In 2011, Petrolia SE established a wholly owned subsidiary in Norway – Petrolia Noco AS – to conduct oil exploration activities on the Norwegian shelf. From the outset, Petrolia Noco AS received a loan from the parent company Petrolia SE. The written loan agreement was first signed later on 15 May 2012. The loan limit was originally MNOK 100 with an agreed interest rate of 3 months NIBOR with the addition of a margin of 2.25 percentage points. When the loan agreement was formalized in writing in 2012, the agreed interest rate was changed to 3 months NIBOR with the addition of an interest margin of 10 percentage points. The loan limit was increased to MNOK 150 in September 2012, and then to MNOK 330 in April 2013. In the tax return for 2012 and 2013, Petrolia Noco AS demanded a full deduction for actual interest costs on the intra-group loan to the parent company Petrolia SE. An assessment was issued by the tax authorities for these years, where the interest deductions had been partially disallowed. The assessment for these years was later upheld in court. For FY 2014, 2015 and 2016, Petrolia Noco AS had also claimed a full deduction for actual interest costs on the entire intra-group loan to the parent company. It is the assessment for these years that is the subject of dispute in this case. The assessment was first brought to the Court of Oslo where a decision in favour of the tax authorities was issued in November 2021. This decision was appealed by Petrolia Noco AS to the Court of Appeal. Judgement of the Court The Court of Appeal dismissed the appeal and decided in favour of the Norwegian tax authorities. Excerpts “The Court of Appeal also agrees with the state that neither the cost plus method nor a rationality analysis can be considered applicable in this case. With the result the Court of Appeal has reached so far, the CUP method should be preferred – in line with the OECD guidelines. After this, in summary, it appears clear that the interest margin on the intra-group loan is significantly higher than in a comparable and independent market and thus not an arm’s length price. The higher interest implies a reduction in the appellant’s income, cf. Tax Act section 13-1 first paragraph. The Court of Appeal cannot see that the adjustments claimed by the appellant change this. In the Court of Appeal’s view, it is also clear that the reduction in income has its cause in the community of interest. Whether adjustments should be made to the basis of comparison at the time of the price change, the Court of Appeal comes back to when assessing the exercise of discretion. Consequently, there was access to a discretionary determination of the appellant’s income according to Section 13-1 first paragraph of the Tax Act, also with regard to the interest margin.” “In the Court of Appeal’s view, additional costs that would have been incurred by independent parties, but which are not relevant in the controlled transaction, must be disregarded. Reference is made to the OECD guidelines (2020) point C.1.2.2, section 10.96: In considering arm’s length pricing of loans, the issue of fees and charges in relation to the loan may arise. Independent commercial lenders will sometimes charge fees as part of the terms and conditions of the loan, for example arrangement fees or commitment fees in relation to an undrawn facility. If such charges are seen in a loan between associated enterprises, they should be evaluated in the same way as any other intra-group transaction. In doing so, it must be borne in mind that independent lenders’ charges will in part reflect costs incurred in the process of raising capital and in satisfying regulatory requirements, which associated enterprises might not incur. The decisive factor is whether the costs or rights that the effective interest margin in the observed exploration loans between independent parties is an expression of, are also relevant in the intra-group loan. As far as the Court of Appeal understands, the appellant does not claim that various fees or costs incurred in exploration loans from a bank have been incurred in the intra-group loan, and in any case no evidence has been provided for this. In the Court of Appeal’s view, such costs and fees are therefore not relevant in the comparison. The appellant, on the other hand, has stated that the loan limit that Petrolia SE had made available, and the fact that the loan limit was increased if necessary, means that a so-called “commitment fee”, which accrues in loans between independent parties where an unused credit facility is provided, must be considered built into the agreed interest rate. In the Court of Appeal’s view, Petrolia SE cannot be considered to have had any obligation to make a loan limit available or to increase the loan limit if necessary. It appears from the loan agreement point 3.2 that the lender could demand repayment of the loan at its own discretion. The appellant has stated that this did not entail any real risk for the borrower. It is probably conceivable that Petrolia SE did not intend for this clause to be used, and that the appellant had an expectation of this. In this sense, it was a reality in the loan framework. However, it is clear, and acknowledged by the appellant, that the point of financing the appellant through loans rather than higher equity was Petrolia SE’s need for flexibility. Thus, it appears to the Court of Appeal that it is clear that the appellant had no unconditional right to the unused part of the loan limit. The Court of Appeal therefore believes that the Board of Appeal has not made any mistakes by comparing with nominal interest margins. On this basis, the Court of Appeal can also see no reason why it should have been compared with the upper tier of the observed nominal interest margins in the exploration loans between independent parties. In ...

Following an audit, Mauser S.p.A. received four notices of assessment relating to the tax periods from 2004 to 2007. These notices contested, in relation to all tax periods, the elusive purpose of a financing operation of Mauser S.p.A. by the non-resident parent company, as it was aimed at circumventing the non-deductibility of interest expense pursuant to Article 98 pro tempore of Presidential Decree No. 917 of 22 December 1986 (TUIR) on the subject of thin capitalisation. The loan, which began in 2004, had resulted in the recognition of €25,599,000.00 among other reserves, indicated as a payment on account of a future capital increase, as well as €55,040,474.29 as an interest-bearing shareholder loan, the latter of which was subsequently partly waived and also transferred to reserves. The loan had also contributed to the generation of losses in the years in question, which had been covered through the use of the aforementioned reserve (as a reserve), whose interest paid to the parent company had then been deducted from taxable income. According to the tax authorities the payment on account of a future capital increase constituted a financial debt towards the sole shareholder and not (as indicated by the taxpayer) a capital contribution, which therefore would not have contributed to the determination of the relevant net equity pursuant to Article 98 TUIR; as a result, the equity imbalance between loans and adjusted net equity pursuant to Article 98, paragraphs 1 and 2, letter a) TUIR pro tempore (net equity increased by the capital contributions made by the shareholder) would have been configured. Consequently, the tax authorities had concluded that the financing transaction as a whole was elusive in nature, as it was of a financial nature and aimed at circumventing the prohibition of the remuneration of the shareholders’ loan in the presence of the thin capitalisation requirements. With the notice relating to the 2006 tax year, Mauser S.p.A. was also charged with a second finding, relating to the infringement of the transfer pricing provisions pursuant to Article 110, paragraph 7 in relation to transactions involving the sale of intra-group assets. The tax authorities, while noting that Mauser S.p.A. had used the cost-plus computation method for the purpose of the correct application of the OECD rules on transfer pricing, had observed that following the merger of Gruppo Maschio SPA – for whose acquisition the above mentioned financing was intended – a merger deficit had resulted, partly allocated to goodwill of the target company. The tax authorities considered that the portion of goodwill amortisable for the year 2006 should be included in the cost base, increasing the percentage of overhead costs as a percentage of production costs, contributing to increase the total cost for the purpose of determining the arm’s length remuneration. Mauser S.p.A. raised preliminary issues relating to the breach of the preventive cross-examination procedure and the forfeiture of the power of assessment, considering the provision of Article 37-bis of Presidential Decree No. 600 of 29 September 1973 to be inapplicable to the case at hand, and also considering the existence of valid economic reasons consisting in the purpose of the acquisition of the company, which was then effectively merged. He then deduced that the method of calculating the transfer prices was erroneous insofar as the Office had included the amortisation quota of the goodwill allocated to the merger deficit. The C.T.P. of Milan upheld the merits of the joined appeals of Mauser S.p.A. An appeal was then filed by the tax authorities and in a ruling dated 19 May 2015, the Lombardy Regional Administrative Court decided in favour of the tax authorities, holding that the loans “were not used in accordance with the rules envisaged in such cases, but were instead used to cover the company’s losses”, and then held that the transfer price recovery was also correct, on the assumption that the amortisation of goodwill was legitimate. Mauser S.p.A. then filed an appeal with the Supreme Court, relying on six grounds. In the first ground of appeal Mauser S.p.A. points out that the grounds of the judgment do not contain adequate evidence of the logical path followed, also in view of the failure to transcribe the judgment at first instance and the arguments of the parties, as well as the statement of the facts of the case. Mauser S.p.A. observes that the confirmation of the finding as to the evasive nature of the financing transaction shows mere adherence to the position of one of the parties to the proceedings without any statement of reasons, nor does it consider what the regulatory provisions subject to assessment would be in relation to both profiles. It also observes how the reasoning relating to the confirmation of the transfer pricing relief refers to facts other than those alleged by the Office. Judgement of the Supreme Court The Supreme Court upheld the first ground of appeal and declared the other grounds of appeal to be absorbed; set aside the judgment under appeal and refered the case back to the Lombardy Regional Administrative Court, in a different composition. Excerpts “The first ground is well founded, agreeing with the conclusions of the Public Prosecutor. The two recoveries made by the Office presuppose – the first – the qualification (for the purposes of the financial imbalance referred to in Art. The two recoveries made by the Office presuppose – the first – the classification (for the purposes of the financial imbalance referred to in Article 98 TUIR pro tempore) of the future capital contribution made by the sole shareholder of the taxpayer company as a debt item and not as a capital reserve item (entered among the other reserves), a fundamental circumstance for the purposes of considering whether or not it contributes to the portion of adjusted shareholders’ equity ‘increased by the capital contributions made by the same shareholder’, capable of constituting the financial imbalance referred to in Article 98 TUIR cited above. Similarly (considering that the Office has moved in the direction of an overall elusive activity), proof is ...

Accordingly, this guidance is not intended to prevent countries from implementing approaches to address the balance of debt and equity funding of an entity and interest deductibility under domestic legislation, nor does it seek to mandate accurate delineation under Chapter I as the only approach for determining whether purported debt should be respected as debt ...

Apex Tool Holding France acquired all the shares of Cooper Industrie France, which has since become Apex Tool France. This transaction was financed by a ten-year vendor loan at a rate of 6%. This claim on Apex Tool Holding France was transferred on the same day by the seller to the parent company of this company, which is the head of a global group specialising in tool manufacturing and thus, from that date, the creditor of its subsidiary. Apex Tool Holding France reintegrated the fraction of interest relating to this intra-group loan exceeding the average annual effective rate charged by credit institutions for variable-rate loans granted to companies into its income for the years 2011 to 2013. Apex considered that an interest rate of 6 % was in line with that which it could have obtained from independent financial institutions or organisations under similar conditions. The analysis was set aside by the tax authorities and an assessment was issued where the deduction of interest had been reduced. Apex filed an appeal with the Administrative Court of Appeal. The Court found in favor of the tax authorities in a decision issued in March 2020. An appeal was then filed by Apex with the Supreme Court. Judgement of the Court The Supreme Court set aside the decision of the Court of Appeal and issued a decision in favor of Apex Tool Group. Excerpts (Unofficial English translation) “3. It is clear from the documents in the file submitted to the trial judges that in order to establish that the rate of 6% at which ATFH1 had paid the loan granted to it by its parent company, which was higher than the rate provided for in the first paragraph of 3° of 1 of Article 39 of the General Tax Code, was not higher than the rate that this company would have obtained from an independent financial institution, the applicant company relied on an initial study drawn up by its counsel. In the absence of previous loans obtained by ATFH1 in 2010, this study first determined the credit rating of the intra-group loan in dispute according to the methodology published by the rating agency Moody’s for the analysis of industrial companies, which took into account the company’s profile, in particular with regard to market data, its size, its profitability, the leverage effect and its financial policy. The rating was set at “BB+”. The study then compared ATHF’s interest rate of 6% with the rates of bond issues over the same period with comparable credit ratings, using data available in the Bloomberg database. The company also relied on an additional study that analysed the arm’s length rate in a sample of bank loans to companies in the non-financial sector with credit ratings ranging from ‘BBB-‘ to ‘BB’. 4. Firstly, in holding that the credit rating assigned to the intra-group loan granted to ATFH1 by the first study in accordance with the methodology set out in point 3 did not reflect the intrinsic situation of that company on the grounds that it had been determined by taking into account the aggregate financial statements of the group that ATHF1 formed with its subsidiaries and sub-subsidiaries whereas, as stated in point 2, for the application of the provisions of Articles 39 and 212 of the General Tax Code, the profile of the borrowing company must in principle be assessed in the light of the financial and economic situation of the group that this company forms with its subsidiaries, the Court erred in law. 5. Secondly, it is clear from the documents in the file submitted to the court that the sample of comparable companies used in the supplementary study, the relevance of which had not been contested by the administration, concerned companies in the non-financial sector such as ATFH1 and which had obtained credit ratings ranging from “BBB-” to “BB”, i.e. one notch above and below the “BB+” credit rating determined for the loan in question in the first study. In dismissing this additional study on the sole ground that the companies in the sample belonged to heterogeneous sectors of activity and that, consequently, it was not established that, for a banker, they would have presented the same level of risk as that of ATFH1, whereas the credit rating systems developed by the rating agencies aim to compare the credit risks of the rated companies after taking into account, in particular, their sector of activity, the Court erred in law. “ Click here for English translation Click here for other translation ...

“M Fastfood S.A” was incorporated as a subsidiary company of an entity not resident in Portuguese territory, M Inc., a company with registered office in the United States. “M Fastfood S.A” had obtained financing from M Inc. for investment in its commercial activity, which resulted in indebtedness totalling EUR 74,000,000.00. The activity of “M Fastfood S.A” is “the opening, assembling, promotion, management, administration, purchase, sale, rental, leasing and cession of exploration of restaurants, for which purpose it may acquire or grant licenses or sub-licenses and enter into franchise contracts. It also includes the purchase, sale, rental, administration and ownership of urban buildings and the acquisition, transfer, exploitation and licensing of copyrights, trademarks, patents and industrial and commercial secrets and, in general, any industrial property rights”. “M Fastfood S.A” was in a situation of excessive indebtedness towards that entity, in light of the average equity capital presented by it in 2004, on 27 January 2005 it submitted a request to the tax authorities for the purposes of demonstrating the equivalence of indebtedness towards an independent entity. Following a tax audit concerning FY 2004 the authorities considered that the interest limitation rule should be applied, which resulted in corrections to the taxable amount in respect of excess interest paid. “M Fastfood S.A” presented a report, which intended to demonstrate that the level and conditions of indebtedness towards M Inc. were similar to those that could be obtained if it had chosen to obtain financing from an independent financial institution. According to the report “M Fastfood S.A.” was, at the time, in a period of strong expansion, which resulted in the opening of 118 fast-food outlets in recent years. That within the scope of its implementation strategy in the national market, the location of the restaurants plays a fundamental role and constitutes a decisive factor for the success of the business. That the ideal or optimum location of the establishments is very costly and therefore substantial investment has become necessary. According to “M Fastfood S.A.”, the conditions obtained were favourable, in particular the interest rates agreed with M Inc., which were lower than those that would be charged by an independent financial institution, presenting as proof financing proposals issued by B… Bank. Based on the report M Fastfood concludes are sufficient to constitute proof that the conditions of the financing considered excessive are similar, or even more favourable, to the conditions practiced by independent entities, the reason why no. 1 of article 61 of the Corporate Income Tax Code is applicable”. The tax authorities found that, the evidence submitted by “M Fastfood S.A.” was insufficient to demonstrate that the debt obtained from M Inc. is at least as advantageous as it would have been had they used an independent financial institution. Decision of Supreme Administrative Court The Supreme Administrative Court set aside the the assessment issued by the tax authorities and decided in favour of “M Fastfood S.A.”. Experts ” … Article 56 EC must be interpreted as meaning that the scope of that legislation is not sufficiently precise. Article 56 EC must be interpreted as precluding legislation of a Member State which, for the purposes of determining taxable profits, does not allow for the deduction as an expense of interest paid in respect of that part of the debt which is classified as excessive, paid by a resident company to a lending company established in a non-member country with which it has special relations, but allows such interest paid to a resident lending company with which the borrowing company has such relations, where, if the lending company established in a third country does not have a holding in the capital of the resident borrowing company, that legislation nevertheless presumes that any indebtedness of the latter company is in the nature of an arrangement intended to avoid tax normally due or where it is not possible under that legislation to determine its scope of application with sufficient precision in advance. As it is up to the national judge faced with such an interpretation to decide on its application to the specific case, it is important to mention that the situation which this review intends to decide on is identical in its contours to the one assessed by the CJEU. In fact, it is clear that the situation at issue in this review falls within the scope of the free movement of capital, and that it translates into less favourable tax treatment of a resident company that incurs indebtedness exceeding a certain level towards a company based in a third country than the treatment reserved for a resident company that incurs the same indebtedness towards a company based in the national territory or in another Member State. What is at issue is deciding whether such discrimination may be justified as a means of avoiding practices the sole purpose of which is to avoid the tax normally payable on profits generated by activities carried on within the national territory. However, although we agree with the CJEU that the provisions in question – Articles 61 and 58 of the CIRC – are appropriate as a means of preventing tax avoidance and evasion, we must agree with the Court that such a restriction is disproportionate to the intended aim. As the court in question correctly states “as article 58 of the CIRC covers situations which do not necessarily imply a participation by a third country lending company in the capital of the resident borrowing company and as it can be seen that the absence of such a participation results from the company’s being a resident borrower”, the Court agrees with the Court. in the absence of such participation, it results from the method of calculation of the excess debt provided for in Article 61(3) that any debt existing between these two companies should be considered excessive, Article 61 consecrates a discriminatory measure which limits the free movement of capital as only non-resident entities are subject to the regime of Article 61 of the CIRC when IRC tax ...

In 2011, Petrolia SE established a wholly owned subsidiary in Norway – Petrolia Noco AS – to conduct oil exploration activities on the Norwegian shelf. From the outset, Petrolia Noco AS received a loan from the parent company Petrolia SE. The written loan agreement was first signed later on 15 May 2012. The loan limit was originally MNOK 100 with an agreed interest rate of 3 months NIBOR with the addition of a margin of 2.25 percentage points. When the loan agreement was formalized in writing in 2012, the agreed interest rate was changed to 3 months NIBOR with the addition of an interest margin of 10 percentage points. The loan limit was increased to MNOK 150 in September 2012, and then to MNOK 330 in April 2013. In the tax return for 2012 and 2013, Petrolia Noco AS demanded a full deduction for actual interest costs on the intra-group loan to the parent company Petrolia SE. Following an audit for FY 2012 and 2013, the tax authorities concluded that parts of the intra-group loan should be reclassified from loan to equity due to thin capitalization. Thus, only a deduction was granted for part of the interest costs. Furthermore, the authorities reduced the interest rate from 10 per cent to 5 per cent. For the income years 2012 and 2013, this meant that the company’s interest costs for distribution between the continental shelf and land were reduced by NOK 2,499,551 and NOK 6,482,459, respectively, and financial expenses by NOK 1,925,963 and NOK 10,188,587,respectively. The assessment was first brought to the Court of Oslo where a decision in favour of the tax authorities was issued in November 2019. This decision was appealed by Petrolia Noco AS to the Court of Appeal. Judgement of the Court The Court of Appeal also decided in favour of the Norwegian tax authorities. Excerpts “The Court adds for this reason that the appellant had higher debt ratio than the company could have had if the loan should have been taken up from an independent lender. In the Court of Appeal’s view, the fact that the appellant actually took out such a high loan as the intra-group loan is solely due to the fact that the lender was the company’s parent company. For this reason, there was a ” reduction ” in the appellant income ” due to” the community of interest. There is thus access to discretion in accordance with the Tax Act § 13-1 first paragraph.” “Thus, there is no basis for the allegation that the Appeals Board’s decision is based on an incorrect fact on this point, and in any case not a fact to the detriment of the appellant. Following this, the Court of Appeal finds that there are no errors in the Appeals Board’s exercise of discretion with regard to the determination of the company’s borrowing capacity. The decision is therefore valid with regard to the thin capitalization.” “The Court of Appeal otherwise agrees with the respondent that the cost- plus method cannot be considered applicable in this case. Reference is made to LB-2016-160306, where it is stated : For loans, however, there is a market, and the comparable prices are margins on loans with similar risk factors at the same time of lending . The cost- plus method provides no guidance for pricing an individual loan. An lender will, regardless of its own costs , not achieve a better interest rate on lending than what is possible to achieve in the market. The Court of Appeal agrees with this, and further points out that the risk picture for Petrolia Noco AS and Petrolia SE was fundamentally different. The financing costs of Petrolia SE therefore do not provide a reliable basis for assessing the arm’s length interest rate on the loan to Petrolia Noco AS.” “…the Court of Appeal can also see no reason why it should have been compared with the upper tier of the observed nominal interest margins in the exploration loans between independent parties. In general, an average such as the Appeals Board has been built on must be assumed to take into account both positive and negative possible variables in the uncontrolled exploration loans in a responsible manner. The Court of Appeal cannot otherwise see that the discretion is arbitrary or highly unreasonable. The decision is therefore also valid with regard to the price adjustment.” Click here for translation ...

A intercompany loan had been granted within the Apex Tool group at an interest rate of 6 percent and to demonstrate the arm’s length nature of the interest rate the borrowing company provided a comparability analyses. The analysis was set aside by the tax authorities and an assessment was issued where the deduction of interest had been reduced. Apex then filed an appeal with the Administrative Court of Appeal. Judgement of the Court The Court dismissed the analyses provided by Apex and upheld the assessment of the tax authorities. Excerpts (Unofficial English translation) “9. The investigation shows that the credit rating assigned to the loan in question by Baker and McKenzie, after several adjustments, was not based on the intrinsic situation of ATHF1, particularly with regard to its lending activity and its development prospects. On the contrary, it was allocated on the basis of the aggregate financial statements of the sub-group it formed with four of its subsidiaries and sub-subsidiaries, only one of which, in any event, carried out the industrial activity that Apex Tool Group claims was the only relevant basis for comparison, in the absence of a basis for holding companies other than investment companies and conglomerates. Furthermore, although it is not excluded that the arm’s length rates can be evaluated by taking into account the yield of bond loans, this is only on condition, even supposing that the loan taken out constitutes a realistic alternative to an intra-group loan, that the companies serving as references are in comparable economic conditions. In the case in point, this condition cannot be considered to have been met for the companies in the Baker and McKenzie sample, for which it is only argued, firstly, that they have credit ratings close to that attributed to the ATHF1 loan and, secondly, that they had recourse to the bond market for transactions of the same duration and maturity. Lastly, although the additional study produced by Apex Tool Group shows arm’s length rates close to those obtained by ATHF1 from its parent company, it has not been established that the so-called comparable companies in the study sample, belonging to heterogeneous sectors of activity, would have presented the same level of risk for a banker as that which ATHF1 faced at the same time. Under these conditions, Apex Tool Group, which did not submit to the judge any offer of a loan from a banking establishment, does not provide the proof that ATHF1 was entitled to deduct the interest on the disputed loan up to the rate of 6% that it had actually paid.” “10. Under the terms of 1. of II of Article 212 of the General Tax Code: “When the amount of interest paid by a company to all directly or indirectly related companies within the meaning of Article 39(12) and deductible in accordance with I simultaneously exceeds the following three limits in respect of the same financial year: / a) The product corresponding to the amount of the said interest multiplied by the ratio existing between one and a half times the amount of the equity capital, assessed at the choice of the company at the opening or at the closing of the financial year and the average amount of the sums left or made available by all of the companies directly or indirectly linked within the meaning of Article 12 of Article 39 during the course of the financial year, b) 25% of the current result before tax previously increased by the said interest, the depreciation taken into account for the determination of this same result and the share of leasing rentals taken into account for the determination of the sale price of the asset at the end of the contract, /c) The amount of interest paid to this company by companies directly or indirectly linked within the meaning of Article 12 of Article 39, / the fraction of interest exceeding the highest of these limits cannot be deducted in respect of this financial year, unless this fraction is less than 150,000 . / However, this fraction of interest which is not immediately deductible may be deducted in respect of the following financial year up to the amount of the difference calculated in respect of that financial year between the limit mentioned in b and the amount of interest allowed for deduction under I. The balance not deducted at the end of this financial year is deductible in respect of subsequent financial years under the same conditions, subject to a discount of 5% applied at the beginning of each of these financial years. 11. Since ATHF1 was unable to benefit from the deductibility of the financial expenses arising from the loan taken out on 4 July 2010 beyond the rates of 3.91% and 3.39% set for the financial years ending in 2011 and 2012 respectively, it was not eligible for the extension of the deductibility limits set by II of Article 212 of the General Tax Code. Consequently, Apex Tool Group’s request that the calculation of ATHF1’s thin capitalisation interest be adjusted so that the balance of its interest subsequently carried forward at 31 December 2013 is increased from EUR 1,435,512 to EUR 2,401,651 can only be rejected. 12. It follows from all the foregoing that Apex Tool Group SAS is not entitled to argue that the Administrative Court of Melun wrongly rejected the remainder of its claim. Consequently, its claims for the application of Article L 761-1 of the Code of Administrative Justice can only be rejected.” Click here for English translation Click here for other translation ...

Accordingly, this guidance is not intended to prevent countries from implementing approaches to address the balance of debt and equity funding of an entity and interest deductibility under domestic legislation, nor does it seek to mandate accurate delineation under Chapter I as the only approach for determining whether purported debt should be respected as debt ...

In 2011, Petrolia SE established a wholly owned subsidiary in Norway – Petrolia Noco AS – to conduct oil exploration activities on the Norwegian shelf. From the outset Petrolia Noco AS received a loan from the parent company Petrolia SE. The written loan agreement was first signed later on 15 May 2012. The loan limit was originally MNOK 100 with an agreed interest rate of 3 months NIBOR with the addition of a margin of 2.25 percentage points. When the loan agreement was formalized in writing in 2012, the agreed interest rate was changed to 3 months NIBOR with the addition of an interest margin of 10 percentage points. The loan limit was increased to MNOK 150 in September 2012, and then to MNOK 330 in April 2013. In the tax return for 2012 and 2013, Petrolia Noco AS demanded a full deduction for actual interest costs on the intra-group loan to the parent company Petrolia SE. Following an audit for FY 2012 and 2013, the tax authorities concluded that parts of the intra-group loan should be reclassified from loan to equity due to thin capitalization. Thus, only a deduction was granted for part of the interest costs. Furthermore, the authorities reduced the interest rate from 10 per cent to 5 per cent. For the income years 2012 and 2013, this meant that the company’s interest costs for distribution between the continental shelf and land were reduced by NOK 2,499,551 and NOK 6,482,459, respectively, and financial expenses by NOK 1,925,963 and NOK 10,188,587,respectively. The Court decided in favor of the Norwegian tax authorities. Click here for translation ...

The draft Guideline provides guidance to entities in applying the arm’s length debt test in Division 820 of the Income Tax Assessment Act 19972 and should be read in conjunction with draft Taxation Ruling TR 2019/D2 Income tax: thin capitalisation – the arm’s length debt test. This Guideline also provides a risk assessment framework that outlines our compliance approach to an application of the arm’s length debt test in certain circumstances that are identified as low risk. The arm’s length debt test is one of the tests available to establish an entity’s maximum allowable debt for thin capitalisation purposes. The test focuses on identifying an amount of debt a notional stand-alone Australian business would reasonably be expected to borrow, and what independent commercial lenders would reasonably be expected to lend on arm’s length terms and conditions. An entity’s debt deductions are reduced to the extent that its adjusted average debt exceeds its maximum allowable debt. The arm’s length debt test may be used to support debt deductions for commercially justifiable levels of debt. In practice, the test is typically only used when an entity is unable to satisfy the safe harbour and worldwide gearing tests (as the compliance burden of applying these tests is generally lower). It is not common for Australian businesses to gear in excess of 60% of their net assets and historically relatively few entities have applied the arm’s length debt test. We consider the choice to apply the arm’s length debt test carries with it the necessity to undertake more rigorous analysis than the safe harbour and worldwide gearing tests. While the arm’s length debt test in some respects draws upon arm’s length concepts that are broadly common to transfer pricing, the test itself is not a transfer pricing analysis, nor does it necessarily proxy an outcome consistent with the arm’s length conditions under Subdivision 815-B. Rather it requires an overlay of factual assumptions that produce a hypothetical entity against which specific factors are to be assessed. This Guideline is limited to providing guidance and a risk assessment framework relating to the application of the arm’s length debt test contained in sections 820-105 and 820-215. It does not set out our approach to reviewing other taxation issues that might arise in relation to debt deductions ...

A Polish subsidiary in a German Group had taken out a significant inter-company loan resulting in a significantly reduced income due to interest deductions. At issue was application of the Polish arm’s length provisions and the arm’s length nature of the interest rate on the loan. The tax authorities had issued an assessment where the interest rate on the loans had been adjusted and the taxable income increased. On that basis, a complaint was filed by the company to the Administrative Court. The administrative court rejected the complaint and ruled in favor of the tax authorities. An appeal was then brought before the Supreme Administrative Court. The Supreme Administrative Court rejected the appeal, although it did not share some of the conclusions and statements of the Court of first instance. The key issue in the case was to determine is whether the provisions of Art. 11 (Containing the Polish arm’s length provisions), allowing the authority to determine the income of the Company and the tax due without taking into account the conditions arising from existing relationships, including capital applies. Art. 11 paragraph 1 and paragraph 4. allows for the this provision to apply if three cumulative conditions are met: 1) the existence of connections between the parties referred to in art. 11 paragraph 1 points 1-3 or in para. 4 item 1 or 2 update; 2) the impact of these connections resulting in conditions that differ from those that would be agreed between independent entities; 3) the taxpayer’s failure to recognize income or income lower than would be expected if the above mentioned connections had not been there. The Supreme Administrative Court agreed that these cumulative conditions are met. The authority has made estimates of income on the basis of § 21 paragraph. 1 and 2 cited above. Regulation in the light of which it rules, if the taxpayer to provide an entity affiliated with the taxpayer loan ( credit ) or will receive such a loan ( credit ), regardless of their purpose and destiny, or also give or receive in any form of warranty or guarantee, the price of the market for this service are the interest or commission or other form of remuneration, which agreeing on for such a service, provided on comparable terms , entities independent ( paragraph. 1). The arm’s length interest rate is determined on the basis of the interest, that the entity would have to pay an independent party for obtaining a loan ( loans ) for the same period in comparable circumstances. However, according to the Supreme Administrative Court the inter group loan agreement differs from the typical loan agreements concluded by banks. The applicant does not conduct an economic activity identical to that of banks; With regard to the nature of the transaction applicant suffered much less risk of insolvency of a counter party, than borne by the bank in relation to the borrowers; The Company had a much greater possibility of controlling the situation of the financial and solvency of the counter party in the course of the duration of the contract than the bank in case of a contract of credit; The applicant does not bear the costs of verifying the ability of credit counter party and had the opportunity to immediately recover the funds provided in the framework of the agreement, which differ from the conditions defined by the parties of the contract of credit, concluded with the bank; The applicant does not incur other costs associated with granting and service the loan , which usually bear the banks; The applicant functioning in the group ‘s capital, implemented assumptions and tasks of economic different from those, which are the essence of the activities of entities operating on the market of services financial. Since comparable transactions between unrelated entities could not be established during the period under consideration, the CUP method was not applicable to the disputed contract. The Supreme Administrative Court states that the judgment under appeal meets the requirements provided for in art. 141 § 4 and fully enables its instance control, despite some shortcomings. The tax authority, while re- examining the case, is not bound within the meaning of the legal assessment contained in the fragment of the justification of the Administrative Court questioned by the Supreme Administrative Court. Instead, the legal assessment contained in this judgment is binding. Considering the, the Supreme Administrative Court dismissed complaint. Click here for translation ...

ARTICLE 9 ASSOCIATED ENTERPRISES 1. Where an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 2. Where a Contracting State includes in the profits of an enterprise of that State – and taxes accordingly – profits on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so included are profits which would have accrued to the enterprise of the first mentioned State if the conditions made between the two enterprises had been those which would have been made between independent enterprises, then that other State shall make an appropriate adjustment to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the other provisions of this Convention and the competent authorities of the Contracting States shall if necessary, consult each other. COMMENTARY ON ARTICLE 9 CONCERNING THE TAXATION OF ASSOCIATED ENTERPRISES 1. This Article deals with adjustments to profits that may be made for tax purposes where transactions have been entered into between associated enterprises (parent and subsidiary companies and companies under common control) on other than arm’s length terms. The Committee has spent considerable time and effort (and continues to do so) examining the conditions for the application of this Article, its consequences and the various methodologies which may be applied to adjust profits where transactions have been entered into on other than arm’s length terms. Its conclusions are set out in the report entitled Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations,’ which is periodically updated to reflect the progress of the work of the Committee in this area. That report represents internationally agreed principles and provides guidelines for the application of the arm’s length principle of which the Article is the authoritative statement. Paragraph 1 2. This paragraph provides that the taxation authorities of a Contracting State may, for the purpose of calculating tax liabilities of associated enterprises, re-write the accounts of the enterprises if, as a result of the special relations between the enterprises, the accounts do not show the true taxable profits arising in that State. It is evidently appropriate that adjustment should be sanctioned in such circumstances. The provisions of this paragraph apply only if special conditions have been made or imposed between the two enterprises. No re-writing of the accounts of associated enterprises is authorised if the transactions between such enterprises have taken place on normal open market commercial terms (on an arm’s length basis). 3. As discussed in the Committee on Fiscal Affairs’ Report on “Thin Capitalisation” there is an interplay between tax treaties and domestic rules on thin capitalisation relevant to the scope of the Article. The Committee considers that: a) the Article does not prevent the application of national rules on thin capitalisation insofar as their effect is to assimilate the profits of the borrower to an amount corresponding to the profits which would have accrued in an arm’s length situation; b) the Article is relevant not only in determining whether the rate of interest provided for in a loan contract is an arm’s length rate, but also whether a prima facie loan can be regarded as a loan or should be regarded as some other kind of payment, in particular a contribution to equity capital; c) the application of rules designed to deal with thin capitalisation should normally not have the effect of increasing the taxable profits of the relevant domestic enterprise to more than the arm’s length profit, and that this principle should be followed in applying existing tax treaties. 4. The question arises as to whether special procedural rules which some countries have adopted for dealing with transactions between related parties are consistent with the Convention. For instance, it maybe asked whether the reversal of the burden of proof or presumptions of any kind which are sometimes found in domestic laws are consistent with the arm’s length principle. A number of countries interpret the Article in such a way that it by no means bars the adjustment of profits under national law under conditions that differ from those of the Article and that it has the function of raising the arm’s length principle at treaty level. Also, almost all member countries consider that additional information requirements which would be more stringent than the normal requirements, or even a reversal of the burden of proof, would not constitute discrimination within the meaning of Article 24. However, in some cases the application of the national law of some countries may result in adjustments to profits at variance with the principles of the Article. Contracting States are enabled by the Article to deal with such situations by means of corresponding adjustments (see below) and under mutual agreement procedures. Paragraph 2 5. The re-writing of transactions bet ween associated enterprises in the situation envisaged in paragraph 1 may give rise to economic double taxation (taxation of the same income in the hands of different persons), in so far as an enterprise of State A whose profits are revised upwards will be liable to tax on an amount of profit which has already been taxed in the hands of its associated enterprise in State B. Paragraph 2 provides that in these circumstances, State B shall make an appropriate adjustment so as to relieve the double taxation. 6. It ...

At issue was interest in relation to loans between related parties. Pursuant to Article 32(1) ZDDPO-2, interest on loans, except in the case of borrowers from banks and insurance companies, received from a shareholder or partner who, at any time during the tax period, directly or indirectly owns at least 25% of the shares or interests in the capital or voting rights of the taxable person, is not recognised as an expense if, at any time during the tax period, such loans exceed four times (in accordance with the transitional provision 81. The excess of loans is determined by reference to the amount and duration of the excess of loans during the tax period, unless the taxpayer proves that the excess of loans could have been obtained from a lender who is an unrelated person. The claimant argued in the proceedings that it could also have obtained the excess loans from an unrelated person, but failed to prove this. Click here for English translation Click here for other translation ...

There are a number of exceptions to the German interest limitation rule essentially limiting the annual interest deduction to 30% of EBITDA as shown in the accounts. One of these is the equity ratio rule exempting a subsidiary company from the interest limitation provided its equity ratio (ratio of shareholder’s equity to the balance sheet total) is no more than two percentage points lower than that of the group and no more than 10% of its net interest cost was paid to any one significant shareholder (a shareholder owning more than 25% of the share capital). A loss-making company paying slightly less than 10% of its total net interest cost to each of two significant shareholders claimed exemption from the interest limitation as its equity ratio was better than that of the group. The tax office applied the limitation as the two significant shareholders together received more than 10% of the net interest cost. The finance ministry decree on the application of the interest limitation supports this view. The Supreme Tax Court decided in favour of the taxpayer. The interest limitation is an exception to the general principle of taxing the net profit of a company and, as an exception, it must be clearly formulated. Given this demand for clarity, suggestions that applying the 10% limit to all significant shareholders collectively might better reflect the legislative intention have no relevance in the face of the clear wording of the statute – “one shareholder”. Similarly, the same wording also excludes suggestions that each significant shareholder is a related party to all others, since the wording clearly treats each shareholder separately. Click here for English translation Click here for other translation ...

The Supreme Tax Court has requested the Constitutional Court to rule on the conformity of the interest limitation with the constitutional requirement to tax like circumstances alike. The interest limitation disallows net interest expense in excess of 30% of EBITDA. However, the rule does not apply to companies with a total net annual interest cost of no more than €3 m or to those that are not part of a group. There are also a number of other exemptions, but the overall effect is to render the actual impact somewhat arbitrary. In particular, the asserted purpose of the rule – prevention of profit shifts abroad through deliberate under-capitalisation of the German operation – seemed somewhat illusory to the Supreme Tax Court in the light of the relatively high threshold and of the indiscriminate application to cases without foreign connotations. The court also pointed out that interest, as such, is a legitimate business expense and that the limitation rule can penalise financing arrangements generally seen as reasonable. Start-ups and crisis management were quoted as examples. Overall, the court found that the interest limitation rule does not meet the constitutional requirements of equal treatment and consistency of application. It has laid the question before the Constitutional Court for a ruling, together with a detailed explanation of its objections. These are a mixture of doubts on the legitimacy of some of the stated aims of the rule and on its suitability as an instrument in meeting others that are legitimate. Click here for English translation Click here for other translation ...

In the INC bank case the tax administration had characterised part of the interest-bearing debt of a local branch of a Dutch bank, ING DIRECT B.V,  as “free” capital, in “accordance” with EU minimum capitalisation requirements and consequently reduced the deductible interest expenses in the taxabel income of the local branch for FY 2002 and 2003. The adjustment had been based on interpretation of the Commentaries to the OECD Model Convention, article 7, which had first been approved in 2008. Judgement of the National Court The court did not agree with the “dynamic interpretation” of Article 7 applied by the tax administration in relation to “free” capital, and ruled in favor of the branch of ING Direct. “In short, in accordance with the terms of the aforementioned DGT Consultation of 1272-98 of 13 July, “Consequently, to the extent that the branch or establishment is that of a banking institution, the interest paid to the head office will be deductible”, the appeal must be upheld in its entirety. Click here for English translation Click here for other translation ...

A russian subsidiary of British American Tobacco was found by the russian tax administration to have overpaid interest on loans from an affiliate in the Netherlands. The Court ruled in favor of the tax administration ...

PepsiCo had devised hybrid securities, which were treated as debt in the Netherlands and equity in the United States. Hence, the payments were treated as tax deductible interest expenses in the Netherlands but as tax free dividend income on equity in the US. The IRS held that the payments received from PepsiCo in the Netherlands should also be characterised as taxable interest payments for federal income tax purposes and issued an assessment for FY 1998 to 2002. PepsiCo brought the assessment before the US Tax Court. Based on a 13 factors-analysis the Court concluded that the payments made to PepsiCo were best characterised as nontaxable returns on capital investment and set aside the assessment. Factors considered were: (1) names or labels given to the instruments; (2) presence or absence of a fixed maturity date; (3) source of payments; (4) right to enforce payments; (5) participation in management as a result of the advances; (6) status of the advances in relation to regular corporate creditors; (7) intent of the parties; (8) identity of interest between creditor and stockholder; (9) “thinness” of capital structure in relation to debt; (10) ability of the corporation to obtain credit from outside sources; (11) use to which advances were put; (12) failure of debtor to repay; and (13) risk involved in making advances. “And, perhaps most convincingly, the “independent creditor test” underscores that a commercial bank or third party lender would not have engaged in transactions of comparable risk.” “However, after consideration of all the facts and circumstances, we believe that the advance agreements exhibited more qualitative and quantitative indicia of equity than debt.” “We hold that the advance agreements are more appropriately characterized as equity for Federal income tax purposes.” ...

In the Banca di Roma case, the Court of Appeals reiterated that the FTA is not allowed to decide whether a business is to be financed through debt or equity. The terms of Article 57 of the French Tax Code (FTC) do not have the purpose, nor the effect, of allowing the administration to assess the ‘normal’ nature of the choice made by a foreign company to finance through a loan, rather than equity, the activity of an owned or controlled French company, and to deduce, if the need arises, tax consequences (cf. Article 212 of the FTC – thin capitalisation). Click here for translation ...

In July, 1956, the appellants (Berkowitz and Kolbert) formed the taxpayer (K B Trail Properties, Inc.). Each of the appellants paid $2500 cash for one-half of the taxpayer’s authorized stock. They advanced the taxpayer $83,000 to begin business because the taxpayer was unable to borrow funds elsewhere. The taxpayer purchased a 99-year lease on business property utilizing these funds and assumed a mortgage of $57,829.20 as part of the purchase price of the lease. Each appellant took notes from the taxpayer totalling $41,500, payable in four installments of $2,500 commencing July 10, 1957, with the unpaid balance due July 10, 1961, with interest at the rate of 6 percent. In October, 1956, to finance the construction of an additional building on a property, the taxpayer borrowed $40,000 at 6 percent interest from a Savings and Loan Association, secured by a mortgage. In December, 1958, the taxpayer purchased the ground under the leasehold for $50,000. This transaction was partially financed by advances from the appellants in the amount of $5,000 each, evidenced by 15 percent notes due in December, 1959. The taxpayer borrowed $30,000 from a New York mortgage company, evidenced by an 8 percent note secured by a second mortgage on the premises. In 1960 the appellants each advanced the taxpayer $4,000. In 1963 they each advanced the taxpayer $3,600. There were no maturity dates for, or written evidence of these advances. Thus through 1963 the appellants had made unsecured advances to the taxpayer of $108,200, and two lending institutions had loaned the taxpayer $70,000 secured by mortgages. Obviously, the taxpayer was thin to the point of being transparent. Although the taxpayer was timely in its payments to the banking institutions, from 1956 through 1963 the taxpayer had paid only $1,980 toward the principal of the advances made by the appellants. There was no plan to reduce the principal further. In 1963 the taxpayer realized $60,000 from the sale of property, but instead of paying off the long overdue “loans” to the appellants, the taxpayer placed the money in a bank account where it drew a maximum of four and one-half percent, while, at the same time, the taxpayer was paying ten to fifteen percent on the principal of the advances made by the appellants. While the appellants, as directors of the taxpayer, made no effort to reduce the principal amount of their “loans” to the taxpayer, they did meet at the end of each year and decide what interest rate to pay. The taxpayer paid interest to the appellant as follows: 1957 — 4%, 1958 — 8%, 1959 — 15%, 1960 — 14%, 1961 — 10%, 1962 — 10%, and 1963 — 13%. On its income tax returns for the years in issue the taxpayer deducted the “interest” it had paid to the appellants during each fiscal year pursuant to section 163(a) of the Code. The Commissioner disallowed these deductions. Section 163(a) of the Internal Revenue Code of 1954 provides that there shall be allowed as a deduction all interest paid or accrued within the taxable year on indebtedness. The tax authorities disallowed these deductions and increased the taxpayer’s income taxes. An appeal was filed by the taxpayer. Judgment of the Court The US Court of Appeal upheld the assessment of the tax authorities. The Court rejected the appellants’ argument that intent was the controlling factor. Instead, the court noted that the parties had objectively manifested their intent, so subjective intent was not determinative. Excerpts “The appellants had the burden to prove that the advances represented indebtedness rather than equity, and the fact that they intended to make loans and not capital contributions to the taxpayer is not determinative of the equity-capital tax issue. Nor is it decisive that the notes were executed in accordance with state law and described by the appellants and the taxpayer as “loans”. Fin Hay Realty Co. v. United States, 3 Cir. 1968, 398 F.2d 694; Tomlinson v. 1661 Corporation, supra. These are just several of the numerous factors to be considered in determining whether the funds advanced to the taxpayer represented capital contributions rather than loans. We have expatiated on the criteria with some specificity as follows: There are at least eleven separate determining factors generally used by the courts in determining whether amounts advanced to a corporation constitute equity capital or indebtedness. They are (1) the names given to the certificates evidencing the indebtedness; (2) the presence or absence of a maturity date; (3) the source of the payments; (4) the right to enforce the payment of principal and interest; (5) participation in management; (6) a status equal to or inferior to that of regular corporate creditors; (7) the intent of the parties; (8) `thin’ or adequate capitalization; (9) identity of interest between creditor and stockholder; (10) payment of interest only out of `dividend’ money; (11) the ability of the corporation to obtain loans from outside lending institutions. … Applying these criteria to the case sub judice, there can be no doubt that the advances were nothing more than capital transfers as opposed to bona fide indebtedness. Obviously the taxpayer was inadequately capitalized. Considering only the advances made by the appellants, which the taxpayer designated as indebtedness, the ratio of debt to equity would have been about 21 to 1. Adding the institutional indebtedness to the advances made by the appellants would have made the ratio more lopsided.” “The problem is not one of ascertaining “intent” since the parties have objectively manifested their intent. It is a problem of whether the intent and acts of these parties should be disregarded in characterizing the transaction for federal tax purposes. It is not the jury’s function to determine whether the undisputed operative facts add up to debt or equity. This is a question of law. It was correctly decided by the District Court in favor of the government.” Click here for other translation ...