“Real Estate Loan B.V.” had deducted 10% interest on loans from its shareholder in its taxable income.
The tax authorities found that the 10% interest rate was not at arm’s length. Furthermore, according to the tax authorities the loans were “non-businesslike” and the deductibility of the interest was therefore limited.
The district court upheld the assessment.
Not satisfied, “Real Estate Loan B.V.” appealed to the Court of Appeal.
Judgment
The Court of Appeal ruled largely in favour of the tax authorities, concluding that a significant portion of the interest was not deductible and was therefore deemed to be a dividend to the shareholders.
The court found that the tax authorities had been able to prove that the loan was “non-businesslike”, as a third party would not have been willing to make a loan on similar terms to Real Estate Loan B.V.
Applying the deemed guarantee approach, the court ruled that the interest rate should be set at 3.09%.
Excerpts in English
“5.3.6.11. The foregoing leads to the conclusion that the Inspector has made it plausible that no arm’s length interest rate can be determined under which an independent third party would have been willing to grant the same loan to the interested party, on otherwise the same terms and conditions, without stipulating an interest rate that is so high that the AHL would essentially become profit-sharing. If so, it must be assumed – barring special circumstances – that the lenders accepted this risk with the intention of serving the interest of the interested party. Special circumstances in the aforementioned sense have, in the opinion of the Court, neither been stated nor proved.
5.3.6.12. Since no arm’s length interest rate can be found in the market, and the AHL thus qualifies as a so-called impractical loan for all years, in accordance with the impractical loan jurisprudence, an interest rate must then be determined as if the AHL had been provided by a third party under surety (cf. HR 25 November 2011, ECLI:NL:HR:2011:BN3442, BNB 2012/37, r.o. 3.3.4:
“(…) The default risk assumed by a company in granting an imprudent loan is comparable to the risk assumed by a company that stands surety for a loan taken directly from a third party under similar conditions by an associated company. In view of this, in the case of an imprudent loan, the company’s taxable profit will have to be determined as far as possible in the same way as if it had guaranteed a loan taken out directly from a third party under comparable conditions by an associated company.
In view of the above and also for reasons of simplicity, the rule of thumb is that the interest on the unsecured loan is set at the interest that the affiliated company would have to pay if it borrowed from a third party with the group company’s guarantee under otherwise identical conditions. This will also prevent a difference in the earnings of the affiliated company with respect to the interest expense depending on whether it borrows under a guarantee from a third party or directly from the group company.”)
On the basis of the so-called guarantee analogy included in the aforementioned judgment, the inspector determined the interest rate for the present case at a maximum of 2.59%. In doing so, he assumed the AHL but without taking into account the default risk. Furthermore, in connection with the surety analogy, the inspector pointed to the credit rating of [company 9] Ltd. as the holding company of its three subsidiaries that are shareholders/creditors in the interested party with a total interest of 85% (see section 2 of the court ruling). [Company 9] Ltd. could therefore be a guarantor in this regard, according to the inspector, if the AHL were sourced from an independent third party.
5.3.6.13. The Court considers that the inspector correctly used the escrow analogy as a starting point to determine the interest payment. The Court considers that in that regard, it has been made plausible by the inspector that [company 9] Ltd. would qualify as a guarantor. However, in the opinion of the Court, neither party has made the interest rate to be taken into account sufficiently plausible. For instance, the inspector indicated in his primary statement that, given the term of the loan, there is reason to take into account a somewhat higher interest rate, while – in the opinion of the Court of Appeal – he completely ignores this when applying the guarantee analogy. Also the interested party has not made the interest rate it defends plausible since in the reports and analyses on which it is based, the AHL has not been taken into account without default risk.
Therefore, taking everything into consideration, the Court, applying the bailment analogy in good justice, will set the interest rate on the AHL at 3.09%.”
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