Brussels to the Point December
Lauded by some yet criticized by others since its introduction, it comes as no surprise that the notional interest deduction (NID) is one of the first tax breaks to be curtailed at a time when governments are being urged to put their fiscal houses in order. This article outlines the most recent developments in this area, focusing on the government's "clarifications" to the NID, the compatibility of the NID with EU law, and the changes proposed by prime minister Elio Di Rupo.
Second addendum to AOIF/AFER1 circular no.
14/2008
The NID rules, which entered into force in tax year 2007, allow
Belgian corporate taxpayers (and foreign corporate taxpayers with a
permanent establishment in Belgium) to benefit from a tax deduction
corresponding to a percentage of fictitious interest on their
adjusted equity.
In 2008, the Belgian tax authorities started to formally react to
alleged abuse of the NID, issuing AOIF/AFER circular no.
14/2008,2 which summarises the (general and specific)
anti-abuse provisions of Belgian tax law and explains how to apply
them in the context of the NID. On 2 June 2008, a first addendum to
the circular was published,3 consisting of a list of
case law on the sham doctrine referred to in the circular.
On 20 June 2011, the tax authorities issued a second addendum to
the circular, based on cases of abuse of the NID identified during
audits.4 This addendum describes two specific schemes
for which the benefit of the NID can be denied.
The first scheme involves intra-group capital flows. In this
scheme, a parent company capitalizes a Belgian financing
subsidiary, which immediately grants a loan to its parent with a
principal amount approximately equal to the funds the parent
contributed to the subsidiary. In this way, the parent company can
deduct its interest payments while the subsidiary can use the NID
to reduce its interest income. According to the addendum, in this
scenario, the authorities will investigate whether the transaction
is "simulated" (i.e. a sham) (in which case, the real
intention and purpose of the parties to the transaction will
prevail over the formal wording or presentation of the deed) and
whether the subsidiary received an "abnormal or gratuitous
advantage" which is not justified by economic needs. If so,
the benefit of the NID will be denied. The addendum lists a number
of factors which can indicate bad faith, such as the number of
entities involved, the (simultaneous) timing of the various stages
of the transaction, violation of the financial assistance rules,
and the specificities of the loan.
The addendum emphasizes that the capitalization of a Belgian
financing subsidiary which grants loans to various entities in the
group can be a bona fide transaction, provided the Belgian entity
consistently acts as a financing company. The addendum also states
that it does not intend to target cases whereby cash from the sale
of corporate assets or the repayment of a loan is contributed to a
financing company, followed by a clearly documented refinancing of
the contributing entity for a different amount.
The second scheme involves the conversion of shares with latent
capital gains into receivables. The purpose of this type of scheme
is to include the net value of the shares from the equity on which
the NID is calculated (whereas those shares themselves are not part
of the adjusted equity on which the NID is calculated). When the
shares are sold, the company's adjusted equity should normally
rise by the tax value of the shares plus any (tax-exempt) capital
gains realized thereon, thus increasing the basis for the
calculation of the NID. In this type of transaction, however, the
purchase price is often not actually paid but rather financed
through an interest-bearing intercompany loan, thus creating an
additional (and tax deductible) interest expense. The interest
income can be offset by the NID. In this scenario, the addendum
instructs the tax officials to investigate whether the transaction
is "simulated" (i.e. a sham), whether the sale is at
arm's length, and whether the company has received an abnormal
or gratuitous advantage that is not justified by economic needs. In
making this assessment, the authorities will take into account the
buyer's financial situation (i.e. whether it has the financial
means to pay back the loan and the accrued interest), the terms and
conditions of the loan, and the party that bears the risk of the
transaction.
The addendum further specifies that normal restructuring
activities are not targeted, such as the sale of shares to
consolidate the holding activities of a group into a separate
entity (and isolate them from the group's financing
activities).
Criticism at the EU level: request for a preliminary
ruling
On 24 June 2011, the Antwerp Court of First Instance submitted a
request for a preliminary ruling to the Court of Justice of the
European Union (CJEU) on the question of whether the NID is
compatible with freedom of establishment when a company that is
subject to tax in Belgium cannot apply the deduction in respect of
risk capital corresponding to the positive difference between (i)
the net book value of the assets of the company's
establishments in other Member States of the European Union and
(ii) the total liabilities imputable to those establishments, while
it can apply the deduction if this positive difference is
attributable to the assets and liabilities of a Belgian
permanent establishment.5 On average, it takes about two
years for the CJEU to render a decision. In 2009, the European
Commission initiated an infringement procedure against Belgium on
the same grounds.
Proposed changes to the NID
On 4 July 2011, Elio Di Rupo presented a proposal for negotiations
to form a new federal government and adopt a 2012 federal budget.
The proposal calls for various new tax measures, including
provisions on the notional interest deduction. Recently, the
negotiators reached a consensus on the budget, but an official text
is not yet publicly available. In this section, we discuss the
proposed changes to the NID in the proposal and how they are
believed to appear in the 2012 budget.
The first proposed change is a reduction in the applicable interest
rate cap. Currently, the applicable interest rate is based on the
average interest rate on ten-year Belgian government bonds (OLOs),
but capped at 6.5% (this cap has been further reduced for tax years
2011 and 2012). This cap is an absolute maximum and currently (for
tax year 2012) the rate actually applicable is 3.425%. However, it
is feared that the way the NID is calculated will result in the NID
to be artificially inflated due to instability in the euro zone. Of
course, this problem could be solved by referring to the average
interest rate on government bonds in all euro zone countries.
However, the proposal chose to continue to base the NID on OLOs,
but the current cap is further decreased to 3%. Note that the
actual NID for tax year 2012 (of 3.425%) under the current rules is
higher than the alleged new cap. The 0.5% increase for SMEs would
be maintained.
Secondly, the proposal repeals the current possibility to carry
forward any unused portion of the NID for a period of seven years.
Any unused portion of the NID built up under the current rules
would remain available but its use would be limited.
Finally, the proposal recommends excluding so-called mandatory
equity from the basis used to calculate the NID. The wording of the
proposal is unclear, however, on how to interpret that term. On the
one hand, it could refer to the minimum share capital needed to
incorporate a private or public limited-liability company (e.g. EUR
61,500 for a public limited-liability company with shares, the
NV/SA), possibly also including the statutory reserve companies
must maintain (at least 1/10 of their authorized share capital). On
the other hand, the proposal could also be referring to the capital
requirements banks are obliged to meet under Basel III. Unofficial
sources seem to suggest that the agreement reached by the
negotiators on the 2012 budget has not upheld this part of the
proposal. Instead it is believed that they have opted to limit the
deductible NID in any given year to 60% of the taxable base, but
not on the first €1 million of the taxable base. It is
also believed that the possibility to carry forward unused NID
would be maintained for the portion of the NID that cannot be
deducted under this new rule.
At the time of writing, no official texts have been circulated
yet, so it is impossible to predict the outcome at this time.
Footnotes
1. Administratie van de Ondernemings- en Inkomensfiscaliteit/Administration de la fiscalité des enterprises et des revenus.
2. Circular Ci.RH.840/592.613 (AOIF no. 14/2008) of 3 April 2008.
3. First addendum to circular Ci.RH.840/592.613 (AOIF no. 14/2008) of 2 June 2008.
4. Second addendum to circular Ci.RH.840/592.613 (AOIF no. 14/2008) of 20 June 2011.
5. Argenta Spaarbank NV v Belgium, C-350/11, OJ C 282 of 24 September 2011.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.