Court agrees: bonds issued under commission agency agreement not to be included in thin capitalisation test
The court agreed with our tax litigation team in a dispute concerning thin capitalisation rules. When applying the test, the economic substance of the credit relationship should be taken as a basis – the bonds issued for unrelated investors under a commission agency agreement should not be included in the test.
Under a commission agency agreement, the principals instructed a related party — a commission agent — to arrange a bond issue in the commission agent’s own name, but for and on the account of the principals, and to ensure, in technical terms, the distribution of the proceeds of the bond issue and the repayment of the bonds to investors until the bonds’ maturity. The legal question at dispute concerned the application of the thin capitalisation test to the interest paid on the bonds thus issued.
From the beginning of the dispute, the tax authorities disagreed that in economic terms the parties to the credit relationship in respect of the bonds were the individual principals and the investors in the bonds and not the commission agent through whom the issue itself took place. The tax authorities thus believed that it was necessary to apply a thin capitalisation test, as the funds provided by a related party — the commission agent — to the individual principals were in their view a credit financial instrument provided between related parties.
The regional court disagreed with the financial administration’s opinion. The court based its conclusion primarily on the material rather than formal aspects of the transaction. The court unequivocally confirmed that when acting for and on the account of principals (indirect representation), the economic result of such acting shall belong to the principal in whose economic sphere the transaction is actually reflected. Therefore, the tax consequences should also be reflected there. The court confirmed that from a tax perspective it is important what the real substance of the transaction is and on whose account it has been carried out. At the same time, according to the regional court, there was no doubt that the purpose and result of concluding the commission agency agreement and issuing and underwriting the bonds was to obtain external funding for the principals and not to provide credit to the principals by the related party commission agent. As this involved obtaining external funding from third parties rather than providing a credit financial instrument within a group, a thin capitalisation test should not be applied to interest paid on the bonds issued.
The regional court’s conclusions were convincing enough for the financial administration to withdraw their cassation complaint, leading to the closing of the proceedings.