Group flows are at the center of two corporate tax decisions (one cash-in, one cash-out). The first decision concerns the treatment of dividends received from a subsidiary, when other tax benefits are subject to limitation due to the specified order of tax deductions defined by the Belgian law. The second case relates to the financing costs for a dividend distribution or a capital reduction by a Belgian company.
Case 1—Treatment of Dividends Received from a Subsidiary
On December 19, 2019, the Court of Justice of the European Union (CJEU) delivered a preliminary ruling on Belgian tax treatment of dividends.
The CJEU decided that Belgium’s treatment of dividend deduction as provided for in the Belgian corporate income tax system is contrary to the objective pursued by the European Parent-Subsidiary Directive. More particularly, the CJEU decided that the deduction system, as organized by Belgian law, results in depriving the parent entity of other tax benefits with limited carry-forward provisions.
Belgian Corporate Tax Deduction Order
As provided for in the Belgian legislation, dividends received from a qualifying subsidiary are tax deductible, as definitive taxed income (DTI), upon conditions and on the profit resulting after the application of other deductions and before other ones (specific order of the deductions set out in the Belgian law).
Belgian tax law provides that if it has not been possible to deduct that DTI, it is to be carried forward to subsequent tax years. Due to the order of deductions stated by the law, the carried forward DTI relief must be deducted as a priority from the positive results achieved by the parent company in subsequent years. Other tax deductions, in particular the deduction for patent income, the deduction for risk capital (DRC) and the carried-forward losses, are deducted from the profit remaining after the DTI relief.
About the Case
Brussels Securities SA, a company established in Belgium, subject to corporate tax, realized in a certain year an operational loss and in that same year the company also received dividends from a qualifying subsidiary, resulting in a carry-forward DTI.
In the following years, the company realized profits, but, due to the specific order of deductions set out in the Belgian law, the company must first deduct the carry-forward DTI and only after that, to the extent that there remain taxable profits, the DRC. At that time, a carry-forward limited in time to the following seven tax periods was available for the DRC relief (such carry-forward possibility has been abolished since).
The carry-forward DRC relief was lost once the end of the limit of carry-forward had been reached. The company claimed that the specific order of deduction results in an indirect taxation of the dividend because it was not able to apply the limited-in-time tax reliefs granted after the DRC in the order of the deductions set out in the Belgian law. Therefore, and in in the view of the company, the national legislation does not comply with Article 4 of the Parent-Subsidiary Directive. The case was referred to the CJEU.
The CJEU considered that “the combination of the DTI scheme applicable to dividends received, the order of deductions set out in the Belgian legislation, and the time limit on the ability to use deduction for risk capital can have the effect that receiving dividends is likely to result in the parent company losing totally or partially another tax advantage, and therefore, that company being taxed more heavily than would have been the case if it had not received dividends from its non-resident subsidiary or if, the dividends had simply been excluded from the parent company’s tax base.”
The first indent of Article 4(1) of the Parent-Subsidiary Directive precludes, subject only to what is permitted by Article 4(2) and (3), both direct taxation of the parent company in respect of profits distributed by its subsidiary and situations in which the parent company is indirectly taxed on dividends received from its subsidiary.
Therefore, the CJEU concluded that the Belgian legislation is contrary to the objective pursued by the Parent-Subsidiary Directive, where the deduction of received dividends from a qualifying subsidiary has priority over another tax deduction which may only be carried forward for a limited time.
Please note that the DTI deduction amounted to 95% of the dividends for the tax year considered by the CJEU. With the corporate tax reform of 2017, the dividend exemption became a full deduction (100%) from January 2018.
In light of this CJEU decision, companies subject to Belgian corporate tax receiving dividends from qualifying subsidiaries should determine whether the application of DTI in any year resulted in the loss of tax deduction/advantage as the deduction for patent income or the deduction for risk capital (DRC). If this has occurred, taxpayers should take action to claim back this deduction before the statute of limitations of the related tax years.
Case 2—Financing a Dividend Distribution (or Capital Reduction) by Debt
In an important judgment of March 19, 2020, the Belgian Supreme Court confirmed that a loan taken out to finance a capital reduction or a dividend distribution may qualify as deductible professional expenses provided that the company proves that the conditions for the application of Article 49 of the Belgian income tax code (BITC) are met, i.e., that the interest charges have been borne or incurred for the purpose of obtaining or retaining taxable income.
The Supreme Court further clarifies that it is the interest charges that must meet the conditions of Article 49 BITC and not the capital reduction or the dividend distribution itself.
About the Case
Nyrstar Belgium NV carried out a capital reduction and a dividend distribution. In order to finance those operations, the company was granted a significant loan from its Dutch parent company. The Belgian tax authorities refused the deduction of any interest costs, considering that Nyrstar did not demonstrate that the interest expenses were incurred with the purpose to generate or preserve taxable income. That position was confirmed by the tribunal of first instance followed by the Court of Appeal of Antwerp.
The Supreme Court examined whether the interest charges have been borne in order to obtain or maintain taxable income (Article 49 of the BITC), the burden of proof of which rests with the taxpayer. In this case, the evidence brought by the company consisted of:
(a) the shareholders’ decision to reduce capital;
(b) the loan agreement, which only states that it is intended for “general corporate purposes”; and
(c) the related financial statement, which includes significant items of income-producing assets.
The appellate judges considered these documents insufficient to meet the required standard of proof, rejecting the deductibility of the interest charge. In its decision of March 19, 2020, the Supreme Court confirmed the Court of Appeal’s decision.
Tax Deductibility of Financing Costs
The question was not related to any transfer pricing issue or any ratio limiting the interest deduction. The Supreme Court ruled on a more fundamental question, about the tax-deductible character of such expense as a professional expense. The Supreme Court clearly stated that there is no rule that automatically allows for the deduction of interest pertaining to Article 49 of the BITC on a loan contracted in order to carry out a capital reduction or a dividend distribution when the company lacks the liquidity to do so.
Professional expenses, and interest expenses must meet the “purpose condition” in order to be tax deductible and more important the burden of that proof rests with the taxpayer. As with every professional expense, it is up to the company to demonstrate clearly and to thoroughly document that a loan (generating interest expenses) has been contracted with a view to generate or preserve taxable income.
For instance, the loan could be justified as allowing the taxpayer to preserve other assets that (would) generate taxable income at least equivalent to the cost of the loan. In that regard, the Supreme Court stated that it is however not sufficient that the company does not have sufficient liquidity at the time that it has to make the payment in execution of the shareholders’ decision to reduce the capital or distribute a dividend. The absence of liquidity does not imply that the associated costs have necessarily been incurred in order to maintain or obtain taxable income.
Aside from the ordinary transfer pricing questions and the Anti-Tax Avoidance Directive rules, the deductibility of interest charges can be challenged on their basement (qualification as professional expenses, with a burden of proof on the taxpayer).
The Supreme Court again illustrates how important it is for the taxpayer to precisely document the purpose and economical context of the loan. To comply with the burden of proof relying on the taxpayer, companies have to pay special attention to the justification, especially when having current assets that could easily finance the contemplated operation instead of contracting a loan.
Laurent Donnay de Casteau is a Partner and Nawel Benaisa is an Associate at Advisius, Brussels.
Part 1 looks at a recent case on the existence of a value-added tax fixed establishment through a related local company.
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