OVERVIEW
In June 2024, the Dutch Court of Appeal issued a judgement related to the circumstances under which a shareholder loan shall be considered “uncommercial loan”, with significant impact on the arm’s length interest rate and interest deductibility considerations.
What’s new?
The tax inspector stated that a shareholder loan shall have security rights incorporated, such as a loan to value covenant. Further to that, the inspector considered the taxpayer’s comparison to its IRR and benchmarking analyses irrelevant and stated that the loan shall be qualified as an “uncommercial loan”, reducing the deductible interest amount significantly.
Arguing that the terms and conditions should be arm’s length (that is, a loan secured with a mortgage and having a repayment schedule and a loan to value covenant), the inspector proposed to first adjust the terms and conditions and, then, determine an arm’s length interest rate range accordingly.
This approach was rejected by the Court of Appeals, however, it confirmed that the taxpayer would not have received financing from any third party under the terms and conditions of the shareholder loan provided, unless it was profit-sharing, therefore the loan is an “uncommercial loan”. The interest rate was reduced from 10.00% to 3.09%.
Impact on Transfer Pricing
This is yet another case when a traditional interest rate benchmarking study is rejected as the (only) valid support to the intragroup financing conditions and the analysis is centered on the type and rationale of the operation.
When an independent third party would not enter the financing operation in the terms and conditions agreed between related parties, the arm’s length character of such conditions could be challenged, and further justification, or adjustments may be necessary.
The interests paid will probably be rejected as tax deductible in case the financing itself is considered an uncommercial loan, i.e. the lender is assuming higher risks than any third party would be willing to do.
Lastly, the fact that the expected equity IRR is higher than the shareholder loan interest rate, is not enough to justify the reasonability and arm’s length character of the interest rate in itself.
Key actions
To comply with the necessary considerations and mitigate the risk of rejection regarding the deductibility of the interest amounts derived from the intragroup financing, further to preparing a benchmarking analysis for the interest rate applied, taxpayers shall analyse and justify the reasonability of the operation as a whole. If the financing could be considered “uncommercial loan”, this should be taken into consideration when setting and/or testing its terms and conditions.
