TAX NEWS - FEBRuary 2010
European Court of Justice allows profit adjustment in non-arm's-length transactions
Under Belgian domestic law, abnormal or gratuitous advantages granted by a Belgian resident company to a related nonresident company are imputed to the taxable base of that Belgian company, whereas the taxable base would not be increased when such advantages are granted to a Belgian company.
In the SGI case, a Belgian company granted an interest-free loan to its French subsidiary (absent any legitimate purpose) and paid management fees to its Luxembourg parent. The Belgian tax authorities first increased SGI's tax base by 5 percent deemed interest because the borrower was associated with the lender, and then disallowed part of the directors' remuneration paid to SGI's parent company, as it was considered excessive. Had the transactions been between related Belgian companies, there would not have been a deemed interest adjustment and the remuneration would have been deductible in full. SGI challenged the profit adjustment on the grounds that the Belgian rule is incompatible with the EU freedom of establishment principle because there is no analogous rule that applies in purely domestic situations.
Decision of the ECJ
The ECJ held that the Belgian measure constitutes a restriction on the freedom of establishment principle, because abnormal or gratuitous advantages granted by a Belgian company are added to its taxable base when the advantages are granted to a related company located in another EU member state, whereas this is not the case when the beneficiary of the advantages is located in Belgium. As a result, a Belgian company could be deterred from acquiring, creating, or maintaining a subsidiary in another member state or from acquiring or maintaining a substantial holding in a company established in that state because of the additional tax burden. Conversely, companies established in other EU member states could be deterred from acquiring, creating, or maintaining a subsidiary in Belgium or from acquiring or maintaining a substantial holding in a Belgian company because of the additional tax burden imposed by the Belgian legislation.
Although the ECJ concluded that the Belgian measure violates the freedom of establishment principle, the Court said the restriction can be justified by the need to ensure a balanced allocation of the power to tax between member states and the prevention of tax avoidance.
According to the ECJ, permitting resident companies to transfer their profits in the form of abnormal or gratuitous advantages to related companies in other member states may undermine the balanced allocation of the power to impose taxes between the member states and carries a risk that, by means of artificial arrangements, income transfers may be structured to accrue to companies established in member states that have the lowest tax rates or in member states in which such income is not taxed.
As a result, the restriction is justified if the Belgian measure does not go beyond what is necessary to attain the objectives pursued. The ECJ considers this to be the case when, in each situation in which there is a suspicion that a transaction is not at arm's length, the taxpayer is given an opportunity - without being subject to undue administrative constraints - to provide evidence of a commercial justification for the transaction and the corrective tax measure is confined to the amount that exceeds the amount that would have been agreed if the companies were not related. It is now up to the referring court to confirm whether this is the case.
The ECJ's decision is not unexpected after AG Kokott's opinion in the case. In line with its previous case law, the ECJ has shown that it is prepared to uphold national measures to combat tax avoidance and to ensure the preservation of the just allocation of taxing powers between the member states. Consequently, Belgian taxpayers must sufficiently document and make sure they can justify all transactions with related companies established in other countries.