“LLC AB” had received an interest free “credit line” by a related party which it considered a loan and on that basis notional interest was deducted for tax purposes.
The tax authorities disagreed with the qualification of the “credit line” and considered the capital similar to equity. On that basis the notional interest deductions was disallowed, which resulted in additional taxable income.
An appeal was filed by “LLC AB” which was dismissed by the Administrative Tribunal in September 2022.
An appeal was then filed by “LLC AB” with the Administrative Court.
Judgment of the Court
The Administrative Court ruled in favor of “LLC AB” and overturned the decision of the Administrative Tribunal and set aside the assessment of the tax authorities.
Excerpt (in English)
“However, as a last important element, the Court must reiterate the finding already made above that the appellant made only very limited use of the credit line opened to it and that the loan was indeed repaid on December 31, 2018. However, neither the state party nor the first judges questioned this repayment. Therefore, in accordance with the principle of substance over form, and with the hindsight inherent in the analysis carried out at the litigation level after the end of the relevant transactions, the IFL was indeed executed by the parties as a loan that was repaid even well before the contractually agreed maturity date.
As a result, the Court concludes that the majority of the relevant points analysed above in the IFL clauses, as well as the performance of the parties involved, confirm the classification of the said contract as a debt instrument which does not form part of the appellant’s equity capital, and which is therefore liable to give rise to the payment and tax deduction of debit interest due to the temporary availability of the stipulated capital.
However, the IFL has expressly stipulated that the appellant has no obligation to pay interest, and the appellant has used the notional interest mechanism to record such interest as an operating expense in the amount of … euros, in accordance with the results of the transfer pricing report, in order to comply with the arm’s length principle. The appellant also states, without being contradicted, that its shareholder recorded the same amount as notional interest income for tax purposes.
The Court is obliged to note that the appellant puts forward the principle of such notional interest on account of the IFL and the amount retained by it on this account on the basis of the aforementioned report of the limited liability company (CD), and that the State has not formulated any plea in the appeal proceedings seeking to have the principle of such interest rejected or the arm’s length nature of the amount concretely retained by the appellant. As the Court is limited by the grounds on which it has been seized, it cannot itself review the principle of notional interest and the arm’s length nature of the notional interest rate declared by the appellant. Under these conditions, it is led to hold that the tax office, followed by the Director and the first judges, was wrong to reclassify the loan between the appellant and its shareholder as equity capital and to refuse to admit the amount put forward by the appellant as notional interest.
It follows from all the foregoing developments that the appeal under review is justified and that, by reversal of the judgment under review, the management decision of January 23, 2020 should be reversed in the sense that the non-accounting adjustment of notional interest in respect of the IFL in the amount of … euros is deductible as an operating expense from the profit generated by the appellant in respect of the 2016 financial year.”
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