Taxpayers win partial victory in thin cap case

Taxpayers have won an initial victory over EU corporate lending tax rules in
a case worth hundreds of millions of pounds.

Advocate General Leendert Geelhoed gave his opinion on the thin cap case
today, backing UK rules that prevent multinationals loading up their UK
subsidaires with debt to reduce their tax bills, but questioning the bases on
which the rules work.

Geelhoed said such rules were fine where they prevented abuse, but that
strict rules of thumb were inappropriate.

Chris Morgan of KPMG said: ‘Although the UK thin cap rules employ an arm’s
length test, in practice, HMRC often applies and sticks rigidly to “rule of
thumb” tests of a 1:1 debt: equity ratio and 3:1 interest cover which relate
back to some guidance issued in 1995 as if they were de facto fixed ratios. If
the ECJ follows the AG’s Opinion, it will strengthen the taxpayer’s hand. This
will be particularly welcomed by industries such as private equity where high
gearing is normal.’

Geelhoed set out several principles that would make tax arrangements
compatible: that the lending was at ‘arm’s length’, ie, that the lending could
be obtained commercially; and that it might not be arm’s length where there were
special situations such as distressed subsidiaries.

The case was brought by 20 or 30 companies, the named claimants being Pepsi,
Lafarge, Volvo and Caterpillar.

The advocate general dismissed a plea from the UK government for a temporal
limitation in relation to the case.

The UK had said the case would cost it 300m euros. Geelhoed said the UK had
made its case for a limitation too late and in inadequate detail.

He also criticised the UK’s move to ‘harmonise down’: the principle whereby
to make EU intra-community rules proportionate, the UK applied transfer pricing
and thin cap rules within UK groups and companies. Such a response only created
problems, he said.

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