THE BOTTOM LINE
- Arm’s-Length Principle is Paramount: Tax deductions for bad debts on intercompany loans can be denied if the loan carries a risk that no independent third party would have accepted, even for a much higher interest rate.
- Debt vs. Equity Matters: Financing a highly leveraged, negative-equity subsidiary with debt (instead of a capital injection) creates a major red flag for tax authorities. If it looks like equity, it will be treated as such, and losses will not be deductible.
- Industry Practice Is No Excuse: Arguing that traditional banks refuse to finance your specific industry (in this case, online gambling) is not a sufficient defense. The burden remains on the company to prove that an independent lender, under the same circumstances, would have still provided the funds.
THE DETAILS
A recent ruling from the District Court of Gelderland serves as a stark reminder for corporate groups about the tax treatment of internal financing. The case involved a Dutch company that, through a subsidiary, lent significant funds to a related Maltese entity set up to run an online gambling operation. When the Maltese venture ultimately failed, the parent company attempted to write off the loan as a bad debt, claiming a tax deduction for the loss. The Dutch Tax Authority disagreed, and the court has now sided with them, disallowing the deduction.
The court’s decision hinged on the well-established Dutch legal doctrine of the unbusinesslike loan (onzakelijke lening). This principle dictates that a loss on a loan between related parties is not tax-deductible if the lender accepted a debtor risk that an objective, independent third party would never have taken. In such scenarios, the loan is not considered a true loan for tax purposes but rather an informal capital contribution. The loss is then viewed as a non-deductible shareholder loss, not a deductible business expense. The core question for the court was whether any third party would have lent money on similar terms.
In this instance, the court found that the financing structure was commercially unjustifiable from an arm’s-length perspective. The judges pointed to several critical facts: the Maltese debtor company had no equity and was entirely financed with borrowed funds (zero capitalization), its solvency was negative from the very beginning, and no security was provided for the loan. Essentially, the lending company bore all the downside risk of the venture, while the shareholders stood to gain all the potential upside. The court ruled that these factors created a strong presumption that the loan was unbusinesslike. The company’s argument that it was “forced” into this structure because traditional banks don’t finance gambling was dismissed as insufficient without concrete evidence that an alternative, independent lender would have accepted such a high-risk proposition.
SOURCE
Source: Rechtbank Gelderland
