|Keith O’Donnell||Samantha Merle|
A group acquired a construction company (LuxCo 2) from private investors via a Luxembourg holding company (LuxCo 1). LuxCo 1 received some debt financing from the group and lent part of the money to LuxCo 2. In 1995, the initial private investors decided to buy back their investment. LuxCo 2 was, at that time, incurring considerable losses. The group sold the shares and receivable on LuxCo 1 for the amount of two Swiss francs: one franc as a consideration for the shares and one franc as a consideration for the receivable. Shortly after this transaction, LuxCo 1 booked a full depreciation on its receivable in LuxCo 2.
The courts (Cour administrative "CA" 7 February 2013, 31230C confirming Tribunal administratif "TA", July 12 2012, 28815) alleged that the structure was abusive: On its balance sheet, LuxCo 2 was keeping a liability deprived of economic reality for the sole purpose of enjoying the carry forward of tax losses. As a result, the liability had to be disregarded for tax purposes and the taxpayer was denied the right to carry forward its losses.
The tax authorities, the TA and the CA all concluded that the structure was abusive, but on different grounds. The tax authorities and the TA found an abuse, but failed to use the proper arguments. The CA reframed the legal disputes, defined the criteria of an abuse of law and analysed, step-by-step, if the conditions were met in the case at hand. An operation is to be characterised as an abuse of law if the following four conditions are met:
- A use of forms or institutions offered by private law;
- A reduction in the tax burden;
- An inappropriate path; and
- The absence of valid non-tax reasons justifying the path chosen.
The judgment seems very strained in its conclusion. We have split our comments into two parts; first, the general principles set down by the CA; and second, the application of those conditions to the facts. The definition of the four conditions seems sensible and broadly in line with international principles. Two comments can be made nonetheless.
- The third condition, inappropriate path, will need clarification as it risks creating a circular logic. There is also a clarification needed as to the burden of proof for this condition.
- The fourth condition, absence of valid non-tax reasons, echoes similar judgments internationally. However, it seems to require that the non-tax reasons justify the path chosen as opposed to the scheme not being wholly artificial, which seems like a higher burden of proof on the taxpayer than in Cadbury Schweppes, for example. It will be interesting to see whether this condition would stand up to EU scrutiny in a cross-border EU context.
As to the application of these conditions to the facts of the case, it seems very hard to arrive at the CA's conclusion, based on the facts presented. There was a clear non-tax transaction which the CA accepted (thankfully overturning a bizarre finding of the lower TA). The CA, however seemed to conclude that what would in normal commercial circumstances be a perfectly standard choice of treatment, for example, maintaining an intercompany receivable rather than waiving it, had insufficient valid non-tax reasons. In our experience, it is exactly the opposite: The waiver is the more complex and less natural transaction, which usually requires more justification commercially before proceeding. The CA therefore seems to postulate that a tax payer is required to carry out an operation (loan waiver) which is legally and commercially questionable to eliminate a tax advantage (loss carry forward) which has been legitimately and commercially obtained. To our knowledge, such a finding is quite unprecedented internationally. Thus, as a preliminary conclusion, we could say that having established a sensible set of general conditions, the CA's finding on the facts is likely to create uncertainty for taxpayers going forward. It will be important to review existing and planned structures to ensure that this dimension is adequately managed.