch group company, Ing Lease Interfinance B.V.. The tax authorities considered that the interest rate on the loan was significantly lower than an arm’s length interest rate and issued a notice of assessment, changing the interest rate from 3.90% to 6.81%, resulting in additional taxable income. ING Bank disagreed with the assessment and appealed to the Provincial Tax Commission and later to the Regional Tax Commission, which ruled in favour of the tax authorities. ING Bank then appealed to the Supreme Court. Judgement of the Court The Supreme Court referred the case back to the Regional Tax Commission for a more detailed explanation of why the tax authorities’ arguments for an upward adjustment of the interest rate were considered decisive for the decision issued. “6.7. In the present case, both parties pointed to evidence supporting the correctness of the loan interest rate as stated by them. Neither party has rigorously proved what the normal interest rate would have been in the free market between independent operators. 6.7.1. The CTR, however, did not clarify why the arguments put forward by the tax administration to estimate the correct interest rate should be considered decisive, while the additional ones acquired at the trial (rate recorded by the Bank of Italy, coeval intra-group financing rate, etc.) should be considered without any doubt recessive. 6.8. The reasoning proposed by the CTR therefore appears to be so incomplete and lacking in several passages as to be merely apparent. The second and third grounds of appeal are therefore well founded and must be allowed.” Click here for English translation Click here for other translation ...

Hargreaves Property Holdings Ltd paid interest on certain loans between 2010 and 2015. HMRC formed the view that Hargreaves should have deducted and accounted for withholding tax on the interest. Hargreaves disagreed and appealed to the First-tier Tribunal on four grounds. All four grounds were rejected ([2021] UKFTT 390 (TC). Hargreaves then appealed on similar grounds to the Upper Tribunal. Hargreaves’ appeal was dismissed ([2023] UKUT 120 (TCC)). An appeal was filed with the Court of Appeal where two of the four grounds were pursued: whether interest payments made from 2012 onwards to a UK tax resident company, Houmet Trading Limited (“Houmet”), fell within the exception from withholding tax in s.933 Income Tax Act 2007 (“ITA 2007”); and whether interest paid on loans the duration of which was less than a year, but which were routinely replaced by further loans from the same lenders, was “yearly interest” within s.874 ITA 2007. Judgment The Court of Appeal dismissed the appeal and upheld the decision of the Upper Tribunal. Excerpts “(…) 81. In conclusion on ground 1, I would dismiss Hargreaves’ appeal. The FTT and UT correctly concluded that Houmet was not beneficially entitled to the interest assigned to it. (…) 86. In this case the FTT found that the loans fulfilled an important commercial need for the business, and (being raised from connected parties) both left the borrower’s assets free from security and could be raised quickly and at minimal cost (para. 78 of the FTT’s decision). They were also repayable on demand (para. 79). However, there was a pattern under which loans were routinely replaced by a further loan from the same lender in the same or a larger amount. The FTT found that the enquiries made of lenders as to whether they wished to carry on lending were formalities, and a new loan was never declined (para. 87). 87. In my view the FTT and UT applied the correct legal approach. The FTT made no legal error in concluding that the interest was yearly interest because the loans were in the nature of long-term funding, were regarded by the lenders as an investment and formed part of the capital of the business, with a permanency that belied their apparent shortterm nature (paras. 79, 81 and 82). It makes no difference to this whether an individual loan happened to last for less than a year. On a business-like assessment, those loans could not be viewed in isolation as short-term advances. In reality, as the FTT concluded at para. 86, the lenders provided attractive long-term funding in the nature of an investment. 88. In conclusion, I would dismiss Hargreaves’ appeal on both grounds. Houmet was not “beneficially entitled” to the interest assigned to it for the purposes of s.933 ITA 2007, and the interest on the loans was yearly interest even if the loan in question had a duration of less than a year.” EWCA Civ 365″] ...

SAP AG (now SAP SE) is a German multinational software corporation that develops enterprise software to manage business operations and customer relations. The company is especially known for its ERP software. SAP France, a 98% subsidiary of SA SAP France Holding, itself wholly owned by the German group, had deposited funds under a Cash Management Agreement as sight deposits carrying an interest of 0%. Following an audit for the financial years 2012 and 2013, two assessment proposals were issued in December 2015 and November 2016, relating in particular to the 0% interest rate charged on the cash deposits. The tax authorities had added interest to SA SAP France’s taxable income calculated by reference to the rate of remuneration on sight deposits. SAP France contested the adjustments and furthermore requested the benefit of the reduced rate of corporation tax on income from industrial property, pursuant to Article 39 of the French General Tax Code, with regard to the royalties from the licensing agreements relating to Business Object products and Cartesis solutions. In regards to added interest on the deposited funds under a Cash Management Agreement the Court of Appeal decided in favor of the tax authorities. An appeal was then filed by SAP France with the Supreme Court, which by decision no. 461642 of 20 September 2022 set aside the decision and referred the case back to the Court of Appeal. Judgment The Court of Appeal ruled in favour of the tax authorities. Excerpts – English translation. “4. The investigation has shown that SA SAP France has made its surplus cash available to the German company SAP SE, which indirectly holds it as described above, in very large amounts ranging from €132 million to €432 million, under a cash management agreement entered into on 17 December 2009. Under the terms of the agreement, these sums were remunerated on the basis of an interest rate equal to the Euro OverNight Index Average (EONIA) interbank reference rate less 0.15 points. The French tax authorities do not dispute the normal nature of the agreement when it was entered into in 2009, or the rate that was thus defined between the parties. During 2012 and 2013, despite the application of this formula, which resulted in negative remuneration due to changes in the EONIA, the parties agreed to set the rate at 0%. As a result, there was no remuneration at all on the sums made available to the cash centre by SAP France from August 2012. The tax authorities compared this lack of remuneration to the remuneration that SA SAP France could have received by investing its money in financial institutions, based on the average rate of remuneration on sight deposits over the period. It then considered that the difference between the two sums constituted a transfer of profits within the meaning of the aforementioned provisions. Contrary to what the company maintains, such an absence of remuneration makes it possible to establish a presumption of transfer of profits for the transactions in question. 5. The company argues that the investment of the funds with SAP SE is particularly secure and that it enables its subsidiary to obtain immediate and unconditional financing from the central treasury. However, it does not deny, as the French tax authorities point out, that its subsidiary’s software marketing business generates structural cash surpluses and that the subsidiary has never had recourse to financing from the central treasury since its inception. Nor does it report any difficulty in investing surplus cash in secure financial products. In addition, it appears from the investigation that the cash flow agreement does not provide for a defined term and stipulates, in paragraph 2 of section IX, that, subject to compliance with a one-month time limit, the parties may terminate the agreement, without condition or penalty. Section XII of the same agreement also states that it has no effect on the independence of each of its co-contractors or on their autonomy of management and administration. SA SAP France therefore had no contractual obligation to remain in the central cash pool beyond a period of one month. Furthermore, the company does not dispute that the rate of interest on advances, which results from the terms of the agreement, is not fixed, even if the aforementioned 2009 agreement does not contain a review clause, and that the parties may agree on a different rate, as they did in 2012. In addition, by simply arguing that the comparable rate used by the authorities is not relevant, when sight deposits, contrary to what it claims, do not exclude any immediate withdrawal of funds, the company, which does not offer any other comparable rate, does not seriously criticise the rates used by the authorities, between 0.15% and 0.18% over the period, which correspond to the remuneration that SA SAP France could have obtained from a financial institution and which, contrary to what it claims, are not negligible, given the amounts of cash surpluses made available. Lastly, although the company argues that the rates used by the authorities could, in any event, only be reduced by 0.15%, which corresponds to the margin of the central treasury that was applied in the 2009 agreement, this discount cannot be accepted since the comparables used by the authorities necessarily include the margin of the financial institutions. The fact that this rate has never been questioned by the authorities since the agreement was signed in 2009 has no bearing on the present analysis, which relates to different years in dispute. In these circumstances, and while SA SAP France persisted in investing its cash, without remuneration, with an affiliated company, the applicant company did not establish that the advantages it granted to the German company SAP SE were justified by the obtaining of quid pro quos favourable to its business or, at the very least, by quid pro quos at least equivalent to the revenue forgone granted. It follows that the tax authorities were right to reinstate in the results of SA SAP France the advantage granted to ...

On 27 March 2024, new paragraphs (3d) and (3e) were added to the German Foreign Tax Act (Außensteuergesetz – AStG) regarding intragroup financing. Paragraph (3d) concerns the determination of arm’s length interest rates, group vs. stand-alone rating and whether capital is treated as a loan or equity. Paragraph (3e) concerns the treatment of financing arrangements, i.e. cash pools, hedging, etc ...

Mylan Australia Holding is a subsidiary of the multinational pharmaceutical company Mylan Group. Mylan Australia Holding is the head of the Australian tax consolidated group, which includes its subsidiary Mylan Australia Pty. In 2007, Mylan Australia Pty acquired the shares of Alphapharm Pty Ltd and a substantial loan (A$923,205,336) was provided by a group company in Luxembourg to finance the acquisition. In subsequent years the interest expense was deducted from the taxable income of Mylan’s Australian tax group. The Australian Taxation Office (ATO) issued amended assessments to Mylan Australia Holding disallowing approximately AUD 589 million of interest deductions claimed for the 2007 to 2017 tax years. The ATO had initially pursued the structure as a transfer pricing issue, but ultimately argued that the deductions should be disallowed under the general anti-avoidance rule. Mylan Australia Holding appealed to the Federal Court. Judgment of the Court The Federal Court decided in favour of Mylan Australia Holding and set aside the amended assessment issued by the tax office. Excerpts “The conclusions I have reached on the principal issues are as follows: (a) MAHPL did not obtain a tax benefit in connection with the primary scheme that may be calculated by reference to the primary counterfactual; (b) had none of the schemes been entered into or carried out, the most reliable — and a sufficiently reliable — prediction of what would have occurred is what I have termed the “preferred counterfactual”; (c) the principal integers of the preferred counterfactual are as follows: (i) MAPL would have borrowed the equivalent of AUD 785,329,802.60 on 7 year terms under the SCA (specifically the term applying to Tranche B), at a floating rate consistent with the rates specified in the SCA; (ii) MAPL would otherwise have been equity funded to the extent necessary to fund the initial purchase of Alphapharm and to stay within the thin capitalisation safe harbour ratio from time to time; (iii) Mylan would have guaranteed MAPL’s borrowing under the SCA; (iv) Mylan would not have charged MAPL a guarantee fee; (v) interest on the borrowing would not have been capitalised; (vi) MAPL would have been required to pay down the principal on a schedule consistent with that specified in the SCA and would have made voluntary repayments to reduce its debt as necessary to stay within the thin capitalisation safe harbour, from time to time; (vii) MAPL would not have taken out hedges to fix some or all of its interest rate expense; (viii) MAPL would have taken out cross-currency swaps into AUD at an annual cost of 3.81% per annum over AUD 3 month BBSW; and (ix) if MAPL’s cashflow was insufficient to meet its interest or principal repayment obligations, Mylan would have had another group company loan MAPL the funds necessary to avoid it defaulting on its obligations, resulting in MAPL owing those funds to that related company lender by way of an intercompany loan, accruing interest at an arm’s length rate; (d) MAHPL did (subject to matters of calculation) obtain a tax benefit in connection with the schemes, being the difference between the deductions for interest obtained in fact, and the deductions for interest that would be expected to be allowed on the preferred counterfactual; and (e) MAHPL has discharged its onus in relation to the dominant purpose enquiry specified by s 177D of the ITAA36 and so has established that the assessments issued to it were excessive.” “Conclusions on dominant purpose I do not consider that, having regard to the eight matters in s 177D(b), it would be concluded that Mylan or any other of the persons who entered into or caried out the schemes or any part of the schemes did so for the purpose of enabling MAHPL to obtain a tax benefit in connection with the schemes. Of the numerous topics addressed above in relation to those eight matters, only one supports a contrary conclusion: the failure to refinance PN A2 or otherwise revisit the interest rate paid on PN A2. Nevertheless, the authorities recognise that not all matters need to point in one direction, whether the conclusion is that that there was the requisite dominant purpose, or the converse: see, eg, Sleight at [67] (Hill J). Other matters addressed are neutral, or point to purposes other than obtaining a tax benefit in connection with the schemes. It must be recalled that merely obtaining a tax benefit does not satisfy s 177D: Guardian at [207] (Hespe J, Perry and Derrington JJ agreeing). Nor does selecting, from alternative transaction forms, one that has a lower tax cost of itself necessarily take the case within s 177D. It is, as the plurality explained in Spotless Services (at 416), only where the purpose of enabling the obtaining of a tax benefit is the “ruling, prevailing, or most influential purpose” that the requisite conclusion will be reached. In my assessment, MAHPL has established that, assessed objectively (and keeping in mind that the question is not what Mylan’s actual, subjective purpose was), the facts of this case do not attract that conclusion.” Click here for translation ...

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 ...

A domestic general partnership (OHG) was the sole shareholder of an Italian corporation (A). OHG had unsecured interest bearing claims against A. During the years of the dispute, the partnership waived part of its claims against A in return for a debtor warrant. Following an audit an adjustment to the taxable income of OHG was issued by the tax authorities. The assessment was later set aside by the administrative court but on appeal by the tax authorities the BFH in 2019 upheld the assessment. A constitutional complaint was lodged against this ruling. Judgment of the Federal Constitutional Court The Court upheld the complaint and overturned the BFH judgment and referred the case back to the BFH. Click here for English translation Click here for other translation ...

The taxpayer paid interest on five loans concluded with its Dutch subsidiary (“BV2”) on 31 December 2017, claiming exemption from withholding tax on the basis of the double taxation treaty between Belgium and the Netherlands (Article 11, §3, (a)). The dispute concerns whether the Dutch subsidiary “BV2” can be considered the beneficial owner of these interests. The concept of “beneficial owner” is not defined in the Belgium-Netherlands double tax treaty. However, this concept is also used in the European Directive on interest and royalties. In the Court’s view, this concept must be interpreted in the same way for the application of the Belgian-Dutch double taxation treaty. Indeed, as members of the EU, Belgium and the Netherlands are also obliged to ensure compliance with EU law. The Court noted that, of the five loans on which the taxpayer paid interest to its subsidiary “BV2”, four loans were linked to four other loans granted by a Dutch company higher up in the group’s organisation chart and having the legal form of a “CV” (now an LLC), to the taxpayer’s Dutch parent company, “BV1”. The fifth loan on which the taxpayer pays interest to its subsidiary “BV2” is clearly linked to a fifth loan granted by the same “CV” (now LLC) to the said subsidiary “BV2”. The taxpayer’s subsidiary “BV2” and its parent company “BV1” together form a tax unit in the Netherlands. At the level of the tax unit, a ruling (“APA-vaststellingsovereenkomst”) has been obtained in the Netherlands, stipulating a limited remuneration for the financing activities that this tax unit carries out for the companies in the group. The “transfer pricing report” attached to the ruling request indicates that a Dutch CV is the lender and that the taxpayer is the final borrower in respect of the loans in question. The “APA-vaststellingsovereenkomst” also clearly shows the link between these various loans. The loans granted by the CV are then transferred to a new Delaware LLC. The mere fact that a tax unit exists between the taxpayer’s subsidiary “BV2” and the parent company “BV1” does not imply ipso facto that the subsidiary “BV2” is a conduit company and therefore does not, in principle, prevent it from being considered a “beneficial owner”. However, a tax unit may be part of an arrangement designed to avoid or evade tax in certain transactions. The tax unity between the subsidiary “BV2” and the parent company “BV1” of the taxpayer has the effect that the interest obtained by the subsidiary “BV2” is offset by the interest paid to the LLC, so that there is virtually no tax to pay on this interest. Furthermore, the taxpayer would not have been able to claim any exemption if he had paid the interest directly to the LLC and if the interposition of the Dutch companies had not been used. In addition to the aforementioned links between the various loans, the Court emphasised the fact that the claims against the taxpayer and the underlying debts were initially held by a single company, that they were then divided between the taxpayer’s Dutch subsidiary “BV2” (claims) and the parent company “BV1” (debts), and then, following a merger between this subsidiary and the parent company, were reunited within the same company (BV 1). According to the court, this also reveals the interlocking nature of these loans, as well as the artificial nature of the construction. It is at least implicit from the above facts that the Dutch subsidiary “BV2” and the parent company “BV1” act only as formal intermediaries and that the final lender is the LLC, which took over the loans from the CV. For the fifth loan, which was financed by the Dutch subsidiary “BV2” directly with the CV (now LCC), it appears that the Dutch company “BV2” has an obligation to pay interest to the CV (now LLC). For the other four loans, significant evidence of actual interest flows was found in the financial statements of the companies concerned. According to the court, the taxpayer had not met his burden of proving that he was the beneficial owner of the interest. The exemption from withholding tax was rightly rejected by the tax authorities on this basis. In addition, the withholding tax must be added to the amount of income for the calculation of the withholding tax (grossing up). Click here for English Translation Click here for other translation ...

Following an audit of Otis Servizi s.r.l. for FY 2007, 2008 and 2009 an assessment of additional taxable income was issued by the Italian tax authorities. The first part of the assessment related to interest received by OTIS in relation to the contract called “Cash management service for Group Treasury” (hereinafter “Cash Pooling Contract”) signed on 20 March 2001 between OTIS and the company United Technologies Intercompany Lending Ireland Limited (hereinafter “UTILI”) based in Ireland (hereinafter “Cash Pooling Relief”). In particular, the tax authorities reclassified the Cash Pooling Agreement as a financing contract and recalculated the rate of the interest income received by OTIS to be between 5.1 and 6.5 per cent (instead of the rate applied by the Company, which ranged between 3.5 and 4.8 per cent); The second part of the assessment related to of the royalty paid by OTIS to the American company Otis Elevator Company in relation to the “Licence Agreement relating to trademarks and company names” and the “Agreement for technical assistance and licence to use technical data, know-how and patents” signed on 1 January 2004 (hereinafter referred to as the “Royalty Relief”). In particular, the tax authorities had deemed the royalty agreed upon in the aforesaid contracts equal to 3.5% of the turnover as not congruous, recalculating it at 2% and disallowing its deductibility to the extent of the difference between the aforesaid rates. Not satisfied with the assessment an appeal was filed by OTIS. The Regional Tax Commission upheld the assessments and an appeal was then filed with the Supreme Court. Judgement of the Supreme Court The Court decided in favour of OTIS, set aside the assessment and refered the case back to the Regional Tax Commission in a different composition. Excerpt related to interest received by OTIS under the cash pooling contract “In the present case, the Agenzia delle Entrate redetermined the rate of the interest income received by the OTIS in relation to the contract between the same and UTILI (cash pooling contract) concerning the establishment of a current account relationship for the unitary management of the group treasury. UTILI, as pooler or group treasurer, had entered into a bank account agreement with a credit institution in its own name, but on behalf of the group companies. At the same time, OTIS had mandated that bank to carry out the various tasks in order to fully implement the cash pooling agreement. Under this contract, all participating companies undertook to transfer their bank account balances (assets or liabilities) daily to the pooling company, crediting or debiting these balances to the pool account. As a result of this transfer, the individual current account balances of each participating company are zeroed out (‘zero balance cash pooling’). Notwithstanding the fact that the tax authorities do not dispute that this is a case relating to “zero balance cash pooling” (a circumstance that is, moreover, confirmed by the documents attached to the appeal), it should be noted that the same practice documentation of the Revenue Agency leads to the exclusion that, in the hypothesis in question, the cause of the transaction can be assimilated to a loan. In particular, in Circular 21/E of 3 June 2015, it is stated (p. 32) that “with reference to the sums moved within the group on the basis of cash pooling contracts in the form of the so-called zero balance system, it is considered that a financing transaction cannot be configured, pursuant to Article 10 of the ACE Decree. This is because the characteristics of the contract – which provides for the daily zeroing of the asset and liability balances of the group companies and their automatic transfer to the centralised account of the parent company, with no obligation to repay the sums thus transferred and with accrual of interest income or expense exclusively on that account – do not allow the actual possibility of disposing of the sums in question in order to carry out potentially elusive transactions’. These conclusions are confirmed in the answer to Interpretation No. 396 of 29 July 2022 (p. 5) where it is specified that ‘cash pooling contracts in the form of the so-called zero balance stipulated between group companies are characterised by reciprocal credits and debits of sums of money that originate from the daily transfer of the bank balance of the subsidiary/subsidiary to the parent company. As a result of this contract, the balance of the bank account held by the subsidiary/subsidiary will always be zero, since it is always transferred to the parent company. The absence of the obligation to repay the remittances receivable, the reciprocity of those remittances and the fact that the balance of the current account is uncollectible and unavailable until the account is closed combine to qualify the negotiated agreement as having characteristics that are not attributable to a loan of money in the relationship between the companies of the group’. That being so, the reasoning of the judgment under appeal falls below the constitutional minimum in so far as the CTR qualified the cash pooling relationship as a loan on the basis of the mere assertion that “the obligation to repay each other by the closing date of the account is not found in the case”. In so doing, the Regional Commission identified a generic financing contract function in the cash pooling without distinguishing between “notional cash pooling” and “zero balance cash pooling”, instead excluding, on the basis of the same documentation of practice of the Tax Administration, that in the second case (“zero balance”), a loan contract can be configured. The reasoning of the contested decision does not therefore make the basis of the decision discernible, because it contains arguments objectively incapable of making known the reasoning followed by the judge in forming his own conviction, since it cannot be left to the interpreter to supplement it with the most varied, hypothetical conjectures” (Sez. U. no. 22232 of 2016), the trial judge having failed to indicate in a congruous manner the elements from which he drew ...

“Lux Credit B.V.” took out various credit facilities from related parties [company name 2] s.a.r.l. and [company name 3] s.a.r.l. – both resident in Luxembourg. These were financings whereby “Lux Credit facility B.V.” could draw funds (facilities) up to a pre-agreed maximum amount. In doing so, “Lux Credit B.V.” owed both interest and “commitment fees”. The commitment fees were calculated on the maximum amount of the facility. Interest and commitment fees were owed. The interest payable to [company name 2] and [company name 3], respectively, was calculated by deducting the commitment fees from the interest payable on the amount withdrawn, with interest payable on the amount withdrawn, the commitment fees owed after the due date and the interest owed after the due date. In its returns for the current financial years, “Lux Credit B.V.” charged both interest and commitment fees against taxable profit. Following an audit, an assessment of additional taxable income was issued for the financial years 2012/2013 – 2016/2017. According to the tax authorities, the financial arrangement was not at arm’s length. The interest rate and commitment fees were adjusted and part of the loans were classified as equity. A complaint was filed by “Lux Credit B.V.” Judgement of the District Court The Court found mainly in favour of Credit Facility B.V.. It upheld most of the adjustments relating to commitment fees, but overturned the adjustment to the interest rate. According to the Court, Lux Credit B.V. was entitled to an interest deduction for the years under review, calculated at the contractually agreed interest rate on the amounts actually borrowed. Excerpts “51. With regard to the transfer pricing documentation, the court considers the following. Although the documentation referred to in Section 8b(3) of the 1969 Vpb Act was not available at the time the defendant requested it, the claimant has remedied this defect by again preparing records to substantiate the conditions surrounding the facilities. In the court’s opinion, the defendant did not make it plausible with what it argued that the claimant’s administration contains such defects and shortcomings that it cannot serve as a basis for the profit calculation that must lead to the conclusion that the claimant did not file the required return.10 The court also took into account that the parliamentary history of Section 8b of the 1969 Vpb Act noted that the documentation requirement of Section 8b(3) of the 1969 Vpb Act relates to the availability of information necessary to assess whether the prices and conditions(transfer prices) used in affiliated relationships qualify as arm’s length. 11 In the court’s opinion, the defendant has not argued sufficiently to conclude that the transfer-pricing data further collected, prepared and documented by the claimant and the documents that were present at [company name 2] and [company name 3] on the determination of the credit ratings are so deficient that the claimant has not complied with the obligations of Section 8b(3) of the 1969 Income Tax Act. The fact that source documents for the period, in which the transactions were entered into, have not been preserved and the defendant has comments on the data used by the claimant and disagrees with the outcomes of the claimant, do not alter this.” “56. In the court’s view, the defendant was right to make the adjustments in respect of commitment fees on facilities 1 and 3 for the years under review. The defendant was also correct in imposing the 2014/2015, 2015/2016 and 2016/2017 assessments to correct the commitment fees on Facility 7bn. In assessing whether the defendant was justified in making those corrections, the court relied on what [company name 1] and [company name 2] and [company name 3] agreed on civilly. The agreements between [company name 1] and [company name 2] and [company name 3] explicitly distinguish between interest due and commitment fees due. The court therefore rejects the plaintiff’s position that it must be assessed whether the total of the commitment fee and interest costs remained within the margins of Section 8b of the 1969 Vpb Act, and the commitment fee and interest costs should be considered together as an “all-in rate”. That the terms of Facilities 1, 3 and 7bn show similarities with Payment in Kind loans, as claimed by the claimant, does not make it necessary in this case to deviate from what the parties agreed under civil law. Indeed, the defendant has argued, with reasons, that stipulating headroom for the purpose of funding interest that may be credited, if the same facts and circumstances are present, is not usual in the market but it is usual in the market that over interest to be credited, a charge arises only at the time of the maturity of the interest. It is not usual that a charge – in this case in the form of commitment fees – is already due before the due date. This involves a double burden, as interest is also charged on the commitment fee. On the other hand, the plaintiff has not made it plausible that independent third-party parties were willing to agree such terms in similar circumstances, nor has it made its economic reality plausible. The court also took into account that the claimant did not make any calculations, prior to setting the maximum amount and commitment fees. 57. In the court’s view, the defendant was right to make the adjustments in respect of the commitment fees and interest payable thereon in respect of Facility 5. The defendant has made it plausible that such an agreement between independent third parties will not be concluded. The defendant was right to point out the following aspects:” “In the court’s opinion, with what the defendant has put forward and also in view of what the claimant has put forward in response, the defendant has failed to make it plausible that the interest rates agreed by [company name 1] , [company name 2] and [company name 3] regarding facilities 1, 3 and 7bn are not in line with what would have been agreed by independent parties in the ...

R.B. NV had entered into a loan agreement with a group company in Switzerland. The interest rate on the loan had been determined by applying the method used by the credit agency, Standard & Poor’s. Moreover, it had been concluded that R.B. NV was a “moderately strategic entity”, and a one-notch correction was applied to the “stand-alone credit rating”. Following an audit, the tax administration concluded that the company had not applied the S&P method consistently and that the company’s credit rating should have been the same as that of the group as the company was a “core entity” in the group. On that basis, the interest rate were reduced. Judgement of the Court The court ruled predominantly in favour of the tax authorities. The court found several unjustified deviations in the way R.B. NV had applied the S&P method and on that basis several adjustments were made by the court. According to the court, R.B. NV was not a “core entity” in the group whose credit rating should be the same as that of the group (as held by the tax authorities), but rather a “highly strategic entity” whose credit rating should be one notch lower than that of the group. Click here for English Translation Click here for other translation ...

After the case was remanded by the Supreme Court in 2022, the Court of Appeal classified a Luxembourg company’s shareholder loan to “X Shareholder Loan B.V.” of €57,237,500 as an ‘imprudent loan’, with the result that the interest due on that loan was only tax deductible to a limited extent. The remaining interest was non-deductible because of fraus legis (evasion of the law). Allowing the interest due on the shareholder loan to be deductible would result in an evasion of tax, contrary to the purpose and purport of the 1969 Corporation Tax Act as a whole. The purpose and purport of this Act oppose the avoidance of the levying of corporate income tax, by bringing together, on the one hand, the profits of a company and, on the other hand, artificially created interest charges (profit drainage), in an arbitrary and continuous manner by employing – for the achievement of in itself considered business objectives – legal acts which are not necessary for the achievement of those objectives and which can only be traced back to the overriding motive of bringing about the intended tax consequence (cf. HR 16 July 2021, ECLI:NL:HR:2021:1152). Click here for English translation Click here for other translation ...

On 17 April 2015, “Loan Ltd” entered into a bond loan agreement with related parties. The effective interest rate charged to “Loan Ltd” (borrowing costs) in the years under consideration (2016 and 2017) was 8.1%. The interest rate had been determined based on the CUP method and external comparable data. The tax authorities determined the arm’s length interest rate for the loan to be 4,03% and issued an assessment of the additional taxable income resulting from the lower borrowing costs. A complaint was filed by “Loan Ltd” Decision of the Board The Board dismissed the complaint and upheld the assessment of the tax authorities. Excerpt “Because the applicant claims that the audit used inappropriate/non comparable data. Because, however, the audit chose the most reliable internal data in accordance with the OECD Guidelines, namely the interest rate agreed with a third independent bank for the provision of a credit facility (2.03%), which it adjusted by the percentage of the guarantee fee provided by the parent company (2%), resulting in an interest rate in accordance with the principle of equivalence equal to 4.03%. This adjustment is correct, in line with the OECD Guidelines and in the context of good administration. In particular, paragraph 10.177 of the OECD Guidelines states that: “The result of this analysis sets a maximum premium for the guarantee (the maximum amount the guarantee recipient will be willing to pay), i.e. the difference between the interest rate with the guarantee and the interest rate without the guarantee. […] The borrower would not have any incentive to enter into a guarantee agreement if, in total, he pays an amount (to the bank interest and to the guarantor commission) equal to what he would have paid to the bank without the guarantee (interest). Therefore, this maximum commission does not necessarily reflect the result of a negotiation made on a purely commercial basis, but represents the maximum that the borrower would be willing to pay’. The audit, in direct application of the OECD Guidelines, adjusted the lending rate by the maximum commission. Otherwise, the borrower would have paid an aggregate amount (interest to the bank and commission to the guarantor) higher than the amount he would have paid to the bank without the guarantee (interest). Because the audit, to corroborate the audit findings and its reasoning , also sought external comparable data (on an ancillary basis), namely, interest rates of comparable loans from the Bank of Greece and the Bank of Denmark. The Bank of Greece yielded an interest rate of 5.02% and from the Bank of Denmark 3.70% (3% plus 0.70% to reflect the country-Greece risk ). Because the above external comparables confirm the correctness of the audit approach, as they are close to the interest rate determined by the audit (4.03%) and at a significant deviation from the interest rate of the assessed intragroup transaction (8.1%). It should be noted that the reliance on central bank data is in line with a number of decisions of our Office (see, for example, BIT 4560/2021), but also a common methodology in numerous Documentation Files. As therefore, the claim of the applicant is rejected as unfounded.” Click here for English translation Click here for other translation ...

“Korean Clothing Corp” had two overseas subsidiaries – a fabric dyeing entity (AAA) and a sweater manufacturing entity (BBB). Following an tax audit for FY 2016~2020, the tax authorities issued an assessment of additional tax as a result of non arm’s length transactions. According to the tax authorities “Korean Clothing Corp” had not collected accounts receivables from related parties AAA and BBB, which had passed the typical payment terms. An arm’s length interest on the outstanding amount had therefor been calculated based on the weighted average interest rates in comparable transactions between independent parties. “Korean Clothing Corp” had also provided a financial guarantee to AAA related to a bank loan in 2014, which later resulted in “Korean Clothing Corp” paying back the loan to the bank in FY2018 and FY2019. “Korean Clothing Corp” accounted for the payment as a loss from the discontinued business in FY2018 and as a ‘miscellaneous loss’ in FY2019. The tax authorities found that “Korean Clothing Corp” arbitrarily had paid back the loan on behalf of AAA and that the amount in question was a non-deductible expense. A complaint was filed by “Korean Clothing Corp” with the Tax Tribunal. Decision of the Tax Tribunal The tribunal dismissed the complaint of “Korean Clothing Corp” and upheld the assessment issued by the tax authorities. The court found that the arm’s length interest rate applied by the tax authorities was reasonable and that denying the tax deductions for the payment of AAA’s loan was also in accordance with local tax regulations. Click here for English translation Click here for other translation ...

“A Corporation” had granted various loans, firstly to a French subsidiary and secondly to the Liechtenstein sister company, B Corporation. The latter essentially passed on these loans to its German subsidiary C GmbH. A Corporation and B Corporation are each wholly owned by Mr D, who is resident in Liechtenstein. B Corporation has a 94% shareholding in C GmbH and D has a 6% shareholding. The loans granted by A Corporation did not bear interest The tax authorities issued an assessment for FY 2013 – 2017 where interest income from these loans had been added to the taxable income of A Corporation in accordance with the safe harbour rates applicable in Liechtenstein. Furthermore, the tax authorities had not fully allowed the equity capital interest deduction claimed by A Corporation in its tax returns An appeal was filed by A Corporation with the Administrative Court. Judgement of the Court The Court dismissed the appeal against the decision and upheld the assessment of the tax authorities. Excerpts “…, it is irrelevant for what motives a loan was granted to a related party and whether there is a case of abuse. If the lender achieves other advantages through its granting of a loan than the achievement of an interest on the loan, this may be taken into account in the third-party comparison, but the complainant has not proven in the present case that a third party would have granted an interest-free loan in the amount of many millions of euros to B Corporation under the concrete circumstances or that a borrower independent of the complainant would not have been willing to pay an interest on the loan under the concrete circumstances. Due to the duty to cooperate (Art. 97 para. 1 SteG), the burden of proof in this regard lies with the taxpayer and not with the tax administration, because the taxpayer is closer to the facts to be proven than the tax administration.” “It is evident from these statements by the government that the legislator was aware of the connection between the arm’s length principle under Art. 49 SteG and the regulations on the equity capital interest deduction, including the provision of Art. 54 para. 3 sentence 1 SteG, and that it thus allowed for a twofold correction when granting loans to related parties, which is why – contrary to the complainant’s submission in its statement of 23 January 2023 – there is no need to speak of an “excessive correction”. The legislator also determined that both corrections are also permissible if no abuse must be assumed. At the same time, this means that the legislator has not left open the possibility of deviating from the provisions of Art. 49 and 54 SteG in individual cases.” “The legislator has a great deal of leeway, especially in tax law (decision-making prerogative of the legislator) (StGH 2010/70 E. 3.1; StGH 2010/82; VGH 2021/002 E. 3. and in addition CJEU 2021/052; CJEU 2021/094 E. 2.6, 3.4, 7). Insofar as the legislator intended to implement certain principles when creating the 2009 Tax Act, these principles are only legally significant to the extent that they were actually implemented in the Act (VGH 2021/002 E. 3.). In addition, the Tax Act by no means guarantees that every path chosen by a taxpayer to achieve a goal must lead to the same tax burden (VGH 2020/107 recital D; VGH 2021/085 E. 7). It is the decision of each taxpayer whether or not to make use of certain tax options (CST 2021/051 E. 4.4). In the present case, as the complainant itself states, it could have distributed the amounts it granted as loans to its sister company B Corporation as dividends to its sole shareholder, and the latter could have passed on the amounts as loans to B Corporation. The fact that such a course of action would have led to a lower tax burden when viewed as a whole does not justify qualifying the offsetting carried out by the tax administration in the proceedings as unlawful and impermissible. 4. For all these reasons, the appeal of 6 December 2022 is not justified.” Click here for English translation Click here for other translation ...

A parent company resident in country Y1 was liable to tax on interest and dividends it had received from its Danish subsidiary. There should be no reduction of or exemption from withholding tax under the Parent-Subsidiary Directive or the Interest and Royalties Directive or under the double taxation treaty between Denmark and country Y1, as neither the parent company nor this company’s own Y1-resident parent company could be considered the rightful owner of the dividends and interest within the meaning of the directives and the treaty, and as there was abuse. The High Court thus found that the Y1-domestic companies were flow-through companies for the interest and dividends, which were passed on to underlying companies in the tax havens Y2-ø and Y3-ø. The High Court found that there was no conclusive evidence that the companies in Y2 were also flow-through entities and that the beneficial owner of the interest and dividends was an underlying trust or investors resident in Y4. The double taxation treaty between Denmark and the Y4 country could therefore not provide a basis for a reduction of or exemption from withholding tax on the interest and dividends. Nor did the High Court find that there was evidence that there was a basis for a partial reduction of the withholding tax requirement due to the fact that one of the investors in the company on Y3 island was resident in Y5 country, with which Denmark also had a double taxation treaty. Click here for English translation Click here for other translation ...

Innodis granted loans to five wholly-owned subsidiaries between 2002 and 2004. The loans were unsecured, interest-free and had a grace period of one year. The subsidiaries to which the loans were granted were either start-up companies with no assets or companies in financial difficulties. The tax authorities (MRA) had carried out an assessment of the tax liability of Innodis Ltd in respect of the assessment years 2002 – 2003 and 2003 – 2004. In the course of the exercise, a number of items were added to the taxable income, including income from interest-free loans to subsidiaries and overseas passage allowances to eligible employees, which had been earmarked but not paid. The tax authorities were of the opinion that the grant of the interest-free loans was not on arm’s length terms in accordance with section 75 of the Income Tax Act 1995 (ITA) and was clearly preferential treatment of the subsidiaries. An assumed interest rate of 13% was applied to the loans, based on the market rate for loans made to Innodis for other purposes around the same time. Innodis Ltd appealed against the decision of the tax authorities to the Assessment Review Committee where all issues raised in the appeal were settled by agreement between the parties except those relating to the items of interest-free loans to subsidiaries and overseas passage allowances to employees. Innodis Ltd subsequently appealed to the Supreme Court. Judgement of the Supreme Court The Court dismissed the appeal of Innodis and upheld the decision of the Assessment Review Committee. Excerpt “With regard to the complaint of the appellant that the ARC wrongly accepted the application of “deemed interest” to assess the liability to tax as such notion has no legal basis, we note that the ARC clearly explained the expression “deemed interest” and its application. In that respect, the ARC observed that “deemed interest” is an expression commonly used in practice by the tax authorities and accountants to denote interest which a party should have claimed from another party if there had been no relationship between them. It also explained that the use of the expression of “deemed interest” was relevant since in the present case, in effect, the Appellant has been assessed on interest income, which it should have derived if it had been at arm’s length with its subsidiaries regarding the loans. It further observed that it is not correct to say that the assessment has no legal basis because it has always been the case for the MRA that this assessment is based on section 75 Income Tax Act 1995 and the term “deemed interest” was used in the heading to designate the nature of the amount assessed under section 75. We find no fault in the above reasoning of the ARC. As a matter of fact, we agree that, as found by the ARC, the assessment itself had a legal basis by virtue section 75, which empowers the Director General to do so if he is of the opinion that the transaction in question was not at “arm’s length.” Once this is done, it was necessary for the Director General to designate by an appropriate term the income that would have been derived if the transactions had been at “arm’s length.” Since the transactions targeted were loans, which in practice generate interests as income, there can be no wrong in designating the income that the applicant ought to have derived from them as “deemed interest”. Furthermore, as observed by the ARC, the concept of “deemed interest” is neither one invented by it or the respondent nor blatantly inappropriate since it is an expression used by the tax authorities and accountants to denote interest which a party should have claimed from another party if there had been no relationship between them. With regard to the application of the provisions under Part Vll of the Income Tax Act, particularly those under section 90, we note that in brushing aside the contentions of the appellant in that respect, the ARC made the following observations, with which we agree. Part VII concerns anti-avoidance provisions and section 90 relates to transactions designed to avoid liability to Income Tax. The MRA had decided to base its case on section 75 or the Income Tax Act as it was entitled to and to the extent that section 75 imposes on domestic companies an obligation to deal with subsidiaries at arm’s length, it is irrelevant whether section 90 could also have been applicable. It is therefore correct to say, as the ARC observed, that even if section 90 would have been applicable, it does not mean that the Director General was bound to apply section 90 or that section 75 was wrongly relied upon. Therefore, there is no substance in the appellant’s contention that the ARC was wrong to have discarded and failed to properly address its mind to the application of section 90 of the Income Tax Act 1995 and the arm’s length principle which is enunciated therein. For all the above reasons, the present appeal cannot succeed. We accordingly dismiss it with costs.” Click here for other translation ...

17 January 2023 the South African Revenue Service (SARS) released an interpretation note titled “DETERMINATION OF THE TAXABLE INCOME OF CERTAIN PERSONS FROM INTERNATIONAL TRANSACTIONS: INTRA-GROUP LOANS” which provides guidance on how SARS will determine arm’s length pricing for intra-group loans. The Note also provides guidance on the consequences for a taxpayer if the amount of debt, the cost of debt or both are not arm’s length. According to the note an intra-group loan would be incorrectly priced if the amount of debt funding, the cost of the debt or both are excessive compared to what is arm’s length ...

RRE and EBL Italia, belonged to the Belgian group ELECTRABEL SA (which later became the French group GDF Suez, now the Engie group); RRE, like the other Italian operating companies, benefited from a financing line from the Luxembourg subsidiary ELECTRABEL INVEST LUXEMBOURG SA (“EIL”). In the course of 2006, as part of a financial restructuring project of the entire group, EBL Italia acquired all the participations in the Italian operating companies, assuming the role of sub-holding company, and EIL acquired 45 per cent of the share capital of EBL Italia. At a later date, EBL Italia and EIL signed an agreement whereby EIL assigned to EBL Italia the rights and obligations deriving from the financing contracts entered into with the operating companies; at the same time, in order to proceed with the acquisition of EIL’s receivables from the operating companies, the two companies concluded a second agreement (credit facility agreement) whereby EIL granted EBL Italia a loan for an amount equal to the receivables being acquired. Both the tax commissions of first and of second instance had found the Office’s actions to be legitimate. According to the C.T.R., in particular, the existence of a “symmetrical connection between two financing contracts entered into, both signed on the same date (31/07/2006) and the assignments of such credits to EBL Italia made on 20/12/2006, with identical terms and conditions” and the fact that “EBL Italia accounted for the interest expenses paid to EIL in a manner exactly mirroring the interest income paid by Rosen, so as to channel the same interest, by contractual obligation, punctually to EIL’ showed that EBL Italia ‘had no management autonomy and was obliged to pay all the income flows, that is to say, the interest, obtained by Rosen immediately to the Luxembourg company EIL’, with the result that the actual beneficiary of the interest had to be identified in the Luxembourg company EIL. Judgement of the Court The Supreme Court confirmed the legitimacy of the notices of assessment issued by the Regional Tax Commission, for failure to apply the withholding tax on interest expense paid. According to the Court ‘abuse in the technical sense’ must be kept distinct from the verification of whether or not the company receiving the income flows meets the requirements to benefit from advantages that would otherwise not be due to it. One thing is the abuse of rights, another thing are the requirements to be met in order to be entitled to the benefits recognised by provisions inspired by anti-abuse purposes. “On the subject of the exemption of interest (and other income flows) from taxation pursuant to Article 26, of Presidential Decree No. 600 of 29 September 1973”, the burden of proof it is on the taxpayer company, which claims to be the “beneficial owner”. To this end, it is necessary for it to pass three tests, autonomous and disjointed” the recipient company performs an actual economic activity the recipient company can freely dispose of the interest received and is not required to remit it to a third party the recipient company has a function in the financing transaction and is not a mere conduit company (or société relais), whose interposition is aimed exclusively at a tax saving. The Supreme Court also ruled out the merely ‘domestic’ nature of the transaction as it actually consisted in a cross-border payment of interest. Click here for English translation Click here for other translation ...

HPI – CZ spol. s r.o. is a subsidiary in the Monier group which is active in the production, sales and services of roofing and insulation products. In June 2012 the Monier group replaced an existing cash pool arrangement with a new cash pool arrangement. The documents submitted show that on 1 April 2009 HPI concluded a cash pool agreement with Monier Group Services GmbH , which consisted in HPI sending the balance of its bank account once a week to the group’s cash pooling account – thus making those funds available to the other members of the group, who could use them to ‘cover’ the negative balances in their accounts. The companies that deposited funds into the cash pooling account received interest on these deposits at 1M PRIBOR + 3%; loans from the shared account bore interest at 1M PRIBOR + 3.75%. With effect from 1 June 2012, HPI concluded a new cash pooling agreement with a newly established company in Luxembourg, Monier Finance S.á.r.l. Under the new agreement, deposits were now remunerated at 1M PRIBOR + 0,17 % and loans at 1M PRIBOR + 4,5 %. HPI was in the position of a depositor, sending the funds at its disposal to the cash pooling account (but also having the possibility to draw funds from that account). Following an audit of HPI the tax authorities issued an assessment of additional income resulting from HPI’s participation in the new cash pool. According to the tax authorities the interest rates applied to HPI’s deposits in the new cash pool had not been at arm’s length. The tax authorities determined the arm’s length interest rates to be the same rates that had been applied by the parties in the previously cash pool arrangement from 1 January 2012 to 31 May 2012. HPI filed an appeal and in February 2022 the Regional court set aside the assessment issued by the tax authorities. The Regional Court held that the tax authority’s view, which determined the arm’s length interest rate by taking it to be the rate agreed in the old cash pool arrangement from 1 January 2012 to 31 May 2012, was contrary to the meaning of section 23(7) of the Income Tax Act. According to the Court it was for the tax authority to prove that the prices agreed between related parties differed from those agreed in normal commercial relations. In the absence of comparable market transactions between independent persons, the tax authority may determine the price as a hypothetical estimate based on logical and rational reasoning and economic experience. However, according to the Court the tax authorities did not even examine the normal price for the period from 1 January 2012 to 31 December 2012 but merely applied the interest rate from the cash pooling agreement in force until 31 May 2012. An appeal was then filed by the tax authorities with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Court decided in favour of HPI and upheld the decision from the Regional Court. Excerpt “….The applicant described the operation of the cash pool until 31 May 2012. Monier Group Services GmbH was the managing member and the applicant sent the balance of the account to the cash pool after assessing its cash flow. As from 1 June 2012, Monier Finance S.a.r.l. became the managing member and the balance was automatically sent to the cash pool account on a daily basis. The balance in the applicant’s bank account was thus zero every day. In the event of a negative balance, the applicant would balance the cash pool account. As regards the sharp drop in the interest rates in the cash pool, she stated that they were set according to the interest rates provided for deposits by local banks. In order to encourage members to join the cash pool, the managing member of the group offered them a rate equivalent to 1M EURIBOR or IBOR + 0,17 % (or 0,174 % in 2016). Thanks to the automatic sending of funds to the cash pool, the applicant saved approximately CZK 100-150 thousand per year in bank charges. In the end, the members set the rate as 1M PRIBOR + 0.17%. The 0,17 % corresponds to the margin of the banks, which, however, deducted it from the reference rate of 1M PRIBOR. The members of the cash pool thus obtained a rate 0.34% higher than the conventional banks. Thanks to the interest rate on a daily basis, the appreciation was higher, and this is what made the new contract from 1 June 2012 different from the original contract. Monier Finance acted as an “in-house bank” for the members of the Group and charged a premium in the form of higher interest for the risks associated with lending money to the members of the cash pool and administrative costs. [19] The tax authorities have not demonstrated a difference between the interest rate agreed between the applicant and the managing member of the cash pool on the one hand and the benchmark rate on the other. Nor did the tax authority prove the reference price (rate) and, on the contrary, required the applicant to explain the difference itself. In short, the applicant’s profit from the interest on the cash pool deposits had decreased, the tax authorities saw no reason for such a decrease and therefore considered the rate which was higher (the rate agreed until 31 May 2012) to be in line with the arm’s length principle. However, it completely refrained from establishing the price that would have been agreed between independent parties and instead asked the applicant to explain the decrease in the agreed interest rate. … —The tax administrator required the applicant to explain the difference between the rates, without having even ascertained the comparative rate itself. Indeed, the tax authorities merely assumed that the original cash pooling agreement provided for a deposit rate of 1M PRIBOR + 3 %. The fact that the new rate was significantly lower could be a ...

On 1 July 2013, HCL Maître Pierre issued a ten-year bond which were convertible into shares and bore interest at a rate of 12%, the accrued amount of which was capitalised annually until the date of redemption or conversion, together with a non-conversion premium at a rate of 3%, if applicable. This loan was subscribed by its sole partner, (SAS) HGFI Saint-Martin. Following an tax audit of HCL Maître Pierre’s for the financial years ended 31 March 2012, 2013 and 2014, the tax authorities considered that the interest at the rate of 12% could only be deducted at a rate set at 2.82%. Judgement of the Supreme Court The Court dismissed the appeal of HCL Maître Pierre and upheld the assessment issued by the tax authorities. Excerpts “3. It follows from the combination of these provisions that interest relating to sums left or made available to a company by a company which directly or through an intermediary holds the majority of the share capital or in fact exercises decision-making power, or which is placed under the control of the same third party as the first company, are deductible within the limit of those calculated at a rate equal to the annual average of the average effective rates charged by credit institutions for variable-rate loans to enterprises with an initial term of more than two years or, if higher, at the rate which the borrowing enterprise could have obtained from independent financial institutions or organisations under similar conditions. The rate which the borrowing undertaking could have obtained from independent financial institutions or organisations under similar conditions shall mean, for the purposes of these provisions, the rate which such institutions or organisations would have been likely, in view of its own characteristics, in particular its risk profile, to grant it for a loan of the same characteristics under arm’s length conditions. The borrowing undertaking, which has the burden of proving the rate it could have obtained from independent financial institutions or bodies for a loan granted under similar conditions, may provide such proof by any means. In order to evaluate this rate, it may, where appropriate, take account of the yield on bonds issued by undertakings in comparable economic circumstances where such bonds constitute, in the circumstances under consideration, a realistic alternative to intra-group financing. Where the sums left or made available to the company by its members consist of the nominal amount of bonds convertible into shares subscribed to by the latter, the reference rate thus assessed should be adjusted to take account of the value of the conversion option associated with the convertible bonds issued. In order to establish that the 12% rate of the convertible bonds in question corresponded to the remuneration of an arm’s length financing, HCL Maître Pierre relied on ten bond issues by Western European companies with comparable risk, selected from a study by PwC, which showed a median rate of 11.91%. The court noted that these companies had ratings of less than BB- on the scale of the Standard and Poor’s rating agency, whereas the rating assigned by the same study to HCL Maître Pierre was BB+. It concluded that, since the comparables cited related to companies with worse credit ratings than its own, HCL Maître Pierre did not justify the arm’s length nature of the 12 % rate by presenting such a sample.” (10) It follows from the foregoing that HCL Maître Pierre does not provide evidence that the 12% rate at which it issued bonds convertible into shares on 1 July 2013 would be the rate it could have obtained from independent financial institutions or organisations under similar conditions, and that the tax authorities were right to limit the deduction of interest to the rate provided for by the provisions of Article 39(1)(3) of the aforementioned General Tax Code. The company is therefore not entitled to seek the annulment of the judgment by which the Strasbourg Administrative Court rejected its claim.” Click here for English translation Click here for other translation ...

SAP AG (now SAP SE) is a German multinational software corporation that develops enterprise software to manage business operations and customer relations. The company is especially known for its ERP software. SAP France, a 98% subsidiary of SA SAP France Holding, itself wholly owned by the German group, had deposited funds under a Cash Management Agreement as sight deposits carrying an interest of 0%. Following an audit for the financial years 2012 and 2013, two assessment proposals were issued in December 2015 and November 2016, relating in particular to the 0% interest rate charged on the cash deposits. The tax authorities had added interest to SA SAP France’s taxable income calculated by reference to the rate of remuneration on sight deposits. SAP France contested the adjustments and furthermore requested the benefit of the reduced rate of corporation tax on income from industrial property, pursuant to Article 39 of the French General Tax Code, with regard to the royalties from the licensing agreements relating to Business Object products and Cartesis solutions. SAP France Holding, the head of the group is appealing against the ruling of 30 January 2020 by which the Montreuil Administrative Court rejected its requests for the reconstitution of its overall tax loss carry-forward in the amount of EUR 171,373 for 2012, 314,395 in duties for 2013 and the additional contribution to corporate income tax on the amounts distributed for 2012 and 2013, for amounts of €5,141 and €14,550 respectively, and, in application of the reduced tax rate, the refund of an overpayment of corporate income tax and additional contributions for €27,461,913 for the years 2012 to 2015. In regards to added interest on the deposited funds under a Cash Management Agreement the Court of Appeal decided in favor of the tax authorities. An appeal was filed by SAP France with the Supreme Court. Judgement of the Conseil d’État The Supreme Court set aside the decision of the Court of Appeal. Excerpt “2. Under the terms of Article 57 of the same code: “For the purposes of determining the income tax due by companies that are dependent on or control companies located outside France, the 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. The same procedure shall be followed in respect of undertakings which are dependent on an undertaking or a group which also controls undertakings situated outside France (…) In the absence of precise information for making the adjustments provided for in the first, second and third paragraphs, the taxable income shall be determined by comparison with that of similar undertakings normally operated. It follows from these provisions that, when it finds that the prices charged by an enterprise established in France to a foreign enterprise which is related to it – or those charged to it by this foreign enterprise – are lower – or higher – than those charged by similar enterprises normally operated, In the event that the charges levied in France by a related foreign company – or those invoiced to it by that foreign company – are lower – or higher – than those levied by similar companies operating normally, i.e. at arm’s length, the administration must be considered to have established the existence of an advantage which it is entitled to reintegrate into the results of the French company, unless the latter can prove that this advantage had at least equivalent counterparts for it. In the absence of such a comparison, the department is not, on the other hand, entitled to invoke the presumption of transfers of profits thus instituted but must, in order to demonstrate that an enterprise has granted a liberality by invoicing services at an insufficient price – or by paying them at an excessive price – establish the existence of an unjustified difference between the agreed price and the market value of the property transferred or the service provided 3. In order to judge that SAP France had granted SAP AG a advantage by renouncing, for the years 2012 and 2013, to receive a remuneration in return for the deposit of its cash surpluses with the latter, the administrative court of appeal ruled that the administrative court of appeal based its decision on the fact that this zero remuneration was unrelated to the remuneration to which the company would have been entitled if it had placed its cash surpluses with a financial institution on that date, without this absence of remuneration finding its counterpart in the possibility of financing cash requirements, which were non-existent for the years in question. In holding, however, that the fact that the rate of remuneration of the sums thus deposited with SAP AG resulted from the application of the rate formula provided for in the cash management agreement, which the parties chose to limit to a non-negative result during the performance of that agreement, is irrelevant in this respect, without investigating whether SAP France had acted in accordance with its interest in concluding the agreement in these terms on 17 December 2009, or what obligations it had during the years in dispute, the Administrative Court of Appeal erred in law. 4. It follows from the foregoing, without it being necessary to rule on the other grounds of appeal, that the company SAP France Holding is entitled to request the annulment of Article 3 of the judgment which it is challenging. In the circumstances of the case, it is appropriate to charge the State with the sum of 3,000 euros to be paid to the company SAP France Holding under Article L. 761-1 of the Administrative Justice Code.” Click here for English translation Click here for other translation ...

Assume that A and B are commonly controlled taxpayers and that the applicable Federal rate is 10 percent, compounded semiannually. On June 30, 1986, A sells property to B and receives in exchange B’s purchase-money note in the amount of $2,000,000. The stated interest rate on the note is 9%, compounded semiannually, and the stated redemption price at maturity on the note is $2,000,000. Assume that the other applicable Code section to this transaction is section 1274. As provided in section 1274A(a) and (b), the discount rate for purposes of section 1274 will be nine percent, compounded semiannually, because the stated principal amount of B’s note does not exceed $2,800,000. Section 1274 does not apply to this transaction because there is adequate stated interest on the debt instrument using a discount rate equal to 9%, compounded semiannually, and the stated redemption price at maturity does not exceed the stated principal amount. Under paragraph (a)(3)(iii) of this section, the district director may apply section 482 and paragraph (a) of this section to this $2,000,000 note to determine whether the 9% rate of interest charged is less than an arm’s length rate of interest, and if so, to make appropriate allocations to reflect an arm’s length rate of interest ...

X and Y are commonly controlled taxpayers. At a time when the applicable Federal rate is 12 percent, compounded semiannually, X sells property to Y in exchange for a note with a stated rate of interest of 18 percent, compounded semiannually. Assume that the other applicable Code section to the transaction is section 483. Section 483 does not apply to this transaction because, under section 483(d), there is no total unstated interest under the contract using the test rate of interest equal to 100 percent of the applicable Federal rate. Under paragraph (a)(3)(iii) of this section, section 482 and paragraph (a) of this section may be applied by the district director to determine whether the rate of interest under the note is excessive, that is, to determine whether the 18 percent stated interest rate under the note exceeds an arm’s length rate of interest ...

The facts are the same as in Example 2 except that the amount lent by Z to B is $9,000, and that amount is the aggregate outstanding amount of loans between Z and B. Under the $10,000 de minimis exception of section 7872(c)(3), no adjustment for interest will be made to this $9,000 loan under section 7872. Under paragraph (a)(3)(iii) of this section, the district director may apply section 482 and paragraph (a) of this section to this $9,000 loan to determine whether the rate of interest charged is less than an arm’s length rate of interest, and if so, to make appropriate allocations to reflect an arm’s length rate of interest ...

B, an individual, is an employee of Z corporation, and is also the controlling shareholder of Z. Z makes a term loan of $15,000 to B at a rate of interest that is less than the applicable Federal rate. In this instance the other operative Code section is section 7872. Under section 7872(b), the difference between the amount loaned and the present value of all payments due under the loan using a discount rate equal to 100 percent of the applicable Federal rate is treated as an amount of cash transferred from the corporation to B and the loan is treated as having original issue discount equal to such amount. Under paragraph (a)(3)(iii) of this section, section 482 and paragraph (a) of this section may also be applied by the district director to determine if the rate of interest charged on this $15,000 loan (100 percent of the AFR, compounded semiannually, as adjusted by section 7872) is an arm’s length rate of interest. Because the rate of interest on the loan, as adjusted by section 7872, is within the safe haven range of 100-130 percent of the AFR, compounded semiannually, no further interest rate adjustments under section 482 and paragraph (a) of this section will be made to this loan ...

An individual, A, transfers $20,000 to a corporation controlled by A in exchange for the corporation’s note which bears adequate stated interest. The district director recharacterizes the transaction as a contribution to the capital of the corporation in exchange for preferred stock. Under paragraph (a)(3)(i) of this section, section 1.482-2(a) does not apply to the transaction because there is no bona fide indebtedness ...

The principles of paragraph (a)(3) of this section may be illustrated by the following examples: ...

If the stated rate of interest on the stated principal amount of a loan or advance between controlled entities is subject to adjustment under section 482 and is also subject to adjustment under any other section of the Internal Revenue Code (for example, section 467, 483, 1274 or 7872), section 482 and paragraph (a) of this section may be applied to such loan or advance in addition to such other Internal Revenue Code section. After the enactment of the Tax Reform Act of 1964, Pub. L. 98-369, and the enactment of Pub. L. 99-121, such other Internal Revenue Code sections include sections 467, 483, 1274 and 7872. The order in which the different provisions shall be applied is as follows – (i) First, the substance of the transaction shall be determined; for this purpose, all the relevant facts and circumstances shall be considered and any law or rule of law (assignment of income, step transaction, etc.) may apply. Only the rate of interest with respect to the stated principal amount of the bona fide indebtedness (within the meaning of paragraph (a)(1) of this section), if any, shall be subject to adjustment under section 482, paragraph (a) of this section, and any other Internal Revenue Code section. (ii) Second, the other Internal Revenue Code section shall be applied to the loan or advance to determine whether any amount other than stated interest is to be treated as interest, and if so, to determine such amount according to the provisions of such other Internal Revenue Code section. (iii) Third, whether or not the other Internal Revenue Code section applies to adjust the amounts treated as interest under such loan or advance, section 482 and paragraph (a) of this section may then be applied by the district director to determine whether the rate of interest charged on the loan or advance, as adjusted by any other Code section, is greater or less than an arm’s length rate of interest, and if so, to make appropriate allocations to reflect an arm’s length rate of interest. (iv) Fourth, section 482 and paragraphs (b) through (d) of this section and §§ 1.482-3 through 1.482-7, if applicable, may be applied by the district director to make any appropriate allocations, other than an interest rate adjustment, to reflect an arm’s length transaction based upon the principal amount of the loan or advance and the interest rate as adjusted under paragraph (a)(3) (i), (ii) or (iii) of this section. For example, assume that two commonly controlled taxpayers enter into a deferred payment sale of tangible property and no interest is provided, and assume also that section 483 is applied to treat a portion of the stated sales price as interest, thereby reducing the stated sales price. If after this recharacterization of a portion of the stated sales price as interest, the recomputed sales price does not reflect an arm’s length sales price under the principles of § 1.482-3, the district director may make other appropriate allocations (other than an interest rate adjustment) to reflect an arm’s length sales price ...

The safe haven interest rates prescribed in paragraph (a)(2)(iii)(B) of this section do not apply to any loan or advance the principal or interest of which is expressed in a currency other than U.S. dollars ...

If the lender in a loan or advance transaction to which paragraph (a)(2) of this section applies is regularly engaged in the trade or business of making loans or advances to unrelated parties, the safe haven rates prescribed in paragraph (a)(2)(iii)(B) of this section shall not apply, and the arm’s length interest rate to be used shall be determined under the standards described in paragraph (a)(2)(i) of this section, including reference to the interest rates charged in such trade or business by the lender on loans or advances of a similar type made to unrelated parties at and about the time the loan or advance to which paragraph (a)(2) of this section applies was made ...

For purposes of paragraph (a)(2)(iii)(B) of this section, the term applicable Federal rate means, in the case of a loan or advance to which this section applies and having a term of – (1) Not over 3 years, the Federal short-term rate; (2) Over 3 years but not over 9 years, the Federal mid-term rate; or (3) Over 9 years, the Federal long-term rate, as determined under section 1274(d) in effect on the date such loan or advance is made. In the case of any sale or exchange between controlled entities, the lower limit shall be the lowest of the applicable Federal rates in effect for any month in the 3-calendar- month period ending with the first calendar month in which there is a binding written contract in effect for such sale or exchange (lowest 3-month rate, as defined in section 1274(d)(2)). In the case of a demand loan or advance to which this section applies, the applicable Federal rate means the Federal short-term rate determined under section 1274(d) (determined without regard to the lowest 3-month short term rate determined under section 1274(d)(2)) in effect for each day on which any amount of such loan or advance (including unpaid accrued interest determined under paragraph (a)(2) of this section) is outstanding ...

Except as otherwise provided in this paragraph (a)(2), in the case of a loan or advance between members of a group of controlled entities, an arm’s length rate of interest referred to in paragraph (a)(2)(i) of this section shall be for purposes of chapter 1 of the Internal Revenue Code – (1) The rate of interest actually charged if that rate is – (i) Not less than 100 percent of the applicable Federal rate (lower limit); and (ii) Not greater than 130 percent of the applicable Federal rate (upper limit); or (2) If either no interest is charged or if the rate of interest charged is less than the lower limit, then an arm’s length rate of interest shall be equal to the lower limit, compounded semiannually; or (3) If the rate of interest charged is greater than the upper limit, then an arm’s length rate of interest shall be equal to the upper limit, compounded semiannually, unless the taxpayer establishes a more appropriate compound rate of interest under paragraph (a)(2)(i) of this section. However, if the compound rate of interest actually charged is greater than the upper limit and less than the rate determined under paragraph (a)(2)(i) of this section, or if the compound rate actually charged is less than the lower limit and greater than the rate determined under paragraph (a)(2)(i) of this section, then the compound rate actually charged shall be deemed to be an arm’s length rate under paragraph (a)(2)(i). In the case of any sale-leaseback described in section 1274(e), the lower limit shall be 110 percent of the applicable Federal rate, compounded semiannually ...

The safe haven rates prescribed in paragraph (a)(2)(iii)(B) of this section shall not apply, and the safe haven rates prescribed in § 1.482-2(a)(2)(iii) (26 CFR part 1 edition revised as of April 1, 1985), shall apply to – (i) Term loans or advances made before May 9, 1986; and (ii) Term loans or advances made before August 7, 1986, pursuant to a binding written contract entered into before May 9, 1986 ...

Except as otherwise provided in paragraph (a)(2) of this section, paragraph (a)(2)(iii)(B) applies with respect to the rate of interest charged and to the amount of interest paid or accrued in any taxable year – (i) Under a term loan or advance between members of a group of controlled entities where (except as provided in paragraph (a)(2)(iii)(A)(2)(ii) of this section) the loan or advance is entered into after May 8, 1986; and (ii) After May 8, 1986 under a demand loan or advance between such controlled entities ...

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Notwithstanding the other provisions of paragraph (a)(2) of this section, if the loan or advance represents the proceeds of a loan obtained by the lender at the situs of the borrower, the arm’s length rate for any taxable year shall be equal to the rate actually paid by the lender increased by an amount which reflects the costs or deductions incurred by the lender in borrowing such amounts and making such loans, unless the taxpayer establishes a more appropriate rate under the standards set forth in paragraph (a)(2)(i) of this section ...

For purposes of section 482 and paragraph (a) of this section, an arm’s length rate of interest shall be a rate of interest which was charged, or would have been charged, at the time the indebtedness arose, in independent transactions with or between unrelated parties under similar circumstances. All relevant factors shall be considered, including the principal amount and duration of the loan, the security involved, the credit standing of the borrower, and the interest rate prevailing at the situs of the lender or creditor for comparable loans between unrelated parties ...

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Notwithstanding the first-in, first-out payment application rule described in paragraph (a)(1)(iv)(A) of this section, the taxpayer may apply payments or credits against amounts owed in some other order on its books in accordance with an agreement or understanding of the related parties if the taxpayer can demonstrate that either it or others in its industry, as a regular trade practice, enter into such agreements or understandings in the case of similar balances with unrelated parties ...

(i) Facts. X and Y are members of a group of controlled entities within the meaning of section 482. Assume that the balance of intercompany trade receivables owed by X to Y on June 1 is $100, and that all of the $100 balance represents amounts incurred by X to Y during the month of May. During the month of June X incurs an additional $200 of intercompany trade receivables to Y. Assume that on July 15, $60 is properly credited against X’s intercompany account to Y, and that $240 is properly credited against the intercompany account on August 31. Assume that under paragraph (a)(1)(iii)(B) of this section interest must be charged on X’s intercompany trade receivables to Y beginning with the first day of the third calendar month following the month the intercompany trade receivables arise, and that no alternative interest-free period applies. Thus, the interest-free period for intercompany trade receivables incurred during the month of May ends on July 31, and the interest-free period for intercompany trade receivables incurred during the month of June ends on August 31. (ii) Application of payments. Using a FIFO payment order, the aggregate payments of $300 are applied first to the opening June balance, and then to the additional amounts incurred during the month of June. With respect to X’s June opening balance of $100, no interest is required to be accrued on $60 of such balance paid by X on July 15, because such portion was paid within its interest-free period. Interest for 31 days, from August 1 to August 31 inclusive, is required to be accrued on the $40 portion of the opening balance not paid until August 31. No interest is required to be accrued on the $200 of intercompany trade receivables X incurred to Y during June because the $240 credited on August 31, after eliminating the $40 of indebtedness remaining from periods before June, also eliminated the $200 incurred by X during June prior to the end of the interest-free period for that amount. The amount of interest incurred by X to Y on the $40 amount during August creates bona fide indebtedness between controlled entities and is subject to the provisions of paragraph (a)(1)(iii)(A) of this section without regard to any of the exceptions contained in paragraphs (a)(1)(iii)(B) through (E) ...

Except as otherwise provided in this paragraph (a)(1)(iv), in determining the period of time for which an amount owed by one member of the group to another member is outstanding, payments or other credits to an account are considered to be applied against the earliest amount outstanding, that is, payments or credits are applied against amounts in a first-in, first-out (FIFO) order. Thus, tracing payments to individual intercompany trade receivables is generally not required in order to determine whether a particular intercompany trade receivable has been paid within the applicable interest-free period determined under paragraph (a)(1)(iii) of this section. The application of this paragraph (a)(1)(iv)(A) may be illustrated by the following example: ...

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(i)Facts. X and Y use the calendar year as the taxable year and are members of the same group of controlled entities within the meaning of section 482. For Y’s 1988 calendar taxable year X and Y intend to use the interest-free period determined under this paragraph (a)(1)(iii)(E) for intercompany trade receivables attributable to X’s purchases of certain products from Y for resale by X in the ordinary course of business to unrelated persons in country Z. For its 1987 calendar taxable year all of X’s sales in country Z were of products within a single product group based upon a three-digit SIC code, were not manufactured, produced, or constructed (within the meaning of § 1.954-3(a)(4)) by X, and were sold in the ordinary course of X’s trade or business to unrelated persons located only in country Z. These sales and the month-end accounts receivable balances (for such sales and for such sales uncollected from prior months) are as follows: Month Sales Accounts receivable Jan. 1987 $500,000 $2,835,850 Feb. 600,000 2,840,300 Mar. 450,000 2,850,670 Apr. 550,000 2,825,700 May. 650,000 2,809,360 June 525,000 2,803,200 July 400,000 2,825,850 Aug. 425,000 2,796,240 Sept. 475,000 2,839,390 Oct. 525,000 2,650,550 Nov. 450,000 2,775,450 Dec. 1987 650,000 2,812,600 Totals 6,200,000 33,665,160 (ii) Average collection period. X’s total sales within the same product group to unrelated persons within country Z for the period are $6,200,000. The average receivables balance for the period is $2,805,430 ($33,665,160/12). The average collection period in whole days is determined as follows: (iii) Interest-free period. Accordingly, for intercompany trade receivables incurred by X during Y’s 1988 calendar taxable year attributable to the purchase of property from Y for resale to unrelated persons located in country Z and included in the product group, X may use an interest-free period of 175 days (165 days in the average collection period plus 10 days, but not in excess of a maximum of 183 days). All other intercompany trade receivables incurred by X are subject to the interest-free periods described in paragraphs (a)(1)(iii) (B), (C), or (D), whichever are applicable. If X makes sales in other foreign countries in addition to country Z or makes sales of property in more than one product group in any foreign country, separate computations of X’s average collection period, by product group within each country, are required in order for X and Y to determine an interest-free period for such product groups in such foreign countries under this paragraph (a)(1)(iii)(E) ...

The interest-free period provided under paragraph (a)(1)(iii)(E) of this section may be illustrated by the following example: ...

An average collection period for purposes of this paragraph (a)(1)(iii)(E) is determined as follows – (i) Step 1. Determine total sales (less returns and allowances) by the related purchaser in the product group to unrelated persons located in the same foreign country during the related purchaser’s last taxable year ending on or before the first day of the related seller’s taxable year in which the intercompany trade receivable arises. (ii) Step 2. Determine the related purchaser’s average month-end accounts receivable balance with respect to sales described in paragraph (a)(1)(iii)(E)(2)(i) of this section for the related purchaser’s last taxable year ending on or before the first day of the related seller’s taxable year in which the intercompany trade receivable arises. (iii) Step 3. Compute a receivables turnover rate by dividing the total sales amount described in paragraph (a)(1)(iii)(E)(2)(i) of this section by the average receivables balance described in paragraph (a)(1)(iii)(E)(2)(ii) of this section. (iv) Step 4. Divide the receivables turnover rate determined under paragraph (a)(1)(iii)(E)(2)(iii) of this section into 365, and round the result to the nearest whole number to determine the number of days in the average collection period. (v) Other considerations. If the related purchaser makes sales in more than one foreign country, or sells property in more than one product group in any foreign country, separate computations of an average collection period, by product group within each country, are required. If the related purchaser resells fungible property in more than one foreign country and the intercompany trade receivables arising from the related party purchase of such fungible property cannot reasonably be identified with resales in particular foreign countries, then solely for the purpose of assigning an interest-free period to such intercompany trade receivables under this paragraph (a)(1)(iii)(E), an amount of each such intercompany trade receivable shall be treated as allocable to a particular foreign country in the same proportion that the related purchaser’s sales of such fungible property in such foreign country during the period described in paragraph (a)(1)(iii)(E)(2)(i) of this section bears to the related purchaser’s sales of all such fungible property in all such foreign countries during such period. An interest-free period under this paragraph (a)(1)(iii)(E) shall not apply to any intercompany trade receivables arising in a taxable year of the related seller if the related purchaser made no sales described in paragraph (a)(1)(iii)(E)(2)(i) of this section from which the appropriate interest-free period may be determined ...

The interest-free period under this paragraph (a)(1)(iii)(E), however, shall in no event exceed 183 days. The related purchaser does not have to conduct business outside the United States in order to be eligible to use the interest-free period of this paragraph (a)(1)(iii)(E). The interest-free period under this paragraph (a)(1)(iii)(E) shall not apply to intercompany trade receivables attributable to property which is manufactured, produced, or constructed (within the meaning of § 1.954-3(a)(4)) by the related purchaser. For purposes of this paragraph (a)(1)(iii)(E) a product group includes all products within the same three-digit Standard Industrial Classification (SIC) Code (as prepared by the Statistical Policy Division of the Office of Management and Budget, Executive Office of the President.) ...

If in the ordinary course of business one member of the group (related purchaser) purchases property from another member of the group (related seller) for resale to unrelated persons located in a particular foreign country, the related purchaser and the related seller may use as the interest-free period for the intercompany trade receivables arising during the related seller’s taxable year from the purchase of such property within the same product group an interest-free period equal the sum of – (i) The number of days in the related purchaser’s average collection period (as determined under paragraph (a)(1)(iii)(E)(2) of this section) for sales of property within the same product group sold in the ordinary course of business to unrelated persons located in the same foreign country; plus (ii) Ten (10) calendar days ...

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If the creditor member or unrelated persons in the creditor member’s industry, as a regular trade practice, allow unrelated parties a longer period without charging interest than that described in paragraph (a)(1)(iii)(B) or (C) of this section (whichever is applicable) with respect to transactions which are similar to transactions that give rise to intercompany trade receivables, such longer interest-free period shall be allowed with respect to a comparable amount of intercompany trade receivables ...

In the case of an intercompany trade receivable arising from a transaction in the ordinary course of a trade or business which is actively conducted outside the United States by the debtor member, interest is not required to be charged until the first day of the fourth calendar month following the month in which such intercompany trade receivable arises ...

Interest is not required to be charged on an intercompany trade receivable until the first day of the third calendar month following the month in which the intercompany trade receivable arises ...

This paragraph (a)(1)(iii) is effective for indebtedness arising after June 30, 1988. See § 1.482-2(a)(3) (26 CFR Part 1 edition revised as of April 1, 1988) for indebtedness arising before July 1, 1988. Except as otherwise provided in paragraphs (a)(1)(iii)(B) through (E) of this section, the period for which interest shall be charged with respect to a bona fide indebtedness between controlled entities begins on the day after the day the indebtedness arises and ends on the day the indebtedness is satisfied (whether by payment, offset, cancellation, or otherwise). Paragraphs (a)(1)(iii)(B) through (E) of this section provide certain alternative periods during which interest is not required to be charged on certain indebtedness. These exceptions apply only to indebtedness described in paragraph (a)(1)(ii)(A)(2) of this section (relating to indebtedness incurred in the ordinary course of business from sales, services, etc., between members of the group) and not evidenced by a written instrument requiring the payment of interest. Such amounts are hereinafter referred to as intercompany trade receivables. The period for which interest is not required to be charged on intercompany trade receivables under this paragraph (a)(1)(iii) is called the interest-free period. In general, an intercompany trade receivable arises at the time economic performance occurs (within the meaning of section 461(h) and the regulations thereunder) with respect to the underlying transaction between controlled entities. For purposes of this paragraph (a)(1)(iii), the term United States includes any possession of the United States, and the term foreign country excludes any possession of the United States ...

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This paragraph (a) does not apply to so much of an alleged indebtedness which is not in fact a bona fide indebtedness, even if the stated rate of interest thereon would be within the safe haven rates prescribed in paragraph (a)(2)(iii) of this section. For example, paragraph (a) of this section does not apply to payments with respect to all or a portion of such alleged indebtedness where in fact all or a portion of an alleged indebtedness is a contribution to the capital of a corporation or a distribution by a corporation with respect to its shares. Similarly, this paragraph (a) does not apply to payments with respect to an alleged purchase-money debt instrument given in consideration for an alleged sale of property between two controlled entities where in fact the transaction constitutes a lease of the property. Payments made with respect to alleged indebtedness (including alleged stated interest thereon) shall be treated according to their substance. See § 1.482-2(a)(3)(i) ...

Paragraph (a) of this section applies only to determine the appropriateness of the rate of interest charged on the principal amount of a bona fide indebtedness between members of a group of controlled entities, including – (1) Loans or advances of money or other consideration (whether or not evidenced by a written instrument); and (2) Indebtedness arising in the ordinary course of business from sales, leases, or the rendition of services by or between members of the group, or any other similar extension of credit ...

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Where one member of a group of controlled entities makes a loan or advance directly or indirectly to, or otherwise becomes a creditor of, another member of such group and either charges no interest, or charges interest at a rate which is not equal to an arm’s length rate of interest (as defined in paragraph (a)(2) of this section) with respect to such loan or advance, the district director may make appropriate allocations to reflect an arm’s length rate of interest for the use of such loan or advance ...

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“X Shareholder Loan B.V.” and its subsidiaries had been set up in connection with a private equity acquisition structure. In 2011, one of “X Shareholder Loan B.V.”‘s subsidiaries bought the shares of the Dutch holding company. This purchase was partly financed by a loan X bv had obtained from its Luxembourg parent company. The Luxembourg parent company had obtained the the funds by issuing ‘preferred equity certificates’ (PECs) to its shareholders. These shareholders were sub-funds of a private equity fund, none of which held a direct or indirect interest in “X Shareholder Loan B.V.” of more than one-third. The tax authorities found, that deductibility of the interest paid by “X Shareholder Loan B.V.” to its Luxembourg parent was limited under Section 10a Vpb 1969 Act. The Court of Appeal upheld the assessment. According to the Court, whether there is an intra-group rerouting does not depend on whether the parties involved are related entities within the meaning of section 10a, i.e. whether they hold an interest of at least one-third. Instead, it should be assessed whether all the entities involved belong to the same group or concern. This does not necessarily require an interest of at least one-third. No satisfied with the decision “X Shareholder Loan B.V.” filed an appeal with the Supreme Court. Judgement of the Supreme Court The Supreme Court declared the appeal well-founded and remanded the case to Court of Appeal for further consideration of the issues that had not addressed by the court in its previous decision. Click here for English translation Click here for other translation ...

The US group, Avery Dennison, manufactures and distributes labelling and packaging materials in more than 50 countries around the world. The remuneration of the distribution and marketing activities performed Avery Dennison Chile S.A. had been determined to be at arm’s length by application of a “full range” analysis based on the resale price minus method. Furthermore, surplus capital from the local company had been placed at the group’s financial centre in Luxembourg, Avery Management KGAA, at an interest rate of 0,79% (12-month Libor). According the tax authorities in Chile the remuneration of the local company had not been at arm’s length, and the interest rate paid by the related party in Luxembourg had been to low, and on that basis an assessment was issued. A complaint was filed by Avery Dennison with the Tax Tribunal and in March 2021 the Tribunal issued a decision in favour of Avery Dennison Chile S.A. “Hence, the Respondent [tax authorities] failed to prove its allegations that the marketing operations carried out by the taxpayer during the 2012 business year with related parties not domiciled or resident in Chile do not conform to normal market prices between unrelated parties..” “Although the OECD Guidelines recommend the use of the interquartile range as a reliable statistical tool (point 3.57), or, in cases of selection of the most appropriate point of the range “the median” (point 3.61), its application is not mandatory in the national tax administration…” “the Claimant [taxpayer]carried out two financing operations with its related company Avery Management KGAA, domiciled in Luxembourg, which contains one of the treasury centres of the “Avery Dennison” conglomerate, where the taxpayer granted two loans for US $3.200.000.- in 2010 and another for US $1.1000.000.- in 2011.” “In relation to the financial transactions, the transfer pricing methodology used and the interests agreed by the plaintiff have been confirmed. Consequently, Assessment No. 210, dated 30 August 2016, should be annulled and, consequently, this Tax and Customs Court will uphold the claim presented in these proceedings.” An appeal was then filed by the tax authorities. Judgement of the Court of Appeal The Court upheld the decision of the Tax Tribunal and set aside the assessment issued by the tax authorities. Excerpts “(…) Fourth: That the OECD regulations – while article 38 of the LIR was in force – should be understood as a guide with indications or suggestions for determining prices assigned between related parties with respect to those charged between independent parties. The aim is to eliminate distortions that may arise between companies with common ownership and to respect market rules. Notwithstanding the above recognition, Article 38 of the LIR regulated transfer prices and even though its normative content was minimal and insufficient to provide an adequate response on the matter, its text must be followed for the purposes of resolving the conflict in question, especially if one considers that the third paragraph of the provision states that when prices between related companies are not in line with the values charged between independent companies for similar transactions, “the Regional Directorate may challenge them, taking as a reference basis for such prices a reasonable profitability for the characteristics of the transaction, or the production costs plus a reasonable profit margin. The same rule shall apply with respect to prices paid or owed for goods or services provided by the parent company, its agencies or related companies, when such prices do not conform to normal market prices between unrelated parties, and may also consider the resale prices to third parties of goods acquired from an associated company, minus the profit margin observed in similar operations with or between independent companies”. The following paragraph adds that if the company does not carry out the same type of operations with independent companies, the Regional Directorate “may challenge the prices based on the values of the respective products or services on the international market (…) for this purpose (…) it shall request a report from the National Customs Service, the Central Bank of Chile or the bodies that have the required information”. It can be inferred from the transcribed rule that the use of external comparables is only authorised if the company does not carry out any type of transaction of goods and services with independent companies; that the challenge must be well-founded; and that the taxpayer and the SII are free to use the method that seems most appropriate to them as long as the legal requirements are met. It is also relevant to note that the domestic regulations at that date did not contemplate all the methods included in the OECD guidelines and it is inappropriate, under article 38 of the LIR, to resort directly to such guidelines in respect of situations not provided for in the domestic regulations, i.e., in relation to methods not included in the aforementioned provision. An interpretation contrary to the above would infringe the principle of legality of taxes or legal reserve, according to which only the law can impose, eliminate, reduce or condone taxes of any kind or nature, establish exemptions or modify existing ones and determine their form, proportionality or progress. Fifth: That the contested act shows that the method used by the SII for the entire period under review, business year 2012, corresponds to the so-called “Transactional Net Margin Method” for marketing operations, and the ” Comparable Uncontrolled Price Method” for financial operations, The Court therefore agrees with the findings of the lower court in grounds 22 to 25 of the judgment under review regarding the lack of the necessary grounds for the administrative act, in that the tax authority, although obliged to do so, omitted to analyse the transactions in accordance with the legislation in force at the date on which they were carried out…” Click here for English translation Click here for other translation ...

Since Arnoldo Mondadori Editore SpA’s articles of association prevented it from issuing bonds, financing of the company had instead been archived via an arrangement with its subsidiary in Luxembourg, Mondadori International S.A. To that end, the subsidiary issued a bond in the amount of EUR 350 million, which was subscribed for by US investors. The funds raised were transferred to Arnoldo Mondadori Editore SpA via an interest-bearing loan. The terms of the loan – duration, interest rate and amount – were the same as those of the bond issued by Mondadori International S.A. to the US investors. The Italian tax authority denied the withholding tax exemption in regards of the interest paid on the loan. According to the tax authorities Mondadori International S.A. had received no benefit from the transaction. The interest paid by Arnoldo Mondadori Editore SpA was immediately and fully transferred to the US investors. Mondadori International S.A. was by the authorities considered a mere conduit company, and the US investors were the beneficial owners of interest which was therefore subject to 12.5% withholding tax. Judgement of the Supreme Court The Supreme Court set aside the assessment of the tax authorities and decided in favor of Arnoldo Mondadori Editore SpA. The court held that the beneficial owner requirement should be interpreted in accordance with the current commentary on Article 11 of the OECD Model Tax Convention. On that basis Mondadori International S.A. in Luxembourg was the beneficial owner of the interest and thus entitled to benefit from the withholding tax exemption. Excerpt “First, the company must take one of the forms listed in the annex to Directive 2004/49; second, it must be regarded, under the tax legislation of a Member State, as resident there for tax purposes and not be regarded, under a double taxation convention, as resident for tax purposes outside the European Union; third, it must be subject to one of the taxes listed in Article 3(a)(iii) of Directive 2003/49, without benefiting from an exemption (cf. paragraph 147 of the aforementioned decision; also paragraph 120 of Court of Justice, 26 February 2019, Case C 116/16, T Danmark; No 117/18, Y Denmark). Nor is the national authority, then, required to identify the entity or entities which it considers to be the beneficial owner of the “interest” in order to deny a company the status of beneficial owner of the “interest” (paragraph 145). Finally, in its judgment of 26 September 2019 on Joined Cases C 115/16, C 118/16, C 119/16 and C 299/16, the Court of Justice expressed the principle that the beneficial owner is anyone who does not appear to be a construction of mere artifice, providing additional indicators or spy-indicators whose presence is an indication of exlusive intent. 4. Now, in the case at hand, it emerges from the principles set out above that the “actual beneficiary” of the interest on the Italian bond must be considered to be the Luxembourg company. And in fact, contrary to the case law examined above, in the case under examination, it is not disputed in the documents that Mondadori International s.a: 1) has existed for more than fifty years; 2) has its own real operational structure and does not constitute an “empty box 3) its corporate purpose is the holding and sale of shares in publishing companies; 4) it produced profits of over EUR 8 million in the tax year in question 5) it issued the bond six months before the Italian company when the latter could not do so and precisely because it could not do so: the two loans remain distinct by virtue of their negotiating autonomy and find different justification 6) the interest received by the Italian parent company was recognised in its financial statements and contributed to its income; 7) it has actual disposal of the sums, in the absence of contractually fixed obligations of direct (re)transfer 8) it issued its own bonds, discounting the relative discipline, placing its assets as collateral for the American investors. In particular, the breach and misapplication of the law emerges due to the examination of the contractual conditions, duly reported in the appeal for cassation, fulfilling the burden of exhaustiveness of the writing (see especially pages 134 – 136). There are no obligations, limits or conditions that provide for the transfer to the United States of the amounts received from Italy, thus leaving entrepreneurial autonomy and patrimonial responsibility in the hands of the Luxembourg company, which, moreover, has a vocation by statute for corporate operations of this type. These principles have misguided the judgment on appeal, which therefore deserves to be set aside and referred back to the judge on the merits so that he may comply with the aforementioned European and national principles, which we intend to uphold. 5. The appeal is therefore well-founded and deserves to be upheld, with the absorption of grounds 1, 2, 4, 6 and 7 of appeal r.g. no. 7555/2013 and the analogous grounds 2, 3, 4, 5, 7 and 8 of appeal r.g. no. 7557/2013, all of which focus on the same question of whether Mondatori Editore is the “beneficial owner” of the payment of interest on the bond loan.” Click here for English translation Click here for other translation ...

“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 ...

At issue in the case of „RĪGAS DZIRNAVNIEKS” was if the interest rates charged on loans between related parties were at arm’s length. Judgement of the Court of Appeals The Court remanded the case to the Regional Court for a new hearing. Excerpts “As already indicated above, paragraphs 84, 91 and 92.3.1 and 92.3.2 of Regulation No 556 deal with the need for adjustments and mathematical calculations when significant differences in the comparable data and their material effects are established. The need for adjustments is also underlined in point 1.35 of the Guidelines. Guidance on how differences between comparables are to be addressed is provided, inter alia, in paragraph 3.57 of the Guidelines. It may be the case that, although every effort is made to exclude items with a lower level of comparability, the result is a series of figures for which it is considered that, given the process used to select the comparables and the information available on the limitations of the comparables, certain comparability defects remain which cannot be identified and/or quantified and are therefore not corrected for. In such cases, if the range includes a large number of observations, a statistical tool that takes into account the central tendency to narrow the range (e.g. to an interquartile range or other percentiles) could help to improve the reliability of the analysis. Thus, the Guidelines consider those cases where the analysis ends with a series of numbers. In such cases, various statistical tools should be used to narrow the range as much as possible. Reading these legal provisions in their context, it is clear that, although Regulation No 556 does not explain how adjustments and mathematical calculations are to be made, it is clear that, according to these legal provisions, the consistency of the transaction price with the price range indicated in the database used for a given type of product is not sufficient in itself to recognise the conformity of the price to be verified with the market price. The above-mentioned provisions of paragraphs 84, 91 and 92 of Regulation No 556 set out a number of relevant factors for the comparability of transactions. This means that for each transaction carried out with a related company, a detailed comparison should be made with the data used, indicating similar and dissimilar circumstances and adjusting the data where necessary. Consequently, the fact that the interest rates applied in the transactions between the applicant and its related companies fall within the range of interest rates used by the District Court does not, in itself, give rise to a finding beyond reasonable doubt that the applicant’s transaction prices are in line with market prices and that no corresponding adjustments are necessary. Moreover, the Regional Court merely referred to the first paragraph of Article 6(4) of the Law on Corporation Tax, which governed the adjustment of taxable income for interest payments during the audit period. However, the Regional Court has not explained whether that provision is also applicable in the present case. Nor has the Revenue Service, in its cassation appeal, put forward any arguments concerning the application and applicability of that provision to the dispute in the present case. Therefore, when examining the merits of the case, if it is concluded that the use of the statistical data compiled by the Bank of Latvia requires an adjustment, it must also be ascertained whether appropriate adjustments are not to be made in accordance with the procedure laid down in the first paragraph of Section 6.4 of the Law on Corporate Income Tax.” Click here for English translation Click here for other translation ...

SAP AG (now SAP SE) is a German multinational software corporation that develops enterprise software to manage business operations and customer relations. The company is especially known for its ERP software. SA SAP France, a 98% subsidiary of SA SAP France Holding, itself wholly owned by the German group, had deposited funds under a Cash Management Agreement as sight deposits carrying an interest of 0%. Following an audit for the financial years 2012 and 2013, two assessment proposals were issued in December 2015 and November 2016, relating in particular to the 0% interest rate charged on the cash deposits. The tax authorities had added interest to SA SAP France’s taxable income calculated by reference to the rate of remuneration on sight deposits. SA SAP France contested the adjustments and furthermore requested the benefit of the reduced rate of corporation tax on income from industrial property, pursuant to Article 39 of the French General Tax Code, with regard to the royalties from the licensing agreements relating to Business Object products and Cartesis solutions. SA SAP France Holding, the head of the group is appealing against the ruling of 30 January 2020 by which the Montreuil Administrative Court rejected its requests for the reconstitution of its overall tax loss carry-forward in the amount of EUR 171,373 for 2012, 314,395 in duties for 2013 and the additional contribution to corporate income tax on the amounts distributed for 2012 and 2013, for amounts of €5,141 and €14,550 respectively, and, in application of the reduced tax rate, the refund of an overpayment of corporate income tax and additional contributions for €27,461,913 for the years 2012 to 2015. Judgement of the Court of Appeal In regards of the added interest on the deposited funds under a Cash Management Agreement the Court decided in favor of the tax authorities. Excerpt “In order to reintegrate into the taxable results of SA SAP France the interest at the monthly rate for sight deposits on the sums it made available to SAP AG under a cash management agreement concluded on 17 December 2009 between the parties, the department noted that SAP AG, now SAP SE, a company under German law, held 100% of SA SAP France Holding, SA SAP France’s parent company, and that the EONIA rate for interbank relations, reduced by 0.15% stipulated in the agreement, had led to a total absence of remuneration for the sums made available to the central treasury by SA SAP France as of August 2012, for very significant amounts ranging from 132 to 432 million euros. In these circumstances, the administration establishes the existence of an advantage consisting of the granting of interest-free advances by SA SAP France to the company SAP AG, located outside France, which controls it through SA SAP France Holding. If the latter argues that the rate stipulated is a market rate whose evolution is independent of the control of the parties, and that it was capped at 0 % whereas a strict application of the agreement would have led to a negative rate, these circumstances are inoperative, since this rate is unrelated to the remuneration to which SA SAP France could have claimed if it had placed its cash surpluses with a financial institution. Furthermore, by maintaining that the investment of its funds with SAP AG is particularly secure and that it enables it to obtain immediate and unconditional financing from the central treasury at the rate of EONIA + 30%, the applicant company does not justify an interest of its own which can be regarded as a consideration, since it is common ground that its situation vis-à-vis the central treasury was constantly in credit for very substantial amounts which greatly exceeded its working capital requirements. Finally, the monthly rate for sight deposits of between 0.15 and 0.18% applied by the department corresponds to the interest rate which SA SAP France could have obtained from a financial institution and the applicant does not propose a more relevant comparable. It follows that the administration establishes the existence during 2012 and 2013 of a transfer of profit, within the meaning of the provisions of Article 57 of the General Tax Code, from SA SAP France to the company SAP AG located outside France, for the amounts of EUR 171 373 in 2012 and EUR 484 986 in 2013, which the administration reintegrated into the results of SA SAP France.” Click here for English translation Click here for other translation ...

The Spanish tax authorities have published a report on the applicability of their domestic General Anti-Abuse Rule (GAAR). In the report, a conduit arrangement aimed at benefiting from an exemption at source on the payment of interest to EU residents is described. Click here for English translation ...

The issue in these two cases is whether withholding tax was payable on interest paid to foreign group companies considered “beneficial owners” via conduit companies covered by the EU Interest/Royalties Directive and DTA’s exempting the payments from withholding taxes. The first case concerned interest accruals totalling approximately DKK 1,476 million made by a Danish company in the period 2007-2009 in favour of its parent company in Sweden in connection with an intra-group loan. The Danish Tax Authorities (SKAT) subsequently ruled that the recipients of the interest were subject to the tax liability in Section 2(1)(d) of the Corporation Tax Act and that the Danish company was therefore obliged to withhold and pay withholding tax on a total of approximately DKK 369 million. The Danish company brought the case before the courts, claiming principally that it was not obliged to withhold the amount collected by SKAT, as it disputed the tax liability of the recipients of the interest attributions. The second case concerned interest payments/accruals totalling approximately DKK 3,158 million made by a Danish company in the period 2006-2008 in favour of its parent company in Luxembourg in respect of an intra-group loan. SKAT also ruled in this case that the interest payments/write-ups were taxable for the recipients and levied withholding tax on them from the Danish company totalling approximately DKK 817 million. The Danish company appealed to the courts, claiming principally that the interest was not taxable. The Eastern High Court, as first instance, dealt with the two cases together. The European Court of Justice has ruled on a number of preliminary questions in the cases, see Joined Cases C-115/16, C-118/16, C119/16 and C-299/16. In both cases, the Ministry of Taxation argued in general terms that the parent companies in question were so-called “flow-through” companies, which were not the “beneficial owners” of the interest, and that the real “beneficial owners” of the interest were not covered by the rules on tax exemption, i.e. the EU Interest/Royalties Directive and the double taxation conventions applicable between the Nordic countries and between Denmark and Luxembourg respectively. Judgement of the Eastern High Court In both cases, the Court held that the parent companies in question could not be regarded as the “beneficial owners” of the interest, since the companies were interposed between the Danish companies and the holding company/capital funds which had granted the loans, and that the corporate structure had been established as part of a single, pre-organised arrangement without any commercial justification but with the main aim of obtaining tax exemption for the interest. As a result, the two Danish companies could not claim tax exemption under either the Directive or the Double Taxation Conventions and the interest was therefore not exempt. On 3 May 2021, the High Court ruled on two cases in the Danish beneficial owner case complex concerning the issue of taxation of dividends. The judgment of the Regional Court in Denmark vs NETAPP ApS and TDC A/S can be read here. Click here for English translation Click here for other translation ...

“A-Geothermal Finance AG” (A AG) financed geothermal projects developed by the E GmbH. The sole shareholder is af A AG. Since 2012, B has also been the sole shareholder of C AG. C AG holds as a subsidiary E GmbH with developed two geothermal projects. These projects were financed by A AG, namely with loans to E GmbH, which forwarded the loan amounts to F S.p.a. In the period from November 2010 to March 2017, A AG granted a large number of loans ranging from EUR 10,000.00 to EUR 270,000.00. At the end of 2017, loans receivable (including interest in arrears on the loan) from E GmbH, amounted to CHF 9,397,427.00. A AG made value adjustments on this amount, namely in 2016 in the amount of CHF 7,676,057.00 and in 2017 in the amount of CHF 1,721,370.00. The tax administration did not recognize these value adjustments as tax deductible business-related operating expenses, essentially with the argument that the granting of the loan did not stand up to the arm’s length principle. An appeal was filed by A AG. Judgement of the Administrative Court The Court dismissed the appeal against the decision and the decision of the tax authorities upheld. Excerpts “The complainant argues in point 2 of its complaint that the lower courts should have clarified the complainant’s intentions and motivations in connection with the considerable advance payments and investments made – i.e. the loans granted – by examining witnesses and parties. This is not the case, because even if the complainant’s intentions and motivations were established as alleged by the complainant, an independent third party would not have made the loans and advance payments that are the subject matter of the proceedings. Thus, even if B, as a member of the competent administrative bodies of the “geothermal group”, had tacitly or even verbally promised a third party that he would provide him with a general contractor contract with a turnover of approximately EUR 16 million if the foreign state granted the concession for the construction of the two geothermal plants, the independent third party would not have granted such loans as the complainant did. “In points 5.3 and 5.4 of its complaint, the complainant argues that it therefore did not provide F S.p.a. and E GmbH with its own funds, because the external financing on the part of the complainant was intended to ensure that, if the project had been successful and a third party investor had entered, the complainant’s investments would have existed as a debt in F S.p.a. and would therefore have had to be satisfied first. This ensured that the complainant would be the first to get back the money it had invested if the project had been successful. The structure chosen in this case had been the best possible and only possible one for participation in the tender. The initiative for the development of geothermal projects had always come from the complainant, which was why the project had also been carried out in the complainant’s interest and at its risk. The security of the pledge of the shares in F S.p.a. would not have resulted in any additional benefit because of the complete control. These arguments do not change the assessment that a third party would not have provided the loans and advance payments at issue in the proceedings at the conditions that the complainant provided and were promised to it. If the complainant had participated in F S.p.a. as sole shareholder from the beginning – which it could also have done indirectly via C AG or E GmbH – it would have had the chance to obtain its profit if the geothermal projects had been successful. With such a participation, the complainant would have been free to make the loans and advance payments at issue in the proceedings as such. The complainant would therefore not have been forced to provide the amount of over EUR 7 million that was the subject of the proceedings as equity capital of the foreign company. Thus, the chosen structure, namely that B rather than the complainant holds the “geothermal group” and that the complainant grants the risk capital in the form of loans, was by no means the only and, moreover, the best possible variant. 8. In summary, the “structure” chosen meant that the complainant had to bear the entire risk associated with the planning and development of the two geothermal projects, at least until the concession was granted by the foreign state. In return, the complainant obtained a written guarantee of a relatively low interest rate on the loans it had granted. In addition, it hoped that after the concession was granted by the foreign state, it would be awarded a contract that it could carry out at a profit – if possible with around EUR 10 million. However, the profit opportunities associated with the geothermal projects – up to EUR 200 million – would not have been available to it, but to its sole shareholder B. Such a structure does not stand up to the arm’s length principle: an independent third party would not have entered into the commitment that the complainant did. From an ex post perspective, it must be noted that only the risk associated with the geothermal projects materialised and the loans and advance payments made by the complainant were lost. Because these services do not stand up to the arm’s length principle, they may not be claimed as tax reductions. 9. For all these reasons, the appeal of 23 September 2021 is not justified” Click here for English translation Click here for other translation ...

Dominion Petroleum Dkenya’s principal activity was exploration of oil and gas. The tax authorities carried out an in-depth audit of Dominion’s operations and tax affairs for the years of income 2011 to 2016, which resulted in the following taxes being raised: Withholding Income Tax (WHT) on imported services – KES 114,993,666.00; WHT on deemed interest – KES 504,643,172.00 and; Reverse Value Added Tax(VAT) on imported services– KES 714,258,472.00 all totaling KES 1,333,895,311.00. An appeal was filed by Dominion with the Tax Appeals Tribunal where, in a judgment dated 24th July 2020, the Tribunal set aside the Commissioner’s Objection decision on Reverse VAT and WHT on Deemed Interest to the extent of the period prior to 1st January 2014. Further, it upheld the Commissioner’s Objection Decision on WHT on local services on condition that the amount of KES 656,892,892.00 paid by Dominion Petroleum to Apache Kenya Limited for seismic data be excluded from the assessment as it was not subject to WHT. In addition, it directed Dominion Petroleum to provide the Commissioner with documentation in support of the errors occasioned by the migration from its Pronto to SUN systems within thirty (30) days of the Tribunal’s ruling to facilitate computation of the WHT payable. The tax authorities was not satisfied with the decision in regards to VAT and withholding tax on deemed interest and filed an appeal with the High Court. Judgement of the High Court The High Court decided partially in favour of the tax authorities and partially in favour of Dominion Petroleum. Excerpts “WHT on deemed interest 23. WHT is a method of tax collection whereby the payer is responsible for deducting tax at source from payments due to the payee and remitting the tax so deducted to the Commissioner. Under section 10(1) of the ITA, the resident company paying interest and deemed interest is required to pay WHT to the Commissioner as follows: 10. Income from management or professional fees, royalties, interest and rents (1) For the purposes of this Act, where a resident person or a person having a permanent establishment in Kenya makes a payment to any other person in respect of- (c) interest and deemed interest 24. Under section 16(3) of the ITA “Deemed Interest” is defined as “….an amount of interest equal to the average ninety-one day Treasury Bill rate, deemed to be payable by a resident person in respect of any outstanding loan provided or secured by the non-resident, where such loans have been provided free of interest.” In essence, it is applicable on interest free borrowing and loans received from foreign-controlled entities in Kenya. Further by section 35(1) of the ITA, a person upon payment of a non-resident person not having a permanent establishment in Kenya in respect of interest which is chargeable to tax is required to deduct withholding tax at the appropriate non-resident rate which is provided for in the Third Schedule to the ITA. 25. Resolution of this issue involves around the nature of financial agreements entered into by the Respondent and its affiliate companies. The Commissioner contends that the agreement between the Respondent and its related companies were interest free outright loan agreements and any payments made to them by the Respondent thereunder fell within the definition of “Deemed Interest”. It observes that all of the Respondent’s related party lenders disclosed in their audited financial statements that the loans were interest free and that the Respondent attempted to introduce a 0.1% rate on one of the loans with Dominion Petroleum Acquisition Limited through contracts dated 5th February 2015 and 10th February 2015 respectively which were backdated to an effective date of 1st January 2014. The Commissioner thus accuses the Respondent of attempting to circumvent provisions of the ITA regarding treatment of interest free loans. 26. The Commissioner faults the Tribunal for holding that the “inter-company loans” do not fit the description of a loan as defined under section 16(3) of the ITA when the parties themselves had decided to call those arrangements ‘loans’ and that there is no such thing as “quasi-equity” from the definition in section 16(3) aforesaid which provides that, ‘’“all loans” means loans, overdrafts, ordinary trade debts, overdrawn current accounts or any other form of indebtedness for which the company is paying a financial charge, interest, discount or premium.” The Commissioner urges the court to take cognizance of the fact that this very chicanery called tax planning is the reason we have an entire body of practice called Transfer Pricing to ensure that related-parties transact at arm’s length as though they are related. (…) 34. I hold that the main factor of consideration is whether there was any interest provided for in the financing agreements amounted to a loan; if there was no interest, then WHT on ‘Deemed Interest’ would apply at the 91-day Treasury Bill rate; if there was interest, WHT would still apply at the rate provided for in the Third Schedule of the ITA. What should be noted is that whichever the case, WHT would still apply. 35. In its judgment, at para. 110, the Tribunal observed that the said agreements were “…all unsecured, interest-free and have no definitive repayment plan…”. Further, at Para. 115, the Tribunal noted that the agreements in question dated 28th March and 24th September 2014 both provided for an earlier effective date and had no interest clause. These agreements were later amended by the contracts dated 5th February 2015 and 10th February 2015 respectively to include an interest clause at the rate of 0.1% with an effective date of 1st January 2014. 36. I am in agreement with the Tribunal that in the absence of any demonstrable fraud or illegality, the parties are free to make amendments to their agreements. I also note that the parties may make an agreement that includes equity and borrowing. In this case, there was clearly a lending transaction and the inclusion of the 0.1% interest rate means that “Deemed Interest” could no longer apply at least from 1st January 2014. However, ...

K-GAS Corp had issued loans and performance guarantees to overseas subsidiaries but received no remuneration in return. The tax authorities issued an assessment where additional taxable income was determined by application of the arm’s length principle. An appeal was filed by K-GAS with the district court. Decision of the Court The court upheld the decision of the tax authorities and dismissed the appeal of K-GAS Corp. Excerpts related to loans “In light of the following circumstances, which can be known by the above acknowledged facts, in light of the above legal principles, it is not economically reasonable for the Plaintiff to decide not to receive interest on the self-financing portion of the case loan to the subsidiaries in question 1 until the end of the exploration phase, and there is no illegality in the method of calculating the normal price of the Defendant. … …the Plaintiff lent the money raised from the outside to the subsidiaries in the first issue, and in this type of financial transaction, it is the most reasonable and direct method to view the interest obtained by adding a certain profit to the borrowing interest corresponding to the procurement cost according to the cost plus method as the normal price (the Plaintiff also argued for the above effect on the normal price on the premise of ‘general loan and loan transactions’ (page 18 of the Complaint)). However, the Defendant not only calculated the normal price by applying the interest rate on the loan in this case, which is lower than the borrowing interest rate of the self-funding in this case, but also the price is lower than the interest rate calculated according to the Comparable Third Party Price Act when the Plaintiff lends funds for overseas resource development projects to Australian subsidiaries at the same time, so it cannot be considered that the normal price calculated by the Defendant exceeds the range of the price that is applied or is expected to be applied in ordinary transactions.” Excerpts related to performance guarantees “In light of the following circumstances, which can be seen by the above acknowledged facts, in the light of the legal principles seen in Paragraph (1) of A.A., it is not economically reasonable for the Plaintiff to not receive the performance guarantee fee from the subsidiaries, etc. of the third issue on the performance guarantee in this case, and there is no illegality in the method of calculating the normal price of the Defendant. … As seen earlier, the Plaintiff has received a performance guarantee fee when he/she guarantees the performance of the liability to pay the price under a gas sales contract of another overseas subsidiary or second-tier company. In cases of the performance guarantee in this case, it is deemed that there exists a reasonable ground not to receive the performance guarantee fee, in distinction from the above transaction, only a difference in the details of the principal obligation subject to the guarantee exists. The Plaintiff also explains that the above transaction is a payment guarantee for the business of an overseas subsidiary in the same position as an independent third-party company, so it is natural to receive a commission in return for the risks borne by the Plaintiff. There is no reason to deem otherwise in that the performance guarantee in this case is also for the business carried out by the subsidiary, etc., which is independent from the Plaintiff. The calculation of the reasonable performance guarantee fee by the Defendant for the provision of performance in this case is based on the risk approach that is the method of calculation of the performance guarantee fee that the Plaintiff has actually received from the overseas subsidiary, and as seen earlier, it is hard to deem that there is any illegality in the method of calculation of the reasonable performance guarantee fee by the Defendant, unless it is impossible to deem that the Plaintiff has no risk of performance guarantee in this case.” Click here for English translation Click here for other translation ...

In 2019, the Danish parent company of the group, EAC Invest A/S, had been granted a ruling by the tax tribunal that, in the period 2008-2011, due to, inter alia, quite exceptional circumstances involving currency restrictions in Venezuela, the parent company should not be taxed on interest on a claim for unpaid royalties relating to trademarks covered by licensing agreements between the parent company and its then Venezuelan subsidiary, Plumrose Latinoamericana C.A. The Tax tribunal had also found that neither a payment of extraordinary dividends by the Venezuelan subsidiary to the Danish parent company in 2012 nor a restructuring of the group in 2013 could trigger a deferred taxation of royalties. The tax authorities appealed against the decisions to the High Court. Judgement of the High Court The High Court upheld the decisions of the tax tribunal with amended grounds and dismissed the claims of the tax authorities. Excerpts: Interest on unpaid royalty claim “The High Court agrees that, as a starting point, between group-related parties such as H1 and the G2 company, questions may be raised regarding the interest on a receivable arising from a failure to pay royalties, as defined in section 2 of the Tax Assessment Act. The question is whether, when calculating H1’s taxable income for the income years in question, there is a basis for fixing interest income to H1 on the unpaid royalty claim by G2, within the meaning of Paragraph 2 of the Tax Assessment Act. Such a fixing of interest must, where appropriate, be made on terms which could have been obtained if the claim had arisen between independent parties. The right to an adjustment is thus based, inter alia, on the assumptions that the failure to pay interest on the royalty claim has no commercial justification and that there is in fact a basis for comparison in the form of contractual terms between a debtor for a claim in bolivar in Venezuela and a creditor in another country independent of the debtor.” … “In the light of the very special circumstances set out above, and following an overall assessment, the Court considers that there are no grounds for finding that the failure to recover H1’s royalty claim from G2 was not commercially justified. The High Court also notes that the Ministry of Taxation has not demonstrated the existence of a genuine basis for comparison in the form of contractual terms for a claim in bolivar between a debtor in Venezuela and a creditor in a third country independent of the debtor. The High Court therefore finds that there is no basis under Section 2 of the Tax Assessment Act, cf. Section 3B(5) of the Tax Control Act, cf. Para 8 cf. Section 5(3), there is a basis for increasing G3-A/S’s income in the income years in question by a fixed rate of interest on the unpaid royalty claim with G2 company.” Dividend distribution in 2012 reclassified as royalty “…the Court of Appeal, after an overall assessment, accepts that the fact that the G2 company did not waive outstanding royalty receivables was solely a consequence of the very specific currency restrictions in Venezuela, that the payment of dividends was commercially motivated and was not due to a common interest between H1 and the G2 company, and that therefore, under Article 2(2) of the Tax Code, there is no need to pay dividends to the G2 company. 1(3), there are grounds for reclassifying the dividend distribution as a taxable deduction from the royalty claim, as independent parties could not have acted as claimed by the Tax Ministry.” Claim in respect of purchase price for shares in 2013 set-off against dividend reclassified as royalty “… For the reasons given by the Tax Court and, moreover, in the light of the very special circumstances of Venezuela set out above, the Court finds that there is no basis under section 2 of the Tax Assessment Act for reclassifying the claim of the G2 company against H2, in respect of the share purchase price for the G9 company, from a set-off against dividends due to an instalment of royalties due.” Click here for English translation Click here for other translation ...

This case deals with arm’s length pricing of various inter-company loans which had been granted – free of interest – by Cypriot company Ltd. to an affiliate group company. Following an audit of Cypriot company Ltd, an upwards adjustment of the taxable income was issued. The adjustment was based on a comparison of the terms of the controlled transaction and the terms prevailing in transactions between independent parties. The lack of interest on the funds provided (deposit of a remittance minus acceptance of a remittance) was not considered in accordance with the arm’s length principle. Cypriot company Ltd disagreed with the assessment and filed an appeal with the tax court. Judgement of the Tax Court The Tax Court dismissed the appeal of Cypriot company Ltd. in regards of the arm’s length pricing of the loans. Excerpt “It is evident from the above that the bond loan taken is related to the outstanding balance of the debt as at 31/12/2014 and is not an investment option. As the contracting companies are related entities, the above transaction falls within the scope of the verification of the arm’s length principle. As in the previous cases above, the independent party for the comparison of the terms of the transaction is understood to be domestic financial institutions. Therefore, the independent market interest rate for the calculation of interest is the interest rate of bank loans in euro for the interest rate category to non-financial companies “To non-financial companies – Long-term loans of regular maturity – Loans over EUR 1 million”, according to the methodology defined by the Bank of Greece. For the month of purchase of the bonds (December 2015), the applicable average market interest rate is approximately 4.86%, higher than the one specified in the contract (2%). It can therefore be seen that in the present case the principle of equal distance is not respected, since interest crediting the lender with a lower interest rate than the one applicable between independent parties is calculated. The accounting of interest on the funds granted at a lower rate of interest constitutes a derogation from the arm’s length principle. Therefore, the audit was right to calculate imputed credit interest in order to restore the arm’s length principle and in accordance with the provisions of Article 50 of the Law. 4174/2013. The applicant claims that it was not informed as to how to calculate the interest for the 2018 tax year in the note of findings, however, the reasoning and the numerical verifications are identical to the corresponding accounting differences of the previous years for which it received detailed information and therefore the allegations made as to the violation of the right to be heard in this matter lack any substantial basis. Since the applicant company also claims that the contested acts, which are unfavourable attributive acts, were adopted by the Tax Administration after the expiry of the exclusive period of one month from the submission of the observations and in breach of the provisions of Article 28 of Law No. 4174/2013 in conjunction with the provisions of Article 10 par. 5 of Law no. 2690/1999. However, this claim is rejected as unfounded as the right to control and issue tax acts is regulated exclusively by Article 36 of Law No. 4174/2013 and as it is clear from the evidence in the file, the stamp duty and income tax differences in question were charged by the issuance and notification of the contested acts within the prescribed limitation period (except for the contested stamp duty act for the tax year 2014, which was referred to above). Because the findings of the audit, as recorded in the 08/12/2020 partial audit reports of the income tax and stamp duty assessment of the C.E.M.E.P. auditor, on which the contested acts are based, are considered to be valid, acceptable and fully reasoned.” Click here for English translation Click here for other translation ...

Natura Cosmeticos S/A had been issued a tax assessment for FY 1999 to 2001. In the assessment interest income from loans granted to foreign group entities had been added to the taxable income of the company. NATURA COSMETICOS S/A stated that the transfer pricing rule provided for in paragraph 1 of article 22 of Law 9,430/96 did not apply. The rule determines that “in the case of a loan with a related person, the lending legal entity, domiciled in Brazil, must recognize, as financial income corresponding to the operation, at least the amount calculated in accordance with the provisions of this article”. Article 22 provides that interest paid to a related person, when arising from a contract not registered with the Central Bank, will only be deductible for purposes of determining taxable income “up to the amount that does not exceed the amount calculated based on the Libor rate”. The remittance to related legal entities abroad was made by means of a transfer in reais, registered in the Central Bank Information System (Sisbacen). For this reason, the operation was submitted to the control of the regulatory authority and there was no legal obligation at the time regarding registration with the BC. Judgement of the Conselho Administrativo de Recursos Fiscais A split decision was handed down in favor of Natura Cosméticos S/A. The majority of counselors understood that the transfer price adjustments in the loan granted by the legal entity domiciled in the country to the related person were not applicable, “to the extent that the exchange or international transfer in reais is registered with Sisbacen, and the supporting documentation of the loan has been presented to the exchange operating bank”. They voted to approve the appeal of Natura Cosméticos S/A. The minority of counselors understood that the rule in paragraph 4 does not apply in the specific case. “The extensive interpretation proposed by the appellant, in the sense of accepting that the simple registration with Sisbacen of the remittance of resources to the linked companies abroad may be equivalent to registration with the BC, is not supported by any normative legal act”. The counselor voted to deny the appeal to prevent the court from admitting “minorization of applicable taxation without support by law”. They voted to dismiss the appeal of Natura Cosméticos S/A. Click here for English Translation Click here for other translation ...

The US group, Avery Dennison, manufactures and distributes labelling and packaging materials in more than 50 countries around the world. The remuneration of the distribution and marketing activities performed Avery Dennison Chile S.A. had been determined to be at arm’s length by application of a “full range” analysis. Furthermore, surplus capital from the local company had been placed at the group’s financial centre in Luxembourg, Avery Management KGAA, at an interest rate of 0,79% (12-month Libor). According the tax authorities in Chile the remuneration of the local company had not been at arm’s length, and the interest rate paid by the related party in Luxembourg had been to low. Judgement of the Tax Tribunal The Tribunal decided in favour of Avery Dennison Chile S.A. “Hence, the Respondent [tax authorities] failed to prove its allegations that the marketing operations carried out by the taxpayer during the 2012 business year with related parties not domiciled or resident in Chile do not conform to normal market prices between unrelated parties..” “Although the OECD Guidelines recommend the use of the interquartile range as a reliable statistical tool (point 3.57), or, in cases of selection of the most appropriate point of the range “the median” (point 3.61), its application is not mandatory in the national tax administration…” “the Claimant [taxpayer]carried out two financing operations with its related company Avery Management KGAA, domiciled in Luxembourg, which contains one of the treasury centres of the “Avery Dennison” conglomerate, where the taxpayer granted two loans for US $3.200.000.- in 2010 and another for US $1.1000.000.- in 2011.” “In relation to the financial transactions, the transfer pricing methodology used and the interests agreed by the plaintiff have been confirmed. Consequently, Assessment No. 210, dated 30 August 2016, should be annulled and, consequently, this Tax and Customs Court will uphold the claim presented in these proceedings.” Click here for English translation Click here for other translation CH vs Avery Dennison 16-9-0001493-0 ...

At issue in this case was whether or not it is possible to regularize transactions between companies by directly applying art. 9.1 of DTA between Spain and French, without resorting to the transfer pricing methods provided for in local Spanish TP legislation. Application of article 9 and taxing according to local tax legislation is often a question of determining the arm’s length price. But sometimes other rules will apply regardless of the value – for instance anti avoidance legislation where the question is not the price but rather the justification and substance of the transaction. In the present case the arm’s length price of the relevant transaction was not discussed, but rather whether or not transaction of shares had sufficient economic substance to qualify for application of Spanish provisions for tax depreciation of the shares in question. The National Court understood that the share acquisition lacked substance and only had a tax avoidance purpose. It could not be understood that the appellant company has undergone a actual depreciation of its shares to the extent necessary to make a tax deduction. Judgement of the supreme Court The Supreme Court dismissed the appeal and upheld the decision of the National Court. The court pointed out that the regularization of transactions between Spanish and French companies, through the application of art. 9.1 in the DTA, can be carried out without the need to resort to the methods provided for in local legislation for determining the arm’s length value of transactions between related parties. Excerpts “IV.- What has just been stated are the abstract terms of the regulation contained in the aforementioned Article 9.1; and this shows that its individualisation or practical application to some singular facts will raise two different problems. The first will be to determine whether the specific commercial or financial transactions concluded between these two legal persons, Spanish and French, have an explanation that justifies them according to the legal or economic logic that is present in this type of relationship. The second problem will have to be tackled once the first one just mentioned has been positively resolved, or when it has not been raised; and it will consist of quantifying the tax scope of the singular commercial or financial operation whose justification has been recognised or accepted. V.- The above shows that the application of this Article 9.1 Tax Treaty must be accompanied by the application of internal rules; and these may be constituted by Article 16 of the TR/LISOC or by other different internal rules, for the reasons expressed below. Thus, Article 10 TR/LISOC shall be applied when, without questioning the justification of the transactions concluded between entities or persons that deserve to be considered as “associated enterprises”, only the quantification or the value, in market terms, of the object or price of these transactions is in dispute. But other internal rules will have to be applied when what is disputed with regard to these transactions is not the amount of their object but the justification of the legal transaction that materialises them, because this externalises a single purpose of fiscal avoidance and is not justified by circumstances or facts that reveal its legal or economic logic. And these rules, as the Abogado del Estado argues in his opposition to the cassation, may be embodied by those which regulate the powers recognised by the LGT 2003 to the Administration in order to achieve a correct application of the tax rules, such as those relating to assessment, the conflict in the application of the tax rule and simulation (Articles 13, 15 and 16 of that legal text). VI.- The answer which, on the basis of what has just been set out, must be given to the question of objective appeal, defined by the order which agreed the admission of the present appeal, must be that expressed below. That the regularisation of transactions between Spanish and French companies, by means of the application of Article 9.1 of the Agreement between the Kingdom of Spain and the French Republic for the avoidance of double taxation and the prevention of evasion and avoidance of fiscal fraud in the field of income tax and wealth tax of 10 October 1995, can be carried out without the need to resort to the methods provided for determining the market value in related transactions and to the procedure established for that purpose in the internal regulations. ELEVENTH – Decision on the claims raised in the appeal. I.- The application of the above criterion to the controversy tried and decided by the judgment under appeal leads to the conclusion that the infringements alleged in the appeal are not to be assessed. This is for the following reasons. The main question at issue was not the amount or quantification of the transactions which resulted in the acquisition by the appellant SARA LEE SOUTHERN EUROPE SL (SLSE) of shares in SLBA Italia. It was the other: whether or not the acquisition of those shares was sufficiently justified to be considered plausible and valid for making the allocations which had been deducted for the depreciation of securities of SARA LEE BRANDED APPAREL, SRL. The tax authorities and the judgment under appeal, as is clear from the foregoing, understood that this acquisition lacked justification and only had a tax avoidance purpose, because this was the result of the situation of economic losses that characterised the investee company in the years preceding the acquisition. They invoked Article 9.1 of the DTA to point out that, in those circumstances of economic losses, the parameter of comparability with normal or usual transactions between independent companies, which that article establishes in order to accept that a related-party transaction actually existed, could not be assessed in the transactions in question. And they reached the final conclusion that, in those particular circumstances, it cannot be understood that the appellant company has undergone a depreciation of its shares to the extent necessary to make a deduction based on those shares.” Click here for English translation Click here ...

An assessment had been issued where the pricing of intra group rental expenses for machinery had been set aside by the tax authorities for FY 2010-2013. By an application filed with the Court of Appeal S.C. A. S.R.L. requested the Court for annulment of the assessment issued by the tax authorities. The Court of Appeal by judgment no. 164 of 31 October 2017, partially partially annulled the assessment. Unsatisfied with this decision, both parties filed an appeal to the High Court. S.C. A. S.R.L. considers that the first court misapplied the substantive rules of law applicable to the case with regard to the additional determination of a corporation tax in the amount of RON 56,715 for 2010, with reference to the interpretation of the OECD Guidelines. “Although the expert appointed by the court of first instance correctly established the adjusted margins of trade mark-up for each of the years 2010 to 2013 and the adjusted margins of operating profit for the same period, he erred in finding that, for the purposes of the final calculation, an analysis of the year-by-year comparability of the profitability indicators obtained in the period 2010 to 2013 is required. The approach is wrong because paragraphs 3.76 and 3.79 of the OECD Guidelines require the elimination of any market influences or gaps that may have an impact on the company, the only correct method being to use multi-year financial data. The use of this method is intended to minimise the impact of individual factors on comparable entities and the economic environment, as well as temporary economic factors such as the economic crisis.” Judgement of Supreme Court The Supreme Court upheld the decision of the court of first instance. Excerpts “As regards the method chosen, although the appellant criticises the ‘year-on-year’ comparability method, it does not specifically point out what its shortcomings are, but only why it is necessary to use the method of multi-year or agreed financial data. The ‘year-on-year’ comparability method was used because it was observed that the adjusted net trading profit margins and adjusted operating profit margins for 2012 were lower than the lower quartile limit, so it was correctly required to adjust the company’s 2012 revenue to bring the profitability indicators to the median of the market range obtained for independent comparable companies. Paragraph 3.76 of the OECD Guidelines was correctly interpreted by the court of first instance as meaning that the provision primarily considers the analysis of the data for the year under assessment and, in the alternative, the data for previous years, so that the use of the aggregate comparison method is not required. Furthermore, paragraph 3.79 of the OECD Guidelines states that the use of multi-yearly data may only be used to improve the accuracy of the range of comparison, but in the present case the appellant has not shown in concrete terms the consequences of using that method.” “With regard to the estimation of transfer prices and the increase of the tax base by the amount of RON 3 815 806, the appellant-respondent submits that the difference in income between the expert’s report and the tax inspection report is due solely to the fact that the expert used the indicators from 7 companies and the tax authority used the indicators from 3 companies out of the 11 chosen. The criticism is unfounded because the expert and, by implication, the court of first instance, demonstrated that there were 4 other companies which were comparable in terms of the activity carried out and for which the tax inspection authorities considered that there was no information, but it was demonstrated by the evidence in the file that they should be included in the comparability sample.” Click here for English translation Click here for other translation ...

A German general partnership (OHG) was the sole shareholder of an Italian corporation (A). In 2002, there was an unsecured claim against this company from a current account overdraft in the amount of approx. … million was outstanding. The receivable bore interest at 4.57 % (1st half of 2002), 4.47 % (2nd half of 2002), 3.14 % (1st half of 2004) and 3.13 % (2nd half of 2004). On 31 December 2002, OHG waived part of this claim in the amount of … € against a debtor warrant. Subsequently, the claim against A rose again by the end of 2004 to approx. …..€. OHG then again waived part of this claim (… €) against a debtor warrant. The amounts corresponded to what the parties to the contract considered to be the worthless part of the claims against A from the overdraft facility. Although these were derecognised in OHG’s balance sheet to reduce profits, the tax authorities neutralised the reduction in profits in accordance with Section 1 (1) AStG by means of an off-balance sheet addition. Judgement of the Bundesfinanzhof The BFH relied on its fundamental ruling on income correction for unsecured group loans and decided that the profit-reducing derecognition of the claim must be corrected by an off-balance sheet addition in accordance with Section 1 Paragraph 1 AStG. “The contested judgement must be set aside and the action dismissed (section 126 (3) sentence 1 no. 1 of the FGO). The lower court wrongly assumed that the plaintiff’s income was not to be corrected.” Click here for English translation Click here for other translation ...

The facts in brief are that TMW ASPF CYPRUS (hereinafter referred to as ‘assessee’) is a private limited company incorporated in Cyprus and is engaged in the business of making investments in the real estate sector. The company in the year 2008 had made investments in independent third-party companies in India (hereinafter collectively known as ‘investee companies’) engaged in real estate development vide fully convertible debentures (FCCDs). It was these investments that made the investee companies an associated enterprise of the assessee as per TP provisions. The assessee had also entered agreements, according to which the assessee was entitled to a coupon rate of 4%. Further, after the conversion of the FCCDs into equity shares, the promoter of Indian Companies would buy back at an agreed option price. The option price would be such that the investor gets the original investment paid on subscription to the FCCDs plus a return of 18% per annum. During the impugned assessment year, the Assessee had received  an  interest  income  of  Rs.60,46,895/  –  from  one  of  the  three investee companies and that too only for the first half of the year. No interest was received by the assessee from any other company. The Assessee Company had sent multiple notices and followed up with the investee companies in relation to the defaults and non compliances with the agreed terms of the agreements. However, no resolution could be sought in this regard. The assessee company on account of the downturn in the real estate market and the fact that the companies were in bad financial position and facing cash crunch, waived its right to receive interest under a mutual agreement with the investee. The case of the assessee company was selected for detailed scrutiny and the matter was referred by the Assessing Officer (AO) to the Transfer Pricing officer (TPO) to examine whether the international transactions entered by the assessee during the captioned assessment year were at arm’s length or not. The TPO held that the assessee was to earn an assured return of 18% and determined the arm’s length price of the coupon rate to be 18%, instead of coupon rate of 4%. Accordingly,  taxable  income  was  revised  to  Rs.36,75,86,430/-  in  the draft assessment order by the AO. Decision of the Court: One of the main contention raised before us by the Counsel that assessee being a non resident and Cyprus based company therefore it was entitled to the benefit of India Cyprus DTAA Article 11(1) of India-Cyprus DTAA reads as under :- “Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State.” The aforesaid para envisages that for taxing the interest income in the hands of a non-resident, it is necessary that the interest should arise in a contracting state, i.e., twin conditions of accrual as well as the payment are to be satisfied. If there is no accrual or actual payment received then same is to be decided within the scope of Article 11(1).  What  the  TPO/AO  have  sought  to  tax  is that,  assessee was supposed to receive interest of 18%, if the contingent event would have arisen, i.e., if in the event, the option was exercised by the assessee to sell its converted shares to the promoters of investee company at an option price then it would have given the return of 18%.  Thus,  entire  edifice  of  the  TPO/AO  was  based  on  fixation  of contingent event which assessee was supposed to receive. It is also matter of record no such conversion was actualised and assessee remained invested even during the year under consideration. The transfer pricing adjustment has been made on this hypothetical amount of interest receivable. Whether such notional income can be brought to tax even under the transfer pricing provision, has been dealt by the Hon’ble Bombay High Court in the case of Vodafone India Services (P) Ltd. vs. Union of India (supra), wherein their Lordships have held that even income arising from international transaction must satisfy the test of income under the Act and must  find its home in one of the charging provisions. Here in this case, nowhere the  TPO/AO  has been  able  to establish  that  notional  interest satisfy the test of income arising or received under the charging provision of Income Tax Act. If income is not taxable in terms  of section 4, then chapter X cannot be made applicable, because section 92 provides for computing the income arising from international transactions with regard to the ALP. Only the interest income chargeable to tax can be subject matter of transfer pricing in India. Making any transfer pricing adjustment on interest which has neither been received nor accrued to the assessee cannot be held to be chargeable in terms of the Income Tax Act read with Article 11(1) of DTAA. Here it cannot be the case of accrual of interest also, because none of the investee companies have acknowledge that any interest payment is due, albeit they have been requesting for waiving of interest of even coupon rate of 4%, leave alone the return of 18% which was dependent upon some future contingencies. Assessee despite all its efforts has acceded to such request. Further, in  the  India Cyprus DTAA wherein similar phrase has been used pertaining to FTS and Royalty in India Cyprus DTAA, Hon’ble Bombay High Court held that assessment of royalty or FTS should be made in the year in which amount have actually received and not otherwise. The coordinate bench of Mumbai ITAT in the case of Pramerica ASPF II Cyprus Holding Ltd. vs. DCIT (supra) on exactly similar set of facts, addition on account of notional interest was made; the Tribunal has held  that  the  interest  income  in  question  can  only  be  taxed  on payment  /receipt  basis.  The  relevant  observation  has already  been incorporated above. The Hon’ble Bombay High Court has confirmed the said finding. Similar view has been taken by the ITAT Chennai Bench in the case of DCIT Inzi Control ...

“HDP Lux SA acquired a building in France and financed the acquisition with a shareholder loan at an interest rate of 12%. The tax authorities issued a tax assessment for FY 2011 and 2012 in which the market interest rate was set at 3.57% and 2.52% respectively and the excess payments were considered as hidden distribution of profit on which withholding tax was applied. Decision of the Administrative Court The court upheld the tax authorities adjustment of the interest paid on the loan and the qualification of the excess payment as a hidden distribution of profits subject to a withholding tax of 15%. In addition, the court held that the OECD Guidelines could not influence the interpretation of the provision on hidden profit distributions, as the domestic provision had been adopted long before the OECD Guidelines, while at the same time recognising that the OECD Guidelines could be used as an “element of appreciation”. Click here for English translation Click here for other translation ...

At issue in this case was UK loan relationship rules – whether a note issued as part of a structure for refinancing the US sub-group without generating net taxable interest income in the UK had an unallowable purpose and the extent of deductions referable to the unallowable purpose considered. The Court ruled in favor of the tax administration: “Did the $140m Promissory Note secure a tax advantage? 110.     In my view, the $140m Promissory Note secured a tax advantage for OIOH 2008 Ltd in that all of the interest arising in respect of the note (apart from 25% of the interest on $94m of the principal amount of the note) was set off against the taxable income of OIOH 2008 Ltd.  Those interest deductions were accordingly a “relief from tax” falling within Section 1139(2)(a) of the CTA 2010. 111.     I consider that that would be the case even if I had accepted Mr Ghosh’s submission to the effect that, because the Scheme was a single structure, the deductions arising as a result of step 8 of the Scheme should be regarded as inextricably linked to the additional interest income generated by steps 1 to 7 of the Scheme in OIOH 2008 Ltd, with the result that the single structure gave rise to no net deductions for tax purposes.  This is because I agree with Ms Wilson that the mere fact that a transaction happens to result in a net neutral tax position or even, as was the case here, a net positive tax position (as a result of the Disclaimer) does not mean, in and of itself, that there has been no “tax advantage”, as defined in Section 1139 of the CTA 2010. In a case where that net neutral or net positive tax position arises as a result of both the generation of income and the generation of deductions, the deductions are still reliefs from tax pursuant to which the amount of income giving rise to tax is reduced.  Consequently, in the words of Jonathan Parker LJ in Sema, it is a situation where “the taxpayer’s liability is reduced, leaving a smaller sum to be paid…[and]  a better position has been achieved vis-à-vis the Revenue.” 112.     In keeping with his position as referred to in paragraph 111 above, Mr Ghosh contended that a straightforward borrowing between two companies within the UK tax net in which the debits in the borrower exactly matched the credits in the lender should also not be regarded as giving rise to a tax advantage.  For the reason set out in paragraph 111 above, I also do not accept that contention. It seems to me that that transaction would be giving rise to a tax advantage (for the borrower) in the form of the deductions which it generated, regardless of the fact that there would be income in the lender which matched those deductions. Of course, the fact that that matching income existed might well be highly relevant in considering whether securing the borrower’s tax advantage was the main purpose, or one of the main purposes, of the borrower in entering into the borrowing, but that is a quite separate question. 113.     Having said that, it will be apparent from the findings of fact set out in paragraph 104 above that I have not accepted the basic premise on which the submissions set out in paragraphs 111 and 112 above are founded.  In other words, I do not accept that the current circumstances should be regarded as being akin to those pertaining where the same loan relationship gives rise to matching debits and credits. Instead, step 8 of the Scheme generated only debits and no credits and was implemented only after the US objectives which were one of OI Plc’s main purposes in procuring the implementation of the Scheme had been achieved by the implementation of steps 1 to 7 of the Scheme. The issue of the $140m Promissory Note was therefore a quite separate step from the steps which gave rise to the income in OIOH 2008 Ltd, a significant part of which was set off against the deductions to which the note gave rise. In those circumstances, it is difficult to see how the deductions to which the $140m Promissory Note gave rise should not be regarded as reliefs falling within the “tax advantage” definition. 114.     For completeness, although neither party referred to this part of the “tax advantage” definition in its submissions, I would have thought that the debits in this case might also fall within paragraph (c) of the definition of “tax advantage” in Section 1139(2) of the CTA 2010, as clarified by Section 1139(3) of the CTA 2010 – in other words, that the debits have given rise to “the avoidance or reduction of a charge to tax…by a deduction in calculating profits or gains”. Was that tax advantage a main purpose of the Appellant? 115.     Section 441 of the CTA 2009 applies to the Appellant in relation to the $140m Promissory Note only if securing the tax advantage to which I have referred above was the main purpose, or one of the main purposes, of the Appellant in issuing, and remaining party to, the $140m Promissory Note. 116.     I have already concluded in my findings of fact that the sole purpose of the Appellant in issuing, and remaining party to, the $140m Promissory Note was to secure the deductions arising in respect of the note and to surrender those deductions to OIOH 2008 Ltd.  It follows that, in my view, the Appellant’s only purpose in issuing, and remaining party to, the $140m Promissory Note was to secure a tax advantage for OIOH 2008 Ltd and that therefore Section 441 of the CTA 2009 applies to the Appellant in relation to the note. What debits are apportionable to the unallowable purpose? 117.      It also follows from that finding of fact that, on the just and reasonable apportionment required by Section 441(3) of the CTA 2009, all of the debits arising in respect of the $140m Promissory Note were attributable ...

A Trust submitted a tax return for 2014 in which an asset loan to the C Trust in the amount of USD 5,393,695 (GBP 3,459,175) and a liability loan to the D Foundation in the amount of USD 7,715,134 (GBP 4,948,000) had been declared. Neither interest income nor interest expense was recognised or declared in respect of the loans, which were interest-free. A Trust reported a net loss of USD 112,870. The tax administration issued an assessment in the amount of USD 241,172, which resulted in taxable net income of USD 188,423 and income taxes of CHF 23,403, in addition to other tax adjustments. The adjustment of USD 241,172 was justified by the fact that the interest-free loan to C was subject to interest of 4.5% under the application of the arm’s length principle. According to Lichtenstein’s arm’s length guidance, in the case of non-interest-bearing or low-interest-bearing loans to related parties, a minimum interest rate is set out in an information sheet (in this case 4.5% for GBP) which should be applied to the loan and the difference between the effective interest income and the interest income that would be generated with an interest rate corresponding to the arm’s length principle should be calculated as income. An appeal was filed by A Trust with the Administrative Court. In its judgment of 09 February 2018, VGH 2017/126, the Administrative Court dismissed the appeal and confirmed the contested decision. An complaint was then filed with the Constitutional Court for violation of constitutional rights and rights guaranteed by the ECHR – Convention from November 1950 protecting basics freedom rights which entered into force in Liechtenstein in September 1982. Judgement of the Constitutional Court The Court dismissed the complaint. A Trust’s constitutional rights and rights guaranteed by the ECHR had not been violated by the contested judgment of the Administrative Court. Click here for English translation Click here for other translation ...

Sogefi Filtration S.p.A. received a notice of assessment for the 2003 financial year concerning various issues, including the deduction of royalties paid for the use of a trademark, interest income on a loan granted to a foreign subsidiary and the denial of a tax credit for dividends received by a French subsidiary. Sogefi appealed to the Regional Court, which ruled largely in its favour. Not satisfied with the decision, the tax authorities appealed to the Supreme Court. Judgement of the Supreme Court On the issue of transfer pricing the Supreme Court clarified, that the French arm’s length provision is not an anti-avoidance rule. Excerpt “4.1. The plea – admissible as it does not concern questions of merit but the correct application of the rule – is well founded. 4.2. It should be noted, in fact, that Art. 76 (now 110) tuir does not incorporate an anti-avoidance regulation in the strict sense, but is aimed at repressing the economic phenomenon of transfer pricing (shifting of taxable income following transactions between companies belonging to the same group and subject to different national regulations) considered in itself, so that the proof incumbent on the tax authorities does not concern the higher national taxation or the actual tax advantage obtained by the taxpayer, but only the existence of transactions, between related companies, at a price apparently lower than the normal price, it being incumbent on the taxpayer, pursuant to the ordinary rules of proximity of proof under Art. 2697 et.e. and on the subject of tax deductions, the taxpayer bears the burden of proving that such transactions took place for market values to be considered normal in accordance with the specific provisions of Article 9(3) of the Income Tax Code (see Court of Cassation no. 11949 of 2012; Court of Cassation no. 10742 of 2013; Court of Cassation no. 18392 of 2015; Court of Cassation no. 7493 of 2016). Such conclusion, moreover, is in line with the ratio of the legislation that is to be found “in the arm’s length principle set forth in Article 9 of the OECD Model Convention””, so that the assessment on the basis of the normal value concerns the “economic substance of the transaction” that is to be compared “with similar transactions carried out under comparable circumstances in free market conditions between independent parties” (see. in particular, Court of Cassation No. 27018 of 15/11/2017 which, in recomposing the different interpretative options that have emerged in the Court’s case law, expressly stated “the ratio of the rules set forth in Article 11O, paragraph 7, of the Income Tax Code must be identified in the arm’s length principle, excluding any qualification of the same as an anti-avoidance rule”). Incidentally, it should be noted that the current OECD Guidelines, in terms not dissimilar from what has been provided for since the 1970s, are unequivocal in clarifying (Chapter VII of the 2010 Guidelines, paras. 7.14 and 7.15 with respect to the identification and remuneration of financing as intra-group services, as well as 7. 19, 7.29 and 7.31 with respect to the determination of the payment), that the remuneration of an intra-group loan must, as a rule, take place through the payment of an interest rate corresponding to that which would be expected between independent companies in comparable circumstances. 4.3. However, in the case in point, the CTR excluded the application of the institute on the assumption that “a more favourable interest rate granted to a subsidiary for the acquisition of a company operating in the same sector in Spain is not necessarily of an avoidance nature” and, therefore, although faced with the objective fact of the divergence from the normal value, it excluded its relevance on the basis of an irrelevant assumption extraneous to the provision, the application of which it misapplied, resulting, in part, in the cassation of the judgment.” Click here for English translation Click here for other translation ...

Company X B.V. held all the shares in the Irish company A. The Tax Agency in the Netherlands claimed that the Irish company A qualified as a “low-taxed investment participation”. The court agreed, as company A was not subject to a taxation of 10 per cent or more in Ireland. The Tax Agency also claimed that X B.V.’s profit should include a hidden dividend due to company A’s providing an interest-free loan to another associated Irish company E. The court agreed. Irish company E had benefited from the interest-free loan and this benefit should be regarded as a dividend distribution. It was then claimed by company X B.V, that the tax treaty between the Netherlands and Ireland did not permit including hidden dividends in X’s profit. The Supreme Court disagreed and found that the hidden dividend falls within the scope of the term “dividends” in article 8 of the tax treaty. Click here for translation ...

A Trust submitted a tax return for 2014 in which an asset loan to C Trust in the amount of USD 5,393,695 (GBP 3,459,175) and a liability loan to the D Trust in the amount of USD 7,715,134 (GBP 4,948,000) had been declared. Neither interest income nor interest expense was recognised or declared in respect of the loans, which were interest-free. A Trust reported a net loss of USD 112,870. The tax administration issued an assessment in the amount of USD 241,172, which resulted in taxable net income of USD 188,423 and income taxes of CHF 23,403, in addition to other tax adjustments. The adjustment of USD 241,172 was justified by the fact that the interest-free loan to C was subject to interest of 4.5% under the application of the arm’s length principle. According to Lichtenstein’s arm’s length guidance, in the case of non-interest-bearing or low-interest-bearing loans to related parties, a minimum interest rate is set out in an information sheet (in this case 4.5% for GBP) which should be applied to the loan and the difference between the effective interest income and the interest income that would be generated with an interest rate corresponding to the arm’s length principle should be calculated as income. An appeal was filed by A Trust with the Administrative Court. In its judgment of 09 February 2018 the Administrative Court dismissed the appeal and confirmed the contested decision. Click here for English translation Click here for other translation ...

In the tax return for FY 2014, A c/o B AG declared a asset loans to related parties (holding company C) in the amount of USD 67,322,417.76 and liability loans to related parties (shareholder) in the amount of USD 110,051,410.39. Furthermore, interest income of USD 1,917,825.02 and interest expenses of USD 1,894,410.39 were declared in the tax return. A c/o B AG reported a net loss of USD 16,803.00. An assessment was issued 10 September 2015 by the tax administration. The tax administration adjusted the taxable net income/loss by an additional income of USD 1,024,661.00 and further tax adjustments of USD 1,224.00. The adjustment of USD 1,024,661.00 was justified because interest of 3.5% (USD 1,024,661.00) had been paid on the outstanding interest claims amounting to USD 29,276,021.00, although it had been agreed in the loan agreement of 28 December 2002 that the interest was to be paid quarterly. The granting of insufficiently interest-bearing advances to related companies constituted a pecuniary benefit in accordance with the “2014 information sheet on interest rates for the calculation of pecuniary benefits”. An appeal was filed by A c/o B AG with the Administrative Court which was dismissed in judgment of 13 June 2017, VGH2017/008. An appeal was then filed with the Constitutional Court Judgement of the Court The Court dismissed the appeal. A c/o B AG’s constitutionally guaranteed rights had not been violated by the contested judgment of the Administrative Court. Excerpts “Contrary to the appellant’s view, the present case does not involve a balance sheet correction, but a balance sheet amendment which it subsequently made. The Administrative Court’s reasoning that the annual financial statement submitted with the tax return does not contain any balance sheet item that violates mandatory commercial law provisions, and that consequently no balance sheet adjustment, but rather a balance sheet amendment was made by the complainant after the submission of the tax return of 25 August 2015 and the annual financial statement, is therefore not objectionable. Likewise, the further reasoning of the Administrative Court that the complainant, in accordance with the principle of the authoritative nature of the commercial balance sheet for the tax balance sheet (cf. VGH 2016/004; VGH 2016/003; VGH 2015/062 [all available at www.gerichtsentscheide.li]), must in principle allow itself to be held liable in the annual financial statements submitted by it, is also factually justifiable. The Administrative Court explained that the balance sheet is final from a certain point in time and subsequent changes can no longer be made. According to case law, an amendment of the balance sheet was only permissible until the submission of the tax return (see above para. 9.3 of the facts with reference to BGE 141 II 83, para. 3.4). The fact that the complainant – according to the Administrative Court – had chosen a procedure that was not optimal from a tax point of view by directly booking the depreciation of participation C (account 1500) with the shareholder’s account correction (account 2100) in a way that did not affect income, did not constitute grounds for a balance sheet correction. Nor were the conditions for a change in the balance sheet fulfilled because the complainant had submitted the tax return without reservations, together with the auditors’ report and the minutes of the general meeting. Thus, the complainant was no longer permitted to subsequently adjust the balance sheet under commercial law. The Administrative Tribunal also points out that the complainant only submitted its amended annual financial statements together with the auditor’s report and the amended tax return to the Administrative Tribunal with its appeal of 16 January 2017. Under procedural law, it is inadmissible under the provisions of tax law to submit new evidence with the appeal to the Administrative Tribunal (Art. 118 para. 3 SteG; cf. also Art. 116 para. 3 sentence 1 and Art. 117 para. 3 sentence 3 SteG). For this reason, too, the Administrative Court was not allowed to address and consider this new evidence. Finally, it is necessary to address the argument made in connection with the complaint of arbitrariness, according to which the authorities had violated the principle of trust. This complaint is unfounded. There was never any assurance from the authorities, which the complainant rightly did not claim. In the absence of an assurance by the authorities, however, the principle of legitimate expectations cannot have been violated (cf. CJEU 2007/112, para. 5.1; CJEU 2012/192, para. 4.1; CJEU 2013/42, para. 4.1; CJEU 2014/55. para. 2.4 [all www.gerichtsentscheide.li]). The complainant’s right to be treated without arbitrariness was therefore not violated. For all these reasons, the complainant was not successful with any of her fundamental rights complaints, so that the present individual complaint had to be dismissed.” Click here for English translation Click here for other translation ...

In the tax return for FY 2014, BF AG declared a asset loans to related parties (holding company C) in the amount of USD 67,322,417.76 and liability loans to related parties (shareholder) in the amount of USD 110,051,410.39. Furthermore, interest income of USD 1,917,825.02 and interest expenses of USD 1,894,410.39 were declared in the tax return. BF AG reported a net loss of USD 16,803.00. An assessment was issued 10 September 2015 by the tax administration. The tax administration adjusted the taxable net income/loss by an additional income of USD 1,024,661.00 and further tax adjustments of USD 1,224.00. The adjustment of USD 1,024,661.00 was justified because interest of 3.5% (USD 1,024,661.00) had been paid on the outstanding interest claims amounting to USD 29,276,021.00, although it had been agreed in the loan agreement of 28 December 2002 that the interest was to be paid quarterly. The granting of insufficiently interest-bearing advances to related companies constituted a pecuniary benefit in accordance with the “2014 information sheet on interest rates for the calculation of pecuniary benefits”. An appeal was filed by BF AG with the Administrative Court Judgement of the Administrative Court The Court dismissed the Appeal. Click here for English translation Click here for other translation ...

This case was about a cross border financing arrangement used by Chevron Australia to reduce it’s taxes – a round robin. Chevron Australia had set up a company in the US, Chevron Texaco Funding Corporation, which borrowed money in US dollars at an interest rate of 1.2% and then made an Australian dollar loan at 8.9% to the Australian parent company. The loan increased Chevron Australia’s costs and reduced taxable profits. The interest payments, which was not taxed in the US, came back to Australia in the form of tax free dividends. The US company was just a shell created for the sole purpose of raising funds in the commercial paper market and then lending those funds to the Australian company. Australian Courts ruled in favor of the tax administration and the case was since appealed by Chevron. In April 2017 the Federal Court decided to dismiss Chevron’s appeal. (Following the Federal Court’s decision, Chevron appealed to the High Court, but in August 2017 Chevron announced that the appeal had been withdrawn.) ...

Continental Tires RUS LLC had been issued a substantial loan from Continental AG (Germany). Following an audit the tax authority established that the main purpose of the loans was the systematic withdrawal of funds abroad. According to the tax authorities the loan transactions were concluded for the purpose of artificially raising cash in the form of loans and, accordingly, artificially increasing accounts payable, while the shortage of working capital arose and arises from the special, continuous and coordinated provision of deferred payments to buyers of tyre products. Judgement of the Russian Court of Appeal The Court ruled in favor of the tax administration. Excerpt: “The provisions of Article 252 of the Tax Code stipulate that the taxpayer reduces the income received by the amount of expenses incurred. Expenses are considered to be justified and documented expenses of the taxpayer. Reasonable expenses are defined as economically justified expenses, the evaluation of which is expressed in monetary form. Documented expenses shall mean expenses supported by documents executed in accordance with the legislation of the Russian Federation. Expenses are deemed to be any expenses on condition that they are incurred for the purpose of carrying out activities aimed at generating income. In accordance with Clause 3 of the Resolution of the Plenum of the Supreme Arbitration Court of the Russian Federation of 12.10.2006 № 53 “On arbitration courts assessing the validity of taxpayers receiving tax benefits”. (hereinafter – Ruling No. 53) tax benefit may be recognised as unjustified, in particular, if for taxation purposes transactions are taken into account not in accordance with their real economic sense or transactions are taken into account not due to reasonable economic or other reasons (business purposes). It is established that the Moscow Arbitration Court in Case No. A40-123542/14 states that, based on an analysis of taxation and financial results of the parent company Continental AG in Germany, the court considered that the so-called interest income received from the taxpayer in Russia actually has nothing to do with the economic activity of the subsidiary in Russia, is not related to the efficiency and business purpose of the taxpayer in the Russian Federation, and has the goal of servicing the losses of the parent company, in the absence of the holding company. In the aforementioned judicial act, the court concluded that the purpose of the relevant operations involving the provision of loans by the parent company to the company (the subsidiary) was to withdraw assets and profit from taxation in Russia, with the creation of fictitious “income” in Germany, without actually paying taxes on it, given the declaration of multimillion losses in view of the permanent reduction of taxable income by means of interest expenses, in connection with which the court regarded these actions as receiving unjustified tax benefits, entailing a loss of taxable profit. Thus, the court concludes that, as a result of the tax control measures taken, the Inspectorate came to a justified and lawful conclusion.” Click here for English translateion Click here for other translation ...

In January 2003, a Swedish company, Nobel Biocare Holding AB, entered into three loan agreements with its Swiss parent company. The loans had 15, 25 and 30 maturity respectively, with terms of amortization and with a variable interest rate corresponding to Stibor plus an interest rate margin of 1.75 percent points for one of the loans and 1.5 percent points for the other two loans. The same day the parent company transfered the loans to a sister company domiciled in the Netherlands Antilles. In June 2008 new loan agreements was signed. The new agreements lacked maturity and amortization and interest rates were stated in accordance with the Group’s monthly fixed interest rates. Amortization continued to take place in accordance with the provisions of the 2003 agreement, and the only actual change in relation to those agreements consisted in raising the interest rates by 2.5 percent points. These loans were transferred to a Swiss sister company. The Swedish Tax administration denied tax deductions corresponding to the difference between the interest rates in 2003 and 2008 respectively, with the support of the so-called correction rule (arm’s length rule) in Chapter 14 Section 19 of the Income Tax Act (1999: 1229). The question before the HFD Court was whether the correction rule could be applied when a contract with a certain condition was replaced by an agreement with a worse conditions – Were an audit according to the correction rule limited to referring only to the interest rate terms of the 2008 agreement or were there any reason to take into account the existence and content of the agreements that had previously been concluded between the parties? The Court stated that a prerequisite for applying the correction rule is that the company’s earnings have been lowered as a result of terms being agreed which differ from what would have been agreed between independent parties. It is thus the effect of the earnings that must be assessed and not how a single income or expense item has been affected. According to the Court, it was not only the new interest rate in the 2008 agreement that should be used as the basis for the audit, but all af the terms agreed by the parties. Of particular importance was the fact that the company accepted an increased interest rate without compensation, even though the 2003 agreement did not contain any such obligation for the company. The Court considered that an independent party had not acted in that way. The Court concluded that the correction rule could be applied when a contract with a certain condition was replaced by an agreement with a worse conditions. Such an interpretation of the correction rule was considered compatible with the OECD Guidelines. Click here for translation ...

“TV Monitors Corp” manufactures and supplies TV monitors and parts. In 2011, “TV Monitors Corp” provided loans to a TV monitor factory located in Brazil. The loans were financed by shareholder loans with an interest rate of LIBOR+2%. Following an audit in 2015, the tax authority issued an assessment of additional income related to the interest rates of the loans. “TV Monitors Corp.” filed an appeal with the Tax Tribunal. Decision of the Tax Tribunal The Tax Tribunal dismissed the appeal. According to the Tribunal, there was no error in the imposition of the additional corporate income tax because the interest rate of ＊% borrowed from the shareholders of “TV Monitors Corp” could not be considered an arm’s length interest rate. Furthermore, the interest rate of LIBOR + ＊% declared by “TV Monitors Corp” was not objectively proven to be a reasonable arm’s length price in light of the standard interest rate in Brazil. Click here for English translation Click here for other translation ...

Hero Cycles had advanced a sum of Rs.1,16,26,128/- to its subsidiary, Hero Fibers Limited, and this advance did not carry any interest. According to the tax authorities, Hero Cycles had borrowed the money from a banks and paid interest thereupon, and on that basis an assessment was issued where the interest paid to the bank had been disallowed. Judgement of the Supreme Court The Supreme court set aside the assessment of the tax authorities. “…once it is established that there is nexus between the expenditure and the purpose of business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the Board of Directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. It further held that no businessman can be compelled to maximize his profit and that the income tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. Applying the aforesaid ratio to the facts of this case as already noted above, it is manifest that the advance to M/s. Hero Fibres Limited became imperative as a business expediency in view of the undertaking given to the financial institutions by the assessee to the effect that it would provide additional margin to M/s. Hero Fibres Limited to meet the working capital for meeting any cash loses. (…)” ...

Bayerische Hypo und Vereinsbank AG (HVB-AG), a banking institution under German law, set up a French branch under the name “HVB-AG Paris” and contributed ten million Deutschmarks to this structure. The French branch also took out loans from the company’s head office or from third-party companies Following an audit of the branch’s accounts, the tax authorities, after considering that these loans revealed an insufficiency of the contribution made by the head office, particularly in relation to the equity capital that the branch should have had if it had had legal personality, refused to allow the interest corresponding to the fraction of the loans deemed excessive to be deducted from the results taxable in France in respect of the branch’s activity and demanded that the company pay additional corporation tax for the financial year ending in 1994, together with increases In order to justify this reassessment, the tax authorities first argued, during the contradictory reassessment procedure, that the disputed interest characterized a transfer of profits to the German head office within the meaning of Article 57 of the General Tax Code, and then by way of substitution of a legal basis that the interest was not borne by an autonomous company carrying on the same or similar activities as the branch under the same or similar conditions and dealing with the company’s head office as an independent company within the meaning of the provisions of Article 209(I) of the General Tax Code in conjunction with the stipulations of Article 4 of the Franco-German tax treaty of 21 July 1959; In 2008, the Paris administrative court discharged the disputed tax assessment. This decision was then appealed by the tax authorities to the Supreme Administrative Court. Judgement of the Supreme Administrative Court The Supreme Administrative Court upheld the decision of the administrative court and dismissed the appeal of the tax authorities. Excerpts “Considering, on the other hand, that there is no need, in order to interpret the stipulations of Article 4(2) cited above, to refer to the comments formulated by the Tax Committee of the Organisation for Economic Co-operation and Development (OECD) on Article 7 of the model convention drawn up by this organisation, since these comments were made after the adoption of the stipulations in question; that, in the wording applicable to the facts of the case, these provisions must be understood as authorising the State of the branch to attribute to the branch the profits that the interested party would have made if, instead of dealing with the rest of the company, it had dealt with separate companies under ordinary market conditions and prices; that, on the other hand, these stipulations do not have the object or, consequently, the effect of allowing that State to attribute to the branch the profits which would have resulted from the contribution to the interested party of own funds of an amount different from that which, entered in the accounting records produced by the taxpayer, faithfully retraces the withdrawals and contributions made between the various entities of the company; that, in particular, the tax authorities cannot substitute for this latter amount the equity capital with which the branch should have been endowed, by virtue of the applicable regulations or with regard, in particular, to the outstanding risks to which it is exposed, if it had enjoyed legal personality; 7. Considering that it follows from this that the terms of Article 209(I) of the General Tax Code subjecting to corporation tax “profits the taxation of which is attributed to France by an international convention on double taxation” could not, any more than the terms and rules mentioned in point 3, have the effect of attributing to the French tax authorities the taxation of profits established in accordance with the disputed reassessments; 8. Considering that it follows from all the above that, without needing to rule on the objection raised by HVB-AG, the Paris Administrative Court of Appeal, which was not required to respond to all the arguments raised before it, sufficiently reasoned its decision and did not commit an error of law, nor did it distort the documents in the file submitted to it by ruling, after having dismissed the domestic law grounds on which the tax authorities intended to base the contested taxes, that the stipulations of Article 4 of the Franco-German tax treaty could not be usefully invoked for the same purpose; that, consequently, the Minister responsible for the budget is not entitled to request the annulment of the judgment he is challenging;” Click here for English translation Click here for other translation ...

Lender S.A had granted a loan to a related entity but had not collected the agreed interest payments and not added the interest to its taxable income. The tax authorities stated that granting an interest-bearing loan to a related entity but not collecting the interest still results in taxable revenue. The reason Lender S.A. did not collect interest on the loan was due to the group relationship. Lender S.A. filed an appeal where it argued that since the interest was not received, it could not be taxed. Judgement of the Court The Supreme Administrative Court stated that the arm’s length principle applies to agreements concluded on arm’s length terms, where these are not implemented in accordance with there wording. Hence, the arm’s length standard also applies when the parties do not follow the agreement. Click here for English translation Click here for other translation ...

This case concerned the Danish company, Swiss Re, Copenhagen Holding ApS, which was wholly owned by the US company, ERC Life Reinsurance Corporation. In 1999 the group considered transferring the German subsidiary, ERC Frankona Reinsurance Holding GmbH, from the US parent company to the Danish company. The value of the German company was determined to be DKK 7.8 billion. The purchase price was to be settled by the Danish Company issuing shares with a market value of DKK 4.2 billion and debt with a market value of DKK 3.6 billion. On 27 May 1999, the parent company and the Danish company considered to structure the debt as a subordinated, zero-coupon note. Compensation for the loan would be structured as a built-in capital gain in order to defer recognition of the compensation for the period 1 July 1999 to 30 June 2000. The Danish company would be unable to use a deduction in income year 1999. A built-in capital gain should be recognized in 2000 where payment of the first instalment would be made. If the compensation were structured as interest payments, the compensation should be recognized on an accrual basis. On 17 June 1999, a bank provided the Danish Company with information about market terms for a zero-coupon loan. On 21 June 1999 the acquisition ofthe German company was approved with effect from 1 July 1999. On 14 September 1999. On 15 October 1999, the parties signed the loan agreement. The principal of the loan was fixed at DKK 4.9 billion corresponding to a market value of DKK 3.6 billion. The effective interest on the loan was 6.1 % per annum. The Capital loss associated with the first instalment on 30 June 2000 was DKK 222 million, which was claimed by the Danish company as a deduction in its tax return for 2000. The Supreme Court affirmed the opinion of the High Court that section 34(5) (Danish statutes of limitation for controlled transactions) covered all types of adjustments of controlled transactions. The income years 1999 and 2000 were thus not time barred. The Court further noted the following : “The Supreme Court notes that the provision in section 2(1) of the Tax Assessment Act under which prices and terms of controlled transactions must comply with the “arm’s length principle” for tax purposes, according to the legislative history covers all relations between the parties, e.g. provision of services, loan agreements, transfer of assets, transfer for use of intangibles etc. According to the provision the tax authorities are entitled to make adjustments of transactions between related parties where a transaction does not reflect what could have been obtained between unrelated parties. The authority to make an adjustment covers all economic elements and other terms of relevance for taxation purposes including, for example, due date, recognition of interest and capital losses and the legal qualification of the transaction. A loan agreement on zero-coupon terms concluded between related parties with retroactive effect may thus be adjusted by the tax authorities on the basis of section 2(1) of the Tax Assessment Act. The Supreme Court further concurs that there is no basis to conclude that a final and binding agreement between Swiss Re Copenhagen Holding ApS and the parent company on the terms of the loan had been concluded before the signing of the loan agreement on 15 October 1999. On this basis the Supreme Court upholds the decision.” The Supreme Court thus held that the loan agreement infringed on the arm’s length principle as laid down in section 2 of the Tax Assessment Act, and that the adjustment made by the tax authorities was warranted. Click here for translation ...

In the Filinvest case an assessment had been issued where the tax authorities had imputed interest on an interest free loan. Judgement of the Tax Court The Court set aside the assessment. The tax authorities power to allocate gross income does not include the power to impute ‘theoretical interest’ because there must be actual or, at the very least, probable receipt or realisation by the taxpayer of the income that is being allocated ...

NatWest is a United Kingdom corporation engaged in international banking activities. For the tax years 1981-1987, NatWest conducted wholesale banking operations in the United States through six permanently established branch locations (collectively “the U.S. Branch”). On its United States federal income tax returns for the years at issue, NatWest claimed deductions for accrued interest expenses as recorded on the books of the U.S. Branch. On audit, the Internal Revenue Service (“IRS”) recomputed the interest expense deduction according to the formula set forth in Treasury Regulation § 1.882-5. The formula excludes consideration of interbranch transactions for the determination of assets, liabilities, and interest expenses. Treas. Reg. § 1.882-5(a)(5) (1981).2 The formula also imputes or estimates the amount of capital held by the U.S. Branch based on either a fixed ratio or the ratio of NatWest’s average total worldwide liabilities to average total worldwide assets. Id. § 1.882-5(b)(2). Pursuant to the IRS’s recalculation of the interest expense deduction, NatWest’s taxable income was increased by approximately $155 million for the years at issue. NatWest concluded that the increased income would result in an additional tax liability of at least $37 million in the United States for which a foreign tax credit would not be available in the United Kingdom. NatWest thus requested, under Article 24 of the 1975 Treaty, that the United Kingdom enter competent authority proceedings with the United States to resolve the double taxation issue. Pursuant to the competent authority proceedings, the United Kingdom presented NatWest with a settlement offer, which NatWest concluded did not sufficiently address its double taxation concerns. NatWest rejected the settlement offer, paid the additional taxes, and filed suit in 1995, claiming that the IRS’s application of § 1.882-5 to an international bank such as NatWest violated the terms of the 1975 Treaty. The 1975 US/UK Double Taxation Treaty contained an Article 7 in similar terms to Article 8 of the 1976 Convention. In the first of three cases, NatWest claimed that the formula used in the Treasury Regulation to calculate deductible interest was inconsistent with Article 7 of the Treaty. The United States Court of Federal Claims upheld the claim. In relation to Article 7 of the US/UK Treaty it said: “The foregoing examination of Article 7 of the Treaty, pre-ratification reports of the Treasury Department and the Senate, and Commentaries intended to assist in interpretation leads to the conclusion that the Treaty contemplates that a foreign banking corporation in the position of plaintiff will be subjected to U.S. taxation only on the profits of its U.S. branch and that such profits should be based on the books of account of such branch maintained as if the branch were a distinct and separate enterprise dealing wholly independently with the remainder of the foreign corporation, provided that the financial records of the branch, especially those reflecting intra-corporate lending transactions, are subject to adjustment as may be necessary for imputation of adequate capital to the branch and to insure use of market rates in computing interest expenses. In addition to normal deductible expenses reflected on the books of the branch, as adjusted, there shall be allowed in the determination of the profits of the U.S. Branch a reasonable allocation of general and administrative expenses incurred for the purposes of the foreign enterprise as a whole.” The Treasury Regulation was held to operate contrary to Article 7 for a number of reasons. It treated the branch as a unit of the bank rather than as a separate entity and applied the formula without regard to the actual assets and liabilities shown on the books of the branch. Judgement of the Court The court allowed the appeal of National Westminster. According to the court there is nothing in the language of Article 7 to suggest that the government is allowed to impose capital requirements on a branch that are the same as those imposed on separately-incorporated banks in order to give meaning to the phrase “separate and distinct.” The phrase “separate and distinct” does not mean the branch should be treated as if it were “separately-incorporated,” but instead “separate and distinct,” means separate and distinct from the rest of the bank of which it is a part. Thus, Article 7 of the Treaty simply allows the taxing authorities to adjust the books and records of the branch to ensure that transactions between the branch and other portions of the foreign bank are properly identified and characterized for tax purposes. There is nothing in the plain words of the Treaty that allows the government to adjust the books and records of the branch to reflect “hypothetical” infusions of capital based upon banking and market requirements that do not apply to the branch. In short, the government’s reading of Article 7 goes too far ...

This case concerns the tax treatment of a sophisticated financing transaction, known as a “weak currency financing scheme”, undertaken by Shell Canada. In 1988, Shell Canada required about $100 million in United States currency (“US$”) for general corporate purposes. The market rate for a direct borrowing of US$ was 9.1 percent. Instead of borrowing US$ directly, however, Shell Canada entered into two agreements. The first agreement (the “Borrowing Contract”), involved the appellant borrowing $150 million in New Zealand currency (“NZ$”) at an interest rate of 15.4 percent per annum (which was found to be the market rate for borrowing NZ$). The second agreement (the “Purchasing Contract”), involved the appellant using the New Zealand funds to purchase US$100 million at the market price. In order to fulfill Shell Canada’s requirement for New Zealand dollars, the Purchasing Contract provided for the appellant to purchase enough New Zealand dollars to satisfy the interest payments under the Borrowing Contract and for the appellant to purchase NZ$150 million for US$79 million on the date when the principal came due under the Borrowing Contract. The difference in the cost of the NZ$150 million at the time the Borrowing Contract was entered (US$100 million) and at the time the principal was to be repaid (US$79 million) resulted in a US$21 million “gain” to Shell Canada. In computing its tax liability, Shell Canada deducted the 15.4 percent interest it had paid under the Borrowing Contract and characterized the US$21 million gain as a capital gain. The tax authorities reassessed the tax liability by allowing only the cost of directly borrowing US$ (9.1 percent) as an interest expense and characterized the “gain” as income. Shell Canada appealed to the Tax Court where the court found in favour of Shell Canada and allowed the full 15.4 percent to be deducted as an expense. The Tax Court also characterized the gain as a capital gain: An appeal was then filed by the tax authorities with the Court of Appeal. The Court of Appeal reversed the Tax Court’s finding with respect to the interest deduction applying an “economic substance over form” doctrine which essentially dictated that the Borrowing Contract and Purchasing Contract be considered together: [1998] 3 F.C. 64. This in turn led the Court of Appeal to a determination that the 15.4 percent interest rate expense claimed failed to comply with three of the requirements that must be satisfied for a claimed expense to qualify as “interest” under the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.): it was not interest, it was not used for the purpose of earning income and it was not reasonable. Therefore, the Court of Appeal disallowed any interest expense claimed above 9.1 percent – the direct cost of borrowing US$. Shell Canada then filed an appeal with the Supreme Court on that issue. Judgement of the Court Excerpt “10 The respondent’s argument on the capital gain issue would not, if accepted, uphold the judgment of the Court of Appeal. According to that judgment, the appellant may claim an interest expense of 9.1 percent per annum on the principal amount borrowed under the Borrowing Contract in the computation of its taxable income. The respondent says that if the appeal against that ruling succeeds, the respondent ought to be free to argue that the tax burden thus reduced should nevertheless be restored in whole or in part by recharacterizing the gain on the Borrowing Contract as income rather than capital. 11 In my view, the respondent would be required to obtain leave to cross-appeal before raising this issue at the hearing of the appeal. 12 In the first place the judgment of the Federal Court of Appeal dated February 18, 1998 refers the matter back to the Minister “to be reassessed in accordance with the Reasons for Judgment herein”. The Minister’s authority is thus closely circumscribed by the reasons as well as the outcome of the appeal to that court. 13 Secondly, there is no reason to believe (and the respondent has not offered any proof) that the net effect of reclassifying the US$21 million gain as income would be the same as the net effect on the appellant’s tax burden of the reasons for judgment of the Court of Appeal. If the tax burden calculated under the respondent’s alternative argument differs from the tax burden calculated under the Court of Appeal’s judgment, then recharacterizing the gain as income rather than capital would not uphold even the outcome, much less the reasons for judgment of the Federal Court of Appeal. 14 Accordingly, if the respondent wishes to keep the capital gain issue alive in this Court, she cannot do so without leave. The proper procedure would be to now serve and provide the Court with the proposed leave application with respect to the cross appeal, accompanied by an application for an extension of time within which to file same, as set out in the Notice to the Profession dated January 1996. The leave panel may then determine whether it is appropriate to have all aspects of the “weak currency financing scheme” before the Court on the main appeal. Click here for translation ...

Conclusion of the Tax Court: “The substance of the transactions is revealed in the lack of arm’s-length dealing between LIIBV and petitioners, the circular flow of funds, and the conduct of the parties by changing the terms of the agreements when needed to avoid deadlines. The Laidlaw entities’ core management group designed and implemented this elaborate system to create the appearance that petitioners were paying interest, while in substance they were not. We conclude that, for Federal income tax purposes, the advances from LIIBV to petitioners for which petitioners claim to have paid the interest at issue are equity and not debt. Thus, petitioners may not deduct the interest at issue for 1986, 1987, and 1988.” NOTE: 13 October 2016 section 385 of the Internal Revenue Code was issued containing regulations for re-characterisation of Debt/Equity for US Inbound Multinationals. Further, US documentation rules in Treasury Regulation § 1.385-2 facilitate analysis of related-party debt instruments by establishing documentation and maintenance requirements, operating rules, presumptions, and factors that impact treatment of a debt instrument as debt or equity ...

The Lever Brothers and Unilever tax case concerned the determination of the source of interest income. It established tax principles that were valid for more than 50 years until they were superseded by changes in the law. The main issue was the application and validity of the practical man principle, and it was concluded that this principle should be applied, not in place of legal theory, but to restrain its unbridled application where it would lead to unfair results. Click here for translation ...