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/AFER[1] 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.
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[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.
