The Court of Justice of the European Union (CJEU) has today published a preliminary ruling in the Lexel case (C-484/19) in which the court finds that the exception to the ten percent rule in the 2013-2018 Swedish interest deduction limitation rules is contrary to the freedom of establishment. The ruling is likely to impact numerous companies that have been denied interest deductions and which, in many cases, should now be able to refer to the ruling to obtain a deduction.
The case at hand concerns a Swedish company that has been denied a deduction, by reference to the exception to the ten percent rule, for interest expenses paid to a French group company with a tax loss generated from French operations. The exception to the ten percent rule states that interest expenses relating to intra-group debt may not be deducted if the main reason (>75%) for the debt relationship was to create a significant tax benefit for the group. The question of interpretation in the case was whether the said rule is in breach of the freedom of establishment.
Decision of the CJEU
The CJEU initially notes that if the lender had been tax resident in Sweden, the Swedish company would have been allowed to deduct the interest expenses, taking into account that the companies would then have been covered by the Swedish group contribution rules. The court concludes that the Swedish rules entail a difference in treatment which has a negative impact on the companies' ability to exercise their freedom of establishment.
This difference in treatment cannot be justified by reference to the need to prevent tax avoidance or abuse, or to the need to ensure a balanced allocation of taxing rights between Member States. Also, a combination of these two grounds of justification cannot be accepted.
In the justification assessment, the Court places particular emphasis on the fact that the exception to the ten percent rule may cover transactions carried out on market terms and which consequently do not constitute wholly artificial or fictitious arrangements.
The CJEU concludes that the Swedish rules are contrary to the freedom of establishment.
It is good news that the CJEU has decided on the issue and that it is now confirmed that the exception to the ten percent rule is in breach of EU law, in particular since the rules have been a source of legal uncertainty in Sweden over a long period of time. A large number of taxpayers have had their deduction for interest expenses denied and the exception to the ten percent rule has been applied widely by administrative courts and the administrative courts of appeal, almost exclusively (with a few exceptions) in favor of the Swedish Tax Agency. The Swedish Supreme Administrative Court has previously found, without requesting a preliminary ruling, that the old rules from 2009 were not in conflict with EU law.
The preliminary ruling by the CJEU concerns only the exception to the ten percent rule. It can be mentioned that the right to deduct interest with the support of the so-called “business purpose test” may also be affected by the decision, especially in view of the analysis by the CJEU with regard to justification, which goes beyond what has previously been stated by the Commission and Swedish courts (for example, the Commission considered that the rules could be justified but that the rules instead were not proportionate).
Furthermore, there could be arguments, based on an interpretation of the CJEU decision in Lexel, that the new rules, introduced from January 1, 2019 to replace these 2013-2018 rules, are also in parts contrary to the freedom of establishment.
It can be noted that the question at hand has only been tested against the freedom of establishment. Thus, the decision is not immediately applicable where the recipient of the interest is resident outside the EU/EEA (although there may potentially be arguments, with different circumstances, to apply the free movement of capital).
The case is now referred back to the Swedish Supreme Administrative Court for a final decision. The decision means that many companies should have new arguments to put forward, with which we can assist, to allow interest deductions.
Please do not hesitate to contact us if you have questions or would like to discuss.
The article in Swedish
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