On 21st September 2012, the Dutch Supreme Court (Hoge Raad der Nederlanden) gave its decision in X BV v. the Tax Administration (case No. 10/05268) on the compatibility of the Dutch thin capitalisation rules with EC law and article 9 of the tax treaties Dutch tax treaties with France, Germany and Portugal.
The Supreme Court rejected the taxpayer’s argument that the thin capitalisation rules are incompatible with the EC Treaty. In the taxpayer’s view this is the case because the rules apply if a Dutch company for 95% or more is owned by a foreign company, which means that in such case mainly foreign companies are affected. The Court based its judgment on an earlier decision of 24th June 2011 (LJN BN3537) in which it was held that domestic and foreign holding companies are not in a comparable situation.
Referring to the decision of the European Court of Justice (ECJ) of 21st July 2011 in Scheuten (Case C-397/09), the Court also held that the thin capitalization rules are not incompatible with the Interest and Royalties Directive (2003/49) because that Directive deals with the position of the creditor and not with that of the debtor.
Following the opinion of the AG, the Court rejected the appeal based on article 25(5) (Non-discrimination) under the treaty with France, because the Taxpayer is not treated differently from another company which is not part of a group and is not comparable with a group company.
Thereafter, the Court decided that the provision at issue is also not incompatible with the arm’s length provisions under article 9 of the France – Netherlands Income and Capital Tax Treaty (1973) (as amended through 2004) and article 9 of the Germany – Netherlands Income and Capital Tax Treaty (1959) (as amended through 1991) because those provisions only provide for a corresponding adjustment in case of contracts and financial relations between related parties which are not at arm’s length, while the Dutch thin capitalisation rules concern the entire financing structure of a company.
Finally, the thin capitalisation rules are also not incompatible with article 9 of the Netherlands – Portugal DTAA because article X of the protocol specifically allows the Member States to apply their domestic thin capitalisation rules. Those rules may only not be applied if related companies prove that their agreements are at arm’s length based on their activities or their specific economic circumstances.
The term “thin capitalisation” is not defined in the Treaty, the term must be interpreted by means of article 31(1) of the Vienna Convention on tax treaty interpretation, which means that the meaning of the term must be determined in good faith based on the subject and purpose of the treaty. Based on the thin capitalisation rules applicable in Portugal at the time of signing of the Treaty, the Court held that the term refers to interest deduction restrictions concerning interest paid on loans to related companies. This is in line with article 9 of that Treaty, which aims to determine whether the conditions in a concrete legal case are at arm’s length. Therefore, the Court held that the term “thin capitalisation” in the Treaty with Portugal only concerns certain loans and not a general thin capitalisation rule which concerns the total financing structure of a company.
Consequently, the Supreme Court held that Dutch thin capitalisation provisions are not incompatible with EC law and article 9 of the Dutch tax treaties with France, Germany and Portugal.
