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Ruling from the European Court of Justice: per element approach allowed outside tax entity in cross-border situations with the EU

Ruling from the European Court of Justice: per element approach allowed outside tax entity in cross-border situations with the EU

The European Court of Justice (“ECJ”) rendered a ruling on 22 February 2018 concerning the Dutch tax concept of “tax entity”. It concerned the application of Section 10a of the Corporation Tax Act 1969 (“Vpb”) in relation to the freedom of establishment that applies in EU law.

What is the legal issue?

In the Netherlands, a tax entity may be applied for under the Vpb subject to certain conditions. If this is the case, a parent company and its subsidiary or subsidiaries are subject to Vpb as if they jointly form a single taxpayer. One of the conditions is that the companies that form part of the tax entity must have their registered office in the Netherlands or have a permanent establishment in the Netherlands.

The question submitted for a preliminary ruling that was submitted to the ECJ was whether a Dutch parent company liable for tax, which was unable to establish a tax entity with its foreign subsidiary, nevertheless qualified for the benefits of a separate element of the Dutch tax group rules. This is referred to as the “per element approach”.

What was the case actually about?

A Dutch company that forms part of an international Swedish group was the parent company of a Dutch tax entity. It had received a loan from a Swedish holding that is part of the group. It used this loan to contribute capital to a new Italian company it had formed. The latter company used the capital that had been contributed to delist an Italian listed company in which listed company the Swedish group already held the majority of the shares and that therefore also forms part of the same group.

The Dutch Tax and Customs Administration did not allow the deduction of the interest on the loan from the Swedish company by the Dutch parent company. Under Section 10a Vpb, you are not allowed to deduct interest on money borrowed from what is known as an affiliated entity if you use the borrowed money to make a capital contribution to another affiliated entity. However, it would have been allowed at the time of the capital contribution if the capital contribution had been made to a Dutch company with which the Dutch parent company formed a tax entity. The reason being that this capital contribution would not have been relevant as regards Vpb because the Dutch parent company and the Dutch subsidiary were considered to be a single taxpayer.

The Dutch parent company considered it to be discrimination. I am not allowed to deduct the interest merely because it concerns an Italian subsidiary that does not have its registered office in the Netherlands instead of a Dutch subsidiary.

This was followed by submission of what is known as a request for a preliminary ruling to the ECJ. The Advocate General of the ECJ agreed with the Dutch parent company on 25 October 2017. And the ECJ held on 22 February 2018 that the opinion of the Dutch tax authorities is indeed in contravention of the freedom of establishment within the European Union. The ECJ allowed the per element approach in this case.

What are the consequences of this ruling?

Good news for Dutch parent companies with foreign subsidiaries? No. The Dutch legislator had already taken account of the fact that the ECJ would rule in this way and would follow the conclusion of the Advocate General. Emergency remedial legislation with retroactive effect until 25 October 2017 was announced immediately after the conclusion of the Advocate General because a ruling against the tax authorities would cost the treasury a lot of money.

The State Secretary communicated immediately after the ECJ’s ruling that this legislation would be submitted in the second quarter of 2018. It is therefore expected that various provisions of the Vpb will be applied within Dutch tax entities as if those tax entities do not exist and such with retroactive effect. This means that it is precisely the Dutch parent companies and their Dutch subsidiaries that form a tax entity that are disadvantaged by this ruling. They will have to pay more tax. In addition to the tax burden, they will also be confronted with an additional administrative burden. This will keep tax advisers very busy.

By Karen Verkerk

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