On May 12, 2011, Advocate General Sharpston of the European Court of Justice in Luxembourg (“ECJ”) delivered her opinion in the Scheuten Solar Technology case. In dispute was whether non-deductible interest on an intra-group loan was deductible under the Interest and Royalties Directive.
Facts
The Scheuten Solar Technology case involved the adding back of interest based on German legislation. For the purposes of corporate income tax (Körperschaftsteuer), the interest paid by the German subsidiary to the Dutch parent company was deductible. However, for the purposes of business tax (Gewerbesteuer) half of the deducted interest was added back to the tax base, effectively resulting in a deduction limitation.
The Bundesfinanzhof (“BFH”) requested the ECJ for a preliminary ruling. One of the questions asked of the ECJ was, briefly put, whether the Interest and Royalties Directive precludes the application of a German interest deduction limitation. In essence, what is being asked is whether the Interest and Royalties Directive requires the deduction of interest in the source State.
The Interest and Royalties Directive was intended to prevent the double taxation of interest and royalties in certain affiliated relationships. The Directive states that, under certain conditions, payments of interest and royalties arising in a Member State are exempt from all taxation in the source State, regardless of whether this taxation is levied as withholding tax or imposed via an assessment. Scheuten Solar argued that this also means that interest deductions are prohibited, because not allowing a deduction increases the taxable profit, which in turn results in an increase in the tax liability.
Advocate General’s opinion
The Advocate General concluded that the deduction limitation falls outside the scope of the Interest and Royalties Directive; one of the reasons being that the tax in question is not based on the interest paid, but on the total annual profit. The Dutch parent company receives the total amount of interest paid without German tax being levied on this amount. The Directive also contains rules for profit determination and deduction limitations.
The Advocate General also rejected the other arguments put forward by Scheuten Solar.
What this boils down to is that the Advocate General believes that the Interest and Royalties Directive is only intended to prevent juridical double taxation. In other words: to prevent the same entity/individual being taxed twice on the same income, for example, via a withholding tax in the source State and then again via a profit tax in the State of residence. According to the Advocate General, the Interest and Royalties Directive is above all not intended to remove economic double taxation. In other words: levying tax twice on the same income element for two different entities/individuals, for example, once as tax on the company profit and then again as taxed levied on the profit received by the shareholder. The Advocate General concludes that the position taken by Scheuten Solar – the removal of economic double taxation − is not covered by the Directive.
Consequences for the Netherlands
The Dutch Corporate Income Tax Act (“CITA”) contains, just like German legislation, various interest deduction limitations. The CITA includes a section on thin capitalization, and a section that is directed against ‘cash roundabouts’, i.e. where the dividend distributed or equity paid into a company is immediately loaned back to the dividend distributing or equity contributing company. It is also expected that as of January 1, 2012, a specific deduction limitation will take effect for interest paid by acquisition holding companies. Because the ECJ’s Advocate General has advised interpreting the Interest and Royalties Directive in such a way that it does not prevent the German interest deduction limitation, it is unlikely that the Advocate General would conclude differently should the ECJ be asked to rule on the Dutch deduction limitation. The ECJ is likely to follow the Advocate General’s opinion, and rule that the interest deduction limitation is contrary to the Interest and Royalties Directive. However, this does not mean that the interest deduction limitation or certain elements included therein could not be contrary to other European rules, such as the freedom of establishment or the free movement of capital, or with provisions included in tax treaties that the Netherlands has concluded with other countries.