Case Note of Lexel AB v Skatteverket (C-484/19) written by Xiaochen Wu

Case Note of Lexel AB v Skatteverket (C-484/19)

written by Xiaochen Wu

Description of Facts

This case is a request for a preliminary ruling from the Högsta förvaltningsdomstolen (Supreme Administrative Court, Sweden). At the time of the case, Lexel AB was a Swedish company, also a member of Schneider Electric group. Schneider Electric group is a multinational groupwhich operates in some of the EU Member States and non-EU countries.

Before the transaction at issue happened, one member of the group, Schneider Electric Services InternationalSPRL (‘SESI’), a company established in Belgium, was 85% owned by Schneider Electric Industries SAS, a French company, and 15% owned by Schneider Electric España SA (‘SEE’), a Spanish company. In 2011, Lexel acquired 15% of the shares in SESI previously owned by SEE. Lexel took out a loan from Bossière Finances SNC (‘BF’) for funding this acquisition. BF was the internal bank of the group, and part of a tax entity established in France. Lexel, SESI, Schneider Electric Industries SAS, SEE, and BF are all members of Schneider Electric group.

In 2013 and 2014, Lexel paid the interest of the loan to BF, the amount was SEK 58 million (about EUR 5.5 million) and SEK 62 million (about EUR 5.9 million)respectively. BF used such income to offset its deficits arose from other activities. Skatteverket (Tax Agency of Sweden) refused Lexel’s request of the deduction of the interest expense.

Lexel claimed that the acquisition was not orchestratedfor tax benefits, since SESI was in need of finance to purchase a company outside the group. The applicable tax rate in France was higher than the rate in Sweden at that time.

Legal Context

According to the Swedish law, a company in a group cannot deduct the expense of interest if it is in relation with debts owed to affiliated companies. However, this limitation does not apply to the following situations:

(i) the interest income will be taxed at a minimum rate of 10% in the residence state of the beneficial owner, providing such interest was its only income (unless the main purpose of the loan arrangement is obtaining actual tax benefit). This is ‘the 10% rule’. If the main purpose of the debt arrangement is to ensure the group obtain a substantial tax benefit, then the deduction of interest will be disallowed. This is ‘the exception’.

(ii) even if the criterion of ‘the 10% rule’ is not met, interest of loan from affiliated company are still deductible if the debt is justified by commercial reasons, only when the income recipient is resident in a member state of European Economic Area (EEA) or in a country that had concluded tax treaty with Sweden. This is ‘the business reason test’.

Regarding the regulations mentioned above, certain guidance for interpretation shall be followed. First, the company requesting for deduction shall be the party presenting proofs about the debts not being incurred for tax benefits. The term ‘mainly’ refers to a percentage no less than 75%. Second, the shifting of income among affiliated companies is allowed if all parties are Swedish companies, according to the group contribution regime. This means the losses of one company in a group could be offset by the profit from another company in the same group, as long as both companies are Swedish.

For the disagreement, Lexel appealed against the Tax Agency’s decision to the Förvaltningsrätten i Stockholm(Administrative Court). This court upheld the Tax Agency’s assessment that the deductions should be rejected on the basis of ‘the exception’. However, that court admitted if BF were a Swedish company, ‘the exception’ would not be applicable, which constituted a restriction of establishment. Lexel appealed to the Kammarrätten i Stockholm (Administrative Court of Appeal), that court upheld the opinion of first instance, also the assessment of Tax Agency, through justification of the restriction under the reason of maintaining thebalanced allocation of taxing power between Member States of EU. Lexel then appealed to the Högsta förvaltningsdomstolen, which granted leave to appealregarding whether the freedom of establishment was infringed by the Swedish law.

Analytical Framework of Court of Justice of the European Union

In this case, the Court found the restriction on the freedom of establishment was involved, since the interest expense of loan from an affiliated company will be allowed to deduct if the creditor and the debtor are both Swedish companies, in contrast with the treatment of Lexel. The only difference is the associated creditor being a French company, so the situation was comparable, which confirmed the restriction.

For the restriction, the Court considered the following justification. First is the need to fight tax evasion. The aim of the Swedish law at issue was preventing aggressive tax planning and erosion of domestic tax base, which covered not only wholly artificial arrangements, but also transactions with business reasons and interest paid at arm’s length. The extent of the regulation did not conform to the proportionality. Therefore, on the basis of prior case law, the Court ruled the prevention of tax evasion did not justify the restriction.

Second is the need to maintain the balanced allocation of taxing right between Member States. Under settled case law, safeguarding the domestic tax revenue is not an overriding reason of public interest that can justify the restriction. Hence the Swedish law cannot be justified by this reason.

Third is the combination of the two justifications above. According to prior case law, the prohibition of interest deduction in relation with wholly artificial arrangements for tax benefits could be justified, but only to the amount exceeding arm’s length price. The Swedish law at issue was not based on such grounds, so the Court did not accept the combination of the two reasons as the justification of the restriction.

The Court concluded that the Swedish law at issue was not compatible with the freedom of establishment.