Introduction
On 6 June 2023, the Amsterdam Tax Court of Appeal (the ‘Court of Appeal’) ruled on the arm’s length nature of a shareholder loan (the ‘SHL’) provided by Alpha Private Equity, a French private equity group to an acquisition vehicle (‘BV’) that acquired the shares in Hans Anders Groep, a Dutch optician group. BV financed the acquisition with senior debt, mezzanine debt, a PIK-loan, the SHL and equity. The SHL was the only internal debt.
In an elaborately reasoned judgment, the Court of Appeal ruled that the interest on the SHL was not deductible based on (i) the qualification of the SHL as an uncommercial loan and (ii) the application of the abuse of law doctrine.
The qualification of the SHL as a so-called uncommercial loan means that the lender, by providing the loan, assumed a credit risk that a commercially behaving lender acting at arm’s length would not have been willing to accept (unless against a profit-sharing remuneration). As a result of this qualification (in line with case law of the Supreme Court) the Court of Appeal determined the applicable interest on the SHL at the risk-free rate. The Court of Appeal determined the risk-free rate at 3.2%, while the SHL bore interest at a rate of 10%. As a second step, the Court of Appeal determined that the 3.2% interest is also not deductible, under the abuse of law doctrine. For more information on the decision of the Court of Appeal see our publication of 22 June 2023.
BV filed appeal against both the decisions of the Court of Appeal (the SHL being an uncommercial loan and the applicability of the abuse of law doctrine) with the Supreme Court. In this summary, we only focus on the transfer pricing aspects, not on the abuse of law aspects. BV’s appeal against the Court of Appeal’s decision that the SHL is a noncommercial loan is based on the arguments (i) that the Court of Appeal has unjustly qualified the SHL as an uncommercial loan and (ii) that the Court of Appeal’s motivation for this qualification is incomprehensible.
In his opinion of 26 January 2024, Advocate-General Wattel (the ‘AG’) disagrees with BV that the Court of Appeal’s motivation is incomprehensible. In line with the Court of Appeal’s decision, the AG considers that the tax inspector has demonstrated that the SHL’s pricing is unlikely arm’s length by pointing out that the mezzanine loan, which was granted almost at the same time to BV by a third-party lender, bore a higher interest rate (13%) than the SHL (10%), whereas the SHL ranked lower, had less security, a lower credit rating, an increasing leverage ratio, and a worse debt service capacity ratio than the third-party loans. Economic logic suggests that under those circumstances the SHL coupon should be higher instead of lower than the mezzanine loan.
The AG also agrees with the Court of Appeal’s rejection of the benchmark study prepared by BV, even though the study followed the commonly used methodology of comparable loan searches using publicly available commercial databases. The AG agrees with the Court of Appeal’s criticism on the comparability and search criteria used by BV’s transfer pricing advisor and identifies a variety of factors on which the SHL differed significantly from the benchmarked debt instruments, including the SHL’s level of subordination, lack of security, its PIK mechanism, low credit rating and an increasing leverage ratio due to the PIK mechanism. The AG also considers that the Court of Appeal correctly ruled that the debt service capacity analysis was based on the wrong cash flow projections, because these were higher than the projections prepared for obtaining the bank financing.
The AG finally considers that the Court of Appeal’s decision that a loan with the SHL’s size and the terms and conditions could not have been obtained without an (effectively) profit-sharing interest rate is of a factual nature, which cannot be tested before the Supreme Court, insofar the Court of Appeal’s judgement was not incomprehensible (which it is not, according to the AG).
Takeaways
While the Supreme Court still needs to rule in this case, this opinion is important for the Dutch transfer pricing practice involving internal loans, because:
- It reconfirms that benchmarks are relatively easily rejected as comparability often is an issue. This opinion is not the first to reject the benchmark study that was carried out in line with the generally applied transfer pricing practice of using publicly available databases.
- By confirming the Court of Appeal’s decision that BV should have used the mezzanine loan as a benchmark, the AG effectively confirms that BV should have applied the internal comparable uncontrolled price method (‘CUP’) with adjustments. Economically, it clearly makes much more sense to use an internal CUP with adjustments as a reference point for determining the arm’s length interest rate on an internal loan, instead of using the outcome of a benchmark that returns data with a low level of comparability. The AG acknowledges this.
What to do?
- If you are currently facing challenges by the authorities about the arm’s length pricing of shareholder loans or other internal debt, we advise to perform an economic analysis in line with this AG’s opinion to review whether the shareholder loan may be qualified as an uncommercial loan and the shareholder loan’s coupon logically relates to the existing external debt’s loan pricing.
- If you are not (yet) facing challenges, similar actions could be taken to allow you to make proper adjustments, if any, and align the interest coupon of the shareholder loan with the economic analysis.
- If you consider implementing internal loans for the financing of a project or an acquisition, ensure that you align the interest coupon and debt volume with the external debt data by performing a cash flow-based economic analysis.
Contacts
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Quirijn Knab +31 20 247 03 03 |
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Mark van Casteren +31 20 247 03 04 |
