EFTA Court rules against Norway on interest deduction limitation rule

As described in our previous article, EFTA case E-3/12 concerns whether the Norwegian interest deduction limitation rule in force from 2014 to 2019 is contrary to the freedom of establishment. The outcome is, however, also relevant for the European Economic Area’s (EEA’s) compliance with the interest limitation rule introduced in 2019.

The taxpayer was a Norwegian limited liability company partly financed with equity and partly with debt. The lender was the parent company, which was tax resident in Luxembourg. Deductions for interest were partially refused on the basis of the interest deduction limitation rule (as the rule read in 2014 and 2015). The subject of the dispute before the EFTA Court was whether the refusal of deduction was contrary to the EEA Agreement.

The relevant Norwegian law is section 6-41 of the Tax Act (‘the TA’), which in 2014 limited the right to deduct net interest expenses above NOK 5 million ($484,632) to 30% of the company’s taxable EBITDA (earnings before interest, taxes, depreciation, and amortisation). The rule applies both to national and cross-border group companies, meaning that there is no difference in treatment under the rule itself.

The discriminatory effect emerges due to interaction with the group contribution rules, as mentioned in our previous article. These rules enable Norwegian companies in a group to reduce the interest limitation (entirely or partly) because the 30% EBITDA rule is affected by group contributions received, a possibility that is not available to EEA-based group companies. This makes it more beneficial to establish a group company in Norway rather than in another EEA country.

The EFTA Court first had to decide whether there was a restriction on the freedom of establishment. The Court of Justice of the EU has previously concluded that a combination of rules (tax consolidation rules and deduction rules) can result in cross-border situations being treated less favourably than national situations (see Lexel (C-484/19) and X and X (C-398/16 and C-399/16)).

The EFTA Court reached the conclusion that the combination of group contribution rules (which apply between group companies with tax liability to Norway) and interest limitation rules (which apply in general) meant that Norwegian borrowers that were in a group with Norwegian companies were exposed to less interest limitation, and therefore paid less tax, than Norwegian borrowers which are in a group with EEA companies. Thus, a discriminatory treatment existed which constituted a restriction on the freedom of establishment.

The EFTA Court also concluded that a Norwegian borrower that was in a group with a Norwegian company was in a comparable situation to a Norwegian borrower that was in a group with an EEA company. It was not relevant for the comparability assessment that there had been no actual group contribution from the EEA company to the borrower in the case.

The last question that the EFTA Court had to answer was which overriding reasons (in the public interest) could defend the restriction. The EFTA Court assessed the consideration of ensuring a balanced allocation of taxation rights but concluded that this consideration could not justify that a tax deduction had been granted in a national but not in a cross-border situation. When an EEA state grants such a benefit in a domestic situation (and renounces part of its taxing rights), it cannot at the same time argue that the same taxing right is important in the cross-border situation.

The EFTA Court reached the conclusion that only the consideration of preventing wholly artificial arrangements could be a relevant justification. In order for this consideration to justify the restriction, there is, however, a requirement that the taxpayer must be given an opportunity to provide evidence of any commercial justification of the arrangement (that the loan is arm’s-length, etc.). The documents presented to the EFTA Court indicated that it was not possible to provide such evidence. Nevertheless, the EFTA Court left it to the national court to verify this.

The interest deduction limitation rule that applied before 2019 applied unconditionally, meaning that it cannot be justified by overriding reasons in the public interest.

The case will now continue before the Oslo District Court. In general, Norwegian courts are not obliged to follow the ruling from the EFTA Court, but the courts normally do.