Court of Appeal ruling in Norway on deduction of debt interest costs to related parties

On 30 August 2023 Borgarting Court of Appeal published a new verdict regarding the interest deduction limitation rules, cf. Section 6-41 of the Tax Act, as they read prior to the latest amendments in 2019.

The taxpayer, a Norwegian limited liability company, was a wholly owned subsidiary of a Luxembourg holding company. The business of the group involved purchase of receivables and service of debts. The Norwegian subsidiary was financed partly by equity and partly by loans from the parent company. The company claimed deductions for interest costs on the loans with NOK 132,969,145 for 2014 and NOK 11,580,008 for 2015. Such deductions were denied in a ruling from the Tax Appeal Board in 2020, based on Section 6-41 of the Tax Act.

Based on a thorough assessment, Borgarting Court of Appeal concluded that the group contribution rules and the interest deduction limitation rules combined resulted in a restriction on the freedom of establishment which was not justified. Consequently, the Tax Appeal Board's decision was invalid.

The parties agreed that the conditions for interest deduction limitation pursuant to Section 6-41 were met. The parties also agreed that the Norwegian group contribution rules constituted a restriction on the freedom of establishment, but that this was justified by the consideration of a balanced distribution of taxation rights and of preventing tax avoidance. Furthermore, the parties agreed that domestic and cross-border situations were comparable.

The fundamental question was whether the combination of the group contribution rules, hereunder the limitations on cross-border group contributions, and the interest deduction limitation rules, constituted a restriction on the freedom of establishment which can only be upheld with a separate justification – i.e., a justification in addition to the justification for the group contribution rules. If this was the case, the question was then whether such separate justification existed, and, if not, what the consequences would be for the decision from the Tax Appeal Board.

The court thoroughly reviewed the practice of the EU Court of Justice, which has delivered a number of verdicts on various tax consolidation schemes meant to ensure a balanced distribution of taxation competence between states, as well as to discourage tax evasion. The court interpreted the practice so that a combination of two different rules could result in a restriction on the freedom of establishment, which had to be justified separately.

Further, the court noted that group contributions are included in taxable income when calculating the allowance for interest deductions under Section 6-41 of the Tax Act. Hence, the company receiving group contributions would be able to increase its deductible interest costs. The group contribution rules could thus reduce or remove the consequences of the interest deduction limitation rules in Section 6-41 so that the company would be able to deduct a larger proportion of its interest costs on debt to related parties.

However, this option is reserved for companies that are taxable in Norway, as only such companies can receive group contributions, cf. Section 10-4 of the Tax Act. If the parent company in the case at hand had been tax resident in Norway, it could thus have given a group contribution and thereby increased the deduction limit for the Norwegian subsidiary, which in turn would have increased the interest deductions and reduced the tax burden for the company.

The court further noted that the EU Court's practice was to be interpreted so that the consolidation of deficits and profits could rightfully be reserved for domestic groups. Based on the consideration of a balanced distribution of taxation competence, the states could not be required to allow cross-border transfer of fiscal deficits. However, denying tax advantages other than such transfer of profits and losses in cross-border situations requires a separate justification. The court thus concluded that the group contribution rules and the interest deduction limitation rules combined constituted a restriction on the freedom of establishment that had to be justified separately.

The court stated that the purpose of the interest deduction limitation rules in Section 6-41 of the Tax Act is to discourage tax evasion, not to ensure a balanced distribution of taxation competence between states. The fact that companies in Norwegian groups, to a greater extent than companies in cross-border groups, were able to avoid this limitation and deduct interest costs on loans from related parties, did not prevent behaviour that could interfere with the Member State's right to exercise tax competence for business on its territory. The rules thus provided a differential treatment which was not justified in terms of a balanced distribution of taxation competence.

Furthermore, the court noted that, in order for a restriction on the freedom of establishment to be justified on the basis of prevention of tax avoidance, the specific aim of the restriction must be to prevent such avoidance. This was not the case for the group in question as the differential treatment did not stem solely from the interest deduction limitation rules, but from these combined with the group contribution rules. Hence, the prevention of tax avoidance was not sufficient to justify the restriction.