During the past four years, the special tax inspectorate ("BBI"/"ISI") has chosen a couple of test cases where companies were borrowing in order to finance their dividend distributions or capital decreases and has disallowed the interest payments as tax deductible expenses in their hands.
The taxman considers that the main condition for the cost deduction enshrined in article 49 of the Income Tax Code (i.e. that costs must be made or incurred with a view to retaining or generating taxable income) is not complied with. The burden of proof for the cost deduction lies with the taxpayer, and the taxman argues that transactions leading to a decrease in the company's equity cannot comply with this condition.
The Minister of Finance has stated twice that tax deductibility in such cases should be examined on a case-by-case basis and that it cannot be excluded that a company could satisfy its burden of proof.
Due to some recent negative developments in case law, the Belgian Ruling Commission currently refuses to grant positive tax rulings in this respect.
Meanwhile, two courts of appeal have already agreed with the tax administration, refusing to allow the tax deduction in particular cases. The first case concerns a debt push-down operation in the framework of an acquisition, and the second concerns a leveraged restructuring of the financing sources of a company. We will briefly discuss these cases.
Court of Appeal of Ghent – debt push-down
The Court of Appeal of Ghent was dealing with a case where two retired but still active shareholders (67 and 80 years old) decided to sell their business (which they had been running since 1972) to an investor who would ensure continuity of the company's activity. The investor borrowed funds from a bank to finance the acquisition price of the shares. On the day of the closing, the target company borrowed EUR 2.5 million from a bank to finance various super dividend payments (of EUR 3.5 million in total) to the investor and new shareholder. With the dividends received, the investor was able to reimburse his loan to the bank.
The taxman disallowed the interest expenses paid by the target company to partially finance the dividend payments.
While the company successfully defended the tax deductibility before the Court of First Instance of Ghent (judgment dated 28 June 2016), the Court of Appeal of Ghent quashed the judgment and disallowed interest payments as tax deductible expenses (judgment dated 9 January 2018).
The court considered that such debt push-downs are mainly in the interest of the selling shareholders and of the acquiring investors and not in the interest of the company incurring substantial risks due to an increase in debt financing and a loss of equity. The court stressed that the company was not able to demonstrate that the acquisition was necessary to safeguard the company's activity (i.e. the purchaser did not make any representations with respect to the company's activities in the SPA). The court considered that the company had artificially created a financing need by paying out a super dividend.
According to reliable sources, an appeal before the Court of Cassation will be lodged against this judgment.
Although, in our view, the court's reasoning can be heavily criticised for a number of reasons, this case demonstrates the importance of having a well-prepared business case and obtaining good advice with respect to this type of transaction.
Court of Appeal of Antwerp – leveraged restructuring
The case which was dealt with by the Court of Appeal of Antwerp concerns Nyrstar Belgium. In 2012, the company decreased its equity through a capital decrease of EUR 350 million (the capital was reduced from EUR 641 million to EUR 291 million) and a dividend of EUR 100 million and decided to finance this with debt of EUR 450 million (a loan it received from its grandparent company). The company did not have sufficient cash to pay out the capital decrease and dividend, so it had to borrow funds.
In this case, too, the taxman disallowed the interest expenses.
The company lost at first instance before the Court of First Instance of Antwerp (judgment dated 29 June 2016) and in the appellate proceedings before the Court of Appeal of Antwerp (judgment dated 8 May 2018).
However, the Court of Appeal of Antwerp did not follow the same (highly questionable) reasoning of the Court of Appeal of Ghent, and rightfully stated that interest payments on a loan used to finance a dividend distribution or a capital decrease cannot automatically be disallowed for tax purposes. However, the court still emphasised that the taxpayer bears the burden of proof and has to demonstrate why such a loan was aimed at retaining or generating taxable income.
The court considered that the company was not able to demonstrate on the basis of reliable evidence that it contracted the loan in order to safeguard income-generating assets it would otherwise have had to sell in order to accommodate the capital decrease and dividend distribution.
This case emphasises even more the importance of having a well-prepared and reasoned case when undertaking such transactions.
Don't panic, but "forewarned is forearmed"
Taking into account the current position of the special tax inspectorate and the recent case law of two courts of appeal, one should realise that debt financing transactions with respect to dividend payments and capital decreases run the risk of being closely scrutinised by the tax administration.
Hence, in order to avoid costly and lengthy court proceedings, one should be well advised and prepared to sufficiently justify the business rationale of such financing.
In our view, there are various good reasons to justify tax deductibility of such interest payments in comparable situations. Such justification and the business purpose of the loan should be well documented in advance.
Our tax partners, Wouter Claes and Svjatoslav Gnedasj, are specialists in this area, and Svjatoslav has also written a book dealing with the tax deductibility of business expenses in corporate income tax. He will be speaking during a seminar at the Fiscal High School (Fiscale Hogeschool) in Ghent on 1 June 2018 which is dedicated to this topic.
Beware! Timely advice can help protect your business. Contact us for more information.