Dutch Supreme Court clarifies link between Article 10a CITA 1969 and fraus legis

Article 10a CITA 1969 (Wet Vpb 1969) permits limiting the deductibility of interest paid on loans granted between group companies in case of profit shifting. This concerns situations in which group financing structures are aimed at obtaining a tax advantage by creating and maximising deduction of interest combined with untaxed or low-taxed interest income. The Dutch Supreme Court recently ruled that fraus legis can be used as a means of refusing deduction of interest, despite successful reliance on the rebuttal evidence scheme of the double business motive test under Article 10a(3)(a) CITA 1969.

Case

In 2011, a Dutch company (hereinafter: the interested party) formed a fiscal unity with its subsidiary and sub-subsidiary. All the entities mentioned above were established with a view to the acquisition of a group of Dutch companies (hereinafter: the B group) by two private equity firms. In order to finance this acquisition, the Luxembourg-based shareholder of the interested party granted loans to the interested party. The Luxembourg shareholder obtained these funds by issuing Preferred Equity Certificates (hereinafter: PECs) to its shareholders. The interested party wished to deduct the interest on the loan obtained. The PEC holders did not have a direct or indirect interest of at least one third in the interested party, which meant that they and the PECs were outside the scope of Article 10a CITA 1969.

No diversion without business motives

The Tax Inspector and the Court of Appeal in The Hague ruled previously in the proceedings that the deduction of interest should be refused under Article 10a CITA 1969 and, more specifically, that the rebuttal evidence scheme could not be met due to the presence of a diversion without business motives (onzakelijke omleiding) and, hence, a non-arm’s length debt. In 2022, the Supreme Court ruled that the funds for the acquisition of the B group had not been diverted without business motives, as none of the PEC holders had at least a one-third interest in the interested party. This implied that the Luxembourg shareholder did not obtain the financing from affiliated entities and, accordingly, that there was no diversion of funds within the group. Therefore, rebuttal evidence within the meaning of the double business motive test (dubbele zakelijkheidstoets) had successfully been provided. The Supreme Court subsequently referred the case back to the Amsterdam Court of Appeal.

This time, the Court had to decide whether the deduction of interest on the shareholder loans was excluded under the non-arm's length loan (onzakelijke lening) doctrine. If the deduction of interest was not excluded under this doctrine, the dispute was whether the deduction of interest was limited under the doctrine of fraus legis (abuse of law).

Fraus legis does apply

The Amsterdam Court of Appeal argued that the successful provision of rebuttal evidence due to the absence of diversion without business motives does not necessarily lead to the conclusion that fraus legis cannot still limit the deduction of interest. The Court considered that in this case the loans were granted solely to generate interest expenses that could then be deducted. The Court labelled the loans 'useless' in all other respects. Therefore, the Court concluded that the deduction of interest is contrary to the aim and purpose of the CITA 1969 as a whole. Only if a loan were originated by a company with a financial pivot function would it be predominantly based on business motives and would the fraus legis motive requirement not be met. However, this was not the case here, since the Luxembourg shareholder acted as a conduit. Subsequently, the interested party once again appealed to the Supreme Court.

Considerations of the Supreme Court

In its judgment, the Supreme Court did not address the non-arm's length loan doctrine, on the basis of which - according to the Amsterdam Court of Appeal - a large part of the interest was already non-deductible. The reason for this was that the Court of Appeal's judgments on this matter were factual in nature and could thus not be reviewed by the Supreme Court in cassation.

The Supreme Court did, however, discuss the second ground of appeal concerning the link between fraus legis and the double business motive test under Article 10a CITA 1969 at length. In this context, the Supreme Court ruled that the successful provision of Article 10a rebuttal evidence - due to the debt being predominantly based on business motives (and the arm’s length nature of the legal act having been established) - does not prevent fraus legis from refusing the deduction of interest. After all, due to an artificiality occurring outside the 10a structure (i.e., the financing by the PEC holders) there may still be abuse, as a result of which, in this case, fraus legis may limit the remaining deduction of interest. On top of that, the Supreme Court added that if there is no violation of the aim and purpose of Article 10a CITA 1969, the intention of profit shifting is not necessarily absent. One (or perhaps the only) exception to this is if the creditor fulfils a so-called financial pivot function within the group. In that case, it is impossible to meet the fraus legis motive requirement in respect of that same loan. As the Court of Appeal had already ruled, the lending company in this case did not perform a financial pivot function, but operated as a conduit. The Supreme Court therefore confirmed the Court of Appeal’s ruling and found that there was fraus legis, as a result of which the deduction of interest also had to be refused in other respects.

Source:

• Supreme Court 5 September 2025, 23/02746, ECLI:NL:HR:2025:1250.