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How do interest deduction limitation rules fit with freedom of establishment within EU and EEA?
Taxand Sweden and Taxand Finland present the core of the Swedish and Finnish tax regimes on interest deductibility limitations and highlight the main problems of the Swedish regime in the light of EU law. Taxand also discusses whether the regimes would stand the test of a trial before the ECJ.
Swedish & Finnish legislation in short
Under Swedish legislation, interest payments to affiliated companies are generally not deductible even if at arm’s length. Interest payments may, however, be deductible in the case that the recipient (the beneficial owner) is subject to an effective tax rate of at least ten percent and the loan is deemed not to have been granted primarily to obtain a significant tax benefit (“the 10 % rule”), or that the purpose of the debt is deemed mainly business motivated (“the business purpose rule”).
In comparison, the Finnish rules are more objective. As of tax year 2014, net interest expenses, ie interest expenses less interest income, are not deductible for the part they exceed 30 percent of the EBITDA (as specifically defined). However, the restriction only concerns interest amounts between related parties, and a safe haven for interest expenses not exceeding EUR 500,000 is provided. Furthermore, the interest could be deductible if the equity/assets ratio of the entity is higher than the corresponding ratio in the consolidated group balance sheet.
The correspondence between the Commission and the Swedish government
According to the Commission, the Swedish legislation appears to amount to an unjustified restriction on the freedom of establishment. Even if the provisions are drafted in a general way, however, in practice they almost exclusively affect interest payments to non-resident companies and therefore amount to an indirect discrimination.
The Commission notes that the objective of the legislation is not limited to prevent “wholly artificial arrangements”. The presence of even a relatively minor tax benefit is in itself sufficient to disallow deduction. It follows from case law from the ECJ that neither tax benefits nor organisational purposes for a transaction can in itself presuppose that the transaction is not genuine and/or proper. The legislation seems to go beyond what is necessary to attain the objective. Interest deduction is denied as a whole even to the extent the conditions are at arm’s length. In addition, no administrative guidance is given on the criteria “business purpose” and “significant tax benefit”. The legislation as a whole does not seem to meet the requirement of the principle of legal certainty, in accordance with which rules of law must be clear, precise and predictable as regard their effects.
In its reply to the Commission, the Swedish government has stated that the legislation cannot be held to be indirectly discriminatory, as the same rules apply no matter if the recipient is domiciled in Sweden or in another state within the EU/EEA. Any difference in the overall outcome of the rules for a group in a cross-border situation compared to in a domestic situation is only a consequence of the difference in taxation of interest income.
Should the legislation nevertheless be deemed to constitute a restriction, the Swedish government sees the restriction as justified, as it intends to ensure an appropriate allocation of taxable income between the Member States. In addition, the legislation aims to prevent tax avoidance. The Swedish government also believes that any restriction is proportionate meaning that the restrictions do not go beyond what is necessary to achieve the objectives pursued. The government also believes that there is sufficient guidance in publicly available preparatory works on how the legislation should be applied.
In our view, there is little doubt that the Swedish legislation is indirectly discriminatory and hence that it constitutes a restriction on the freedom of establishment within the EU/EEA.
The purposes of the legislation are, in our view, not sufficient to justify a restriction. The protection of the tax base is not an accepted and valid argument for such a restriction according to case law from the ECJ. As the legislation does not target only wholly artificial arrangements, the argument of “preventing tax avoidance” should also not be enough to justify the restriction. Furthermore, the drafting of the provisions is so vague that it is almost impossible to predict in advance the outcome of the application of the rules. The guidance given in the preparatory works with regard to how the legislation should be applied does not provide much guidance in this respect. In our view, the legislation fails to meet the requirements of proportionality.
It remains to be seen whether the Commission will put Sweden on trial before the ECJ. If they do, however, it seems likely that the Swedish legislation will be deemed to constitute an unjustified restriction in the freedom of establishment with the consequence that the limitation rules may not be applied in cases of cross-border interest payments within the EU/EEA. Considering the possibility of the Swedish legislation to be declared void, multinationals should follow the development carefully. If deductions have been denied on unlawful grounds, restitution may be granted for the companies concerned.
With regards to Finland, the legislation applies to both domestic and cross-border situations, and the restriction is based on objective criteria which do not relate to how the interest income is taxed for the recipient. It therefore seems that the legislation is compliant with the EU laws. The exemption based on a comparison between the equity/assets ratios of the entity in question and of the parent entity may in practice result in differences in treatment based on the country of the parent entity and the applicable accounting rules, but in our opinion these differences should be seen as inevitable and justified.