Court of Appeal: The Notional Interest Deduction does not require substance

On 12 January 2016, the Antwerp Court of Appeal rendered an interim judgement on the Notional Interest Deduction.

(a) Facts. In the beginning of 2008, a Finish Group acquired a Russian power plant. It used a Belgian intra-group finance company to structure the acquisition. The Belgian company obtained a loan from the Finish parent company, which it lend on to a Swedish group company. The latter purchased the Russian power plant. Shortly thereafter, the Finish parent company contributed its receivable to the paid-up capital of the Belgian company.

The increase of the paid-up capital significantly increased the basis for the Notional Interest Deduction of the Belgian company, allowing it to offset the deduction against the interest income received from the Swedish company.

The Belgian company distributed the interest as interim dividends to its Finish parent company.

The activity of the Belgian company was limited to the management and holding of one single receivable. It had no employees and rented, together with another group company, a small office in a business centre in Antwerp.

(b) Legal background. The Notional Interest Deduction permits Belgian companies and branches to deduct a deemed interest from its taxable income. The measure has been introduced in 2005.

The Belgian tax administration refused to grant the Notional Interest Deduction. Its position is based on a specific anti-abuse rule laid down in article 207 of the Belgian income tax Code 1992 and a circular letter of 3 April 2008 (Belgium-1, news 16 April 2008). Pursuant to this provision and the circular letter, the notional interest deduction cannot be used to offset that part of the profits that consists of “abnormal or benevolent advantages” received from a related party.

According to the tax administration, article 207 BITC 1992 applies because the structure put in place is purely tax driven.

On 25 June 2015, the Antwerp Court of first instance decided in favour or the tax administration, stating that the abnormal advantage is equal to the amount of interest the Belgian company did not have to pay as a consequence of the contribution of the receivable to its paid-up capital .

(c) Decision. The Antwerp Court of Appeal overturned the decision of the Antwerp Court of First Instance. According to the Court, the contribution of the receivable to the paid-up capital of the Belgian company cannot qualify as an “abnormal advantage”. The rationale behind the anti-abuse rule is according to established case law to prevent profit shifting by means of transfer pricing mechanism.

The Notional Interest Deduction has a totally different rationale. It is aimed at the limitation of the difference in tax treatment between debt and equity. This has to be taken into account when interpreting the notion of “abnormal or benevolent advantages” in the framework of the Notional Interest Deduction.

The Court is of the opinion that the interposing of a Belgian finance company is, as such, not abnormal even if it only holds one single loan. The receiving and granting of a loan, and the management thereof, is clearly an economic activity and given the magnitude of the loan not abnormal. The activity of the Belgian company does not require assets and employees.

More precise, the Antwerp Court of Appeal rejects the position of the Belgian tax administration put forward in its circular letter of 3 April 2008 (Belgium-1, news 16 April 2008) that a purely tax driven structure cannot benefit from the Notional Interest Deduction.

The Notional Interest Deduction is not conditional upon having a certain level of substance.

The Belgian company has complied with all legal provisions, has an economic activity, is not a sham, and should thus be able to benefit from the Notional Interest Deduction.

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