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The tax deductibility of interest on a loan to finance a capital decrease or a dividend distribution to its parent company has been a hot topic in Belgian tax law for many years. The Court of Appeal of Ghent has recently confirmed that the interest is tax deductible as there was sufficient proof that by contracting the loan the taxpayer avoided a sale of its income-generating assets.
The tax authorities often deny the tax deductibility of interest on a loan contracted to finance a dividend distribution of capital decrease (e.g. in the context of a debt push-down or a stock market exit). This is based on the reasoning that these interest expenses do not meet the “finality condition”, which requires that an expense must be made to acquire or preserve taxable income, of Article 49 of the Belgian Income Tax Code (“ITC”).
The burden of proof with respect to the fulfilment of the “finality condition” lies with the taxpayer.
In recent years, several higher courts have rejected the tax deductibility of interest payments in this context, for example based on the reasoning that the loan was not used to finance the company’s own investment but rather the investment made by its shareholder (e.g. in the context of the acquisition of a Belgian company by a private equity fund or to repay a bridge financing in the context of a stock exchange exit).
This reasoning was confirmed by the Supreme Court case of 19 March 2020, which, however, leaves room to argue that interest paid in the framework of a leveraged dividend distribution or capital decrease may still be tax deductible if it can be demonstrated that the loan was contracted to avoid the loss of incoming-generating assets, i.e. a so-called “securing of assets” test. However, the mere fact that the company does not have sufficient liquidity to finance the dividend distribution is no sufficient proof in this respect. A taxpayer needs to prove in concreto that the loan was contracted to acquire or preserve taxable income.
Case law following this Supreme Court case remained very strict and ruled in favour of the tax authorities, thus casting doubts whether the “securing of assets” test and thus the “finality condition” could ever be met in practice in the context of leveraged dividends or capital decreases.
This is the first published case since the 2020 Supreme Court case, where a Court of Appeal has accepted that the evidence provided by the taxpayer on the “securing of assets” test in the context of the “finality condition” was sufficient.
The facts of this case were as follows. The company contracted a loan of EUR 1,5 million to help finance a dividend of EUR 1,2 million and a capital reduction of EUR 600k. The company’s main assets were participations, which were also invoiced for management services and receivables, all of which generated taxable income.
The Court establishes, first, that it is clear that the company did not have sufficient liquidity to finance the dividend and capital decrease and, second, that by contracting the loan the company avoided the sale of (part of) its participations (= incoming generating assets) which would have triggered a (partial) unwinding of the group.
On this basis, the court deemed the “finality condition” met and thus confirmed the deductibility of the interest. The fact that the shareholder of the company used the upstreamed funds to make a private purchase does not impact this conclusion.
This judgement of the Court of Appeal of Ghent is a welcome confirmation that interest can still be tax deductible in the context of leveraged dividends or capital decreases.
However, as the judgement seems rather lenient as compared to other recent case law, taxpayers should remain prudent. It is our recommendation to demonstrate in advance that the “securing of assets” test is met in concreto, i.e. through a thorough and well-documented analysis that a sale of the company’s assets was considered to finance the dividend distribution or capital decrease, but that all of these assets were expected to yield returns higher than the interest due on the loan.
It remains to be seen whether the tax authorities will file an appeal.
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