The EFTA case concerns the Norwegian interest deduction limitation rule, in force from 2014 to 2019, and whether it is in breach of the freedom of establishment. The outcome is also relevant for the new interest limitation rule introduced in 2019.
The EFTA Surveillance Authority (ESA) concluded in its reasoned opinion dated October 25 2016 that the Norwegian interest deduction limitation rule from 2014 was in breach of EU/EEA law.
The Norwegian government did not agree and maintained that the rule was in line with the EEA Agreement. Due to the introduction of the new interest deduction limitation rule in 2019, ESA closed the infringement case against Norway.
Based on ESA’s reasoned opinion, several taxpayers who had been subject to interest limitation (including the plaintiff in the EFTA Court case), requested a reassessment. This was denied by the tax office and eventually, for some taxpayers, by the Tax Appeal Board. The plaintiff in the EFTA Court case therefore brought the case to the Oslo District Court and argued for a referral of the EEA questions to the EFTA Court.
Relevant Norwegian tax law and discriminatory effect
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 5 million kroner ($583,308) to 30% of the company’s taxable EBIDTA (earnings before interest, taxes, depreciation and amortisation).
The rule applies both to national and cross-border group companies. Thus, it is not this rule itself that creates the discriminatory effect. The difference in treatment emerges due to interaction with the group contribution rules.
These rules enable Norwegian companies in a group to reduce the interest limitation (entirely or partly) because the 30% EBIDTA 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.
It is established in the ECJ Oy AA case (C-231/05) that restricting the possibility to make and receive group contributions to domestic group companies constitutes a restriction on the freedom of establishment. The same should therefore apply when the rules on group contributions affect the interest deduction limitation rule. Furthermore, the restriction (to deny interest deductions) cannot be justified by overriding reasons in the public interest.
Firstly, the consideration of preventing tax avoidance cannot be used as justification because the interest deduction limitation rule also covers interest on loans made on commercial terms and not only wholly artificial arrangements.
Secondly, the consideration of a balancing allocation right between members states cannot justify why a deduction shall be denied in the national and not the cross-border situation. Such a difference is treatment has only been accepted by the ECJ for tax consolidation rules, not for other tax rules such as interest limitation rules. On this basis, the Norwegian interest deduction limitation rule is in our view contrary to the freedom of establishment.
This view is supported by the two recent ECJ cases, X and X (C-398/16 and C-399/16) and Lexel (C-484/19). In both cases the discriminatory effect was due to the interaction between group consolidation rules and interest limitation rules.
Possible consequences of the judgment
The Oslo District Court is not obliged to follow the ruling from the EFTA Court but Norwegian courts normally do if the conclusion is that the interest deduction limitation rule from 2014–2019 is in contrary to the freedom of establishment, the Norwegian government may choose to appeal the case to the Court of Appeal. If not, the plaintiff will be entitled to a reduced interest limitation. Furthermore, other taxpayers that have been denied interest deductions in these years, may request a reassessment.
The EFTA Court case will also be relevant for the current rules, under which group contributions can still be used to limit interest limitation. From 2019, an equity escape clause was introduced which in effect exempts 100% Norwegian based groups from interest limitation. This feature could also be in breach of EU/EEA law as it makes it more beneficial to invest in Norwegian subsidiaries compared to foreign subsidiaries.
The overriding reasons discussed above would in our view not defend restrictions caused by the interaction with the group contribution rules and the equity escape clause that effectively exempt 100% Norwegian-based groups. The EFTA Court would hopefully give guidance that could answer some of these questions too.
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