Inter-company financing: beware of non-deductible interest
Inter-company financing: non-deductible interest
Avoid that interest is not deductible by the debtor and is taxed at creditor. These are expensive loans. A recent decision made clear that repairing the loan terms retrospectively does not always work.
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In a recent court decision the interest paid by the subsidiary was not deductible. The shareholder / creditor tried to change the loan terms in such a way they thought the interest income would be tax free. The court disagreed with the shareholder with double taxation as a result: the interest was taxable income.
What is the background?
Interest is not always deductible. Think of rules like thin capitalization or profit drainage - skimming profits by charging interest (no interest deduction for certain 'tainted' transactions). By legislation or case law a finance can be qualified as loan or equity. If the debtor and creditor are in two different countries, this is an opportunity to avoid taxation (double dip) or threat for double taxation.
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What does this mean for our relationships?
The terms of inter-company loans have to be drafted carefully, since the result may be that the interest paid is not deductible and the interest received is taxed. By changing the terms, you can achieve that interest: 1) is not taxed and is not deductible; 2) taxed and deductible; 3) or the best: not taxed and deductible (this only works in an international context)
Check in advance or interest is not deductible and if so what needs to be done.
Change the loan terms so that interest is deductible.
Or change the financing terms so that it qualifies as equity or as a loan that qualifies as equity. As a consequence the finance income is exempt (participation exemption).
To the extent possible and desirable: finance not internally but externally.