Background of the case
The repayment of PPF by a Belgian subsidiary was carried out through the assignment of promissory notes to the Luxembourg parent company at nominal value, in accordance with repayment terms under the PPF. However, the actual market value of the notes was significantly higher than the nominal value, resulting in the Luxembourg parent company realizing a substantial profit for tax purposes on such assignment of the notes. On the same day, the Luxembourg parent company sold the promissory notes at market value to another group company.
The Luxembourg parent company declared the profit realized from the assignment of the promissory notes as a tax-exempt hidden profit distribution, invoking the domestic participation exemption regime introduced by the Parent-Subsidiary Directive. However, the Luxembourg tax authorities considered this profit as being derived from the sale of receivables, which does not qualify for the domestic participation exemption. The tax authorities challenged transaction as abusive based on two separate legal sources: the GAAR and the PSD SAAR.
Court decision
The Administrative Court upheld the decision of the Administrative Tribunal in first instance, rejecting the appeal, albeit on different grounds – specifically invoking PSD SAAR instead of GAAR. Historically, as in the present case, the Luxembourg tax authorities have often invoked different anti-avoidance rules, GAAR and certain specific anti-avoidance rules, in a combined manner. However, the courts have not explicitly addressed the hierarchy between these rules. In the present case, the Court emphasized that when there are two distinct legal sources of equal rank, the provision specifically targeting a particular abusive tax practice should be applied first (the general principle that special rules override general rules). The Court determined that because the appellant company sought the benefits of the domestic participation exemption regime, it was necessary to first assess the potential abuse of law under the PSD SAAR.
The Court then examined whether the assignment and subsequent disposal of the promissory notes constituted an abuse of law under one of the two alternative criteria established by PSD SAAR. Firstly, the Court examined whether the deduction of payments made by the Belgian subsidiary under the PPF was involved. As no deduction had been made in Belgium concerning the exempted income in this case, the first condition for establishing abuse of law was not met.
The Court then examined the second criterion: whether the disputed transaction was part of a “non-genuine” arrangement that had been put into place with a main purpose or one of the main purposes of obtaining a tax advantage that defeated the object or purpose of the Parent-Subsidiary Directive. An arrangement is considered “not genuine” if, based on all relevant facts and circumstances, it was not structured for “valid commercial reasons that reflect economic reality”.
The Court systematically dismissed each argument presented by the taxpayer, concluding that the assignment of the promissory notes at their nominal value to the taxpayer lacked commercial rationale, especially given that the market value of these notes was significantly higher. This resulted in a tax-exempt transfer of substantial profits within the group, which the Court found was primarily motivated by tax avoidance rather than legitimate business reasons. The Court determined that these specific transactions were not genuine but were instead designed to exploit tax exemptions, failing to align with the legitimate purposes of the Parent-Subsidiary Directive.
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