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Interest on Shareholder Loans: Agreed Interest Rate Is Not at Arm’s Length

Dutch court rules that in this specific case, a shareholder loan’s interest exceeding 4.25% is not at arm’s length, with excess treated as a deemed dividend for tax purposes.

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Executive Summary

The tax payer manages and invests in commercial real estate. To finance this, it has taken out loans from its foreign shareholders at an interest rate of 8%.
This article examines a recent Dutch court decision (ECLI:NL:RBNHO:2024:14223) where interest on the shareholder loans was found partly non–arm’s length. The judgment clarifies that while the loans themselves were considered at arm’s length, the 8% agreed interest exceeded the limit of an acceptable interest rate based on the arm’s length principle (4.25%), making the excess a deemed dividend subject to withholding tax.

Outcome Focused Conclusion

The court concluded that although the loans from shareholders were not considered “non-businesslike loans” under Dutch case law, the 8% annual interest rate was above the upper limit of an arm’s length interest rate. Based on comparable data specified on the commercial real estate market, the upper limit of an arm’s length range was determined at 4.25%. Any interest paid above that threshold was deemed an informal capital distribution — triggering Dutch dividend withholding tax obligations.
For internationally operating groups, this court ruling highlights that a robust Transfer Pricing report is necessary but not sufficient. Tax authorities and the court may still reject benchmark studies if comparables lack relevance to the specific borrower profile or market conditions. 

Understanding the court’s Reasoning

  • The commercial nature of the loans
    The Inspector initially argued the loans were non-businesslike. Both the District Court and Court of Appeal disagreed. The borrower was solvent, owned prime leased office property, had predictable cashflows, and retained a BBB– investment grade credit rating even with an 8% interest obligation. Thus, a third party could have lent under similar terms, although likely at a lower rate, as a result of which the loans are not considered 'non-businesslike loans'.


  • Determining the arm’s length interest rate
    The taxpayer’s Transfer Pricing economic analysis relied mainly on public bond data from banks — including Southern European issuers during the post-crisis period. The court found these not fully comparable to the Dutch real estate holding. By contrast, market reports specified on commercial real estate and debt proposals from commercial lenders indicated financing could be obtained at 3.0% to 4.25% without certain covenants. The court adopted 4.25% as the top of the acceptable range, rejecting both the 1.78% stated interest rate from the tax authority’s and the 8% agreed interest rate based on the taxpayer’s submitted benchmark study.


  • From excess interest to deemed dividend
    Under Dutch law, when interest exceeds the arm’s length rate, the excess may constitute a deemed profit distribution. The court held that both borrower (company) and lenders (shareholders) should have been aware of the benefit arising from the 8% agreed interest rate, given the size of the gap in agreed interest rate and arm’s length interest rate (8% vs. 4.25%). The excess (3.75%) was thus requalified as a dividend, subject to 15% Dutch dividend withholding tax. According to the court, it has not been sufficiently demonstrated that a secondary adjustment is justified.


  • No penalties due to lack of proven intent
    Although the deemed profit distribution test was met, the court struck down the Inspector’s 50% penalties. This was because the taxpayer had relied on professional Transfer Pricing studies and similar structures where higher interest rates had been deemed arm’s length. The court stressed that Transfer Pricing is not an exact science and good faith reliance on expert reports reduced culpability.
  • Implications 
    This case underscores the need for industry-relevant comparables in intercompany loan pricing. It also illustrates that dividend withholding tax exposure may arise from intra-group financing, even without formal dividend declarations. The burden of proof for penalties remains high, and the financial exposure from principal tax and interest can still be significant.

Key Takeaways

The following lessons can be drawn for multinationals structuring shareholder loans:

  • A shareholder loan itself can be businesslike in nature, but its interest rate must still fall within an arm’s length range; in this case, the upper limit of the range was determined at 4.25%.
  • Transfer Pricing benchmark studies must use comparables relevant to the borrower’s specific market, sector, and credit profile; irrelevant data will be disregarded.
  • Excess interest above the arm’s length rate may be recharacterised as a deemed dividend, triggering dividend withholding tax.
  • Both lender and borrower awareness of the benefit is required for a deemed profit distribution; however, this awareness test differs from the intent test for penalties.
  • Having proper transfer pricing documentation is crucial and can protect the tax payer from a switch in the burden of proof and penalties.

 

*Disclaimer: This article provides general information only and does not constitute professional advice. Seek tailored guidance before acting.

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