The PRA case: the Norwegian Supreme Court determines that the former interest deduction limitation rule was in breach with the EEA law

During the proceedings before the Oslo District Court, the court sought an advisory opinion from the EFTA Court. In case E-3/21, the EFTA Court concluded that the Norwegian rules were unlawful under EEA law. Oslo District Court ultimately decided not to follow the EFTA Court's opinion and ruled in favour of the State. The verdict was appealed to Borgarting Court of Appeal, which concurred with the EFTA Court's opinion. In the end, the Supreme Court upheld the decision of Borgarting Court of Appeal, thus establishing a precedent for future cases concerning cross-border interest deductions within the EEA.

The Supreme Court's assessment mainly focused on two questions.

The first question was whether the Norwegian interest deduction limitation rule (Nw. "rentebegrensingsregelen") imposed a restriction on the right to freedom of establishment by disadvantaging parent companies based outside of Norway, but within the EEA.

In order to prevent tax evasion to low-tax countries, Norway has regulations that limit the amount of interest deduction companies can claim on intra-group loans. The key aspect of the rule is that the size of the deduction a company can claim is linked to its operating profit (EBITDA). The rule itself is neutral – it does not differentiate between debt interest paid to Norwegian and foreign related companies.

However, Norwegian companies can use the group contribution rules (Nw: "konsernbidragsreglene") to increase the recipient company's EBITDA, thereby increasing the threshold for the interest deduction. A prerequisite for using these rules is that both the contributor and the recipient are Norwegian companies. The group contribution rules in themselves thus constitute a restriction on the freedom of establishment, but the restriction is considered necessary to prevent companies within a group from freely choosing the state where their profits are taxed. Cross-border group contributions can therefore only be made under very strict conditions that no company has yet succeeded in meeting.

In other words, neither the interest deduction limitation rule nor the group contribution rules are, on their own, in breach with EEA law. Aligned with the conclusion of the EFTA Court, the Supreme Court did, however, agree that the interaction of the rules created a discriminatory effect against foreign companies, thus restricting the freedom of establishment.

The next question for the Supreme Court was whether the restriction could be deemed justifiable under legitimate tax considerations. Established and well-accepted practice in the EU Court holds that a restriction can be justified by compelling legitimate considerations. The law imposing the restriction must be suitable for protecting the relevant consideration and must not go beyond what is necessary.

The Supreme Court stated that one such legitimate consideration is the risk that equal treatment might lead to EEA states losing their taxation authority. However, in this case, Norway had relinquished its national taxation authority through the group contribution rules. Thus, Norway could not claim that the right to tax was significant in a cross-border context.

Furthermore, the Supreme Court regarded the need to combat tax evasion as a legitimate consideration. The restriction is deemed justified if the intra-group loan is a purely artificial arrangement, lacking genuine commercial justification. The taxpayer was, however, not given an opportunity to demonstrate that the transaction was made on arm's length, rendering the rule unsuitable to protect such a consideration.

In this context, a key question was whether the ATAD directive, enacted by the EU, necessitated a different approach to the tax evasion consideration. As the directive had not yet come into force in the EU at the time in question, and is not applicable under EEA law, the Supreme Court held that companies should be given the opportunity to prove that their loan transactions were conducted on an arm's length basis under the principle of the freedom of establishment.

Since the restriction could not be justified by compelling legitimate considerations, it was deemed illegal. The Supreme Court thus concluded that the interest deduction limitation rule violated the EEA Agreement, and consequently, that the tax assessments for PRA Group AS for 2014 and 2015 had to be adjusted on the grounds that these rules were not applicable.

The ruling confirms that the former interest deduction limitation rule was in breach of the EEA agreement. It is worth noting that the EFTA Surveillance Authority (ESA) previously initiated proceedings against Norway regarding the same issue. As a result, Norway revised the rule in 2019. Given that this case involves the rule prior to its revision, it is mainly relevant to deductions sought before 2019. Whether the current interest deduction limitation rule, following the revision, complies with EEA standards remains an unresolved question. The restrictive element has, however, been partially retained in the new regulations introduced in 2019, suggesting that the Supreme Court ruling continues to have significance today and that a revision of the rule may be necessary.