Belgium: Leveraged distributions challenged by the tax authorities

A common challenge in M&A transactions is to achieve a tax-effective interest deduction with regard to the acquisition funding. One potential strategy for the target company is to make a dividend distribution from retained earnings (or a reimbursement of share capital), and to take out a (bank) loan in order to have sufficient cash to pay out the dividend distribution (or capital reimbursement). The cash received by the acquiring entity can be used to reimburse its acquisition funding. As the target company is often an operational/profitable company, a tax-effective interest deduction can in principle be realised at that level.

However, the Belgian tax authorities (and in particular the Special Tax Inspectorate, focusing on major allegedly ‘abusive’ cases) increasingly challenge the tax deductibility of interest charges that are linked to such ‘leveraged distributions’. The tax authorities take the stance that such interest charges are not ‘borne to acquire or maintain taxable income’ for the distributing company, which is a key condition for costs to qualify as deductible business expenses for corporate income tax purposes.

In two landmark cases, the courts (including the Belgian Supreme Court) have ruled in favour of the tax authorities. The taxpayers’ key argument was that the company had to take out a loan (and, hence, pay interest) to be able to pay off the liability resulting from the dividend distribution (or capital reimbursement) without having to sell certain income-generating assets (and to satisfy the liability with the sales proceeds). Therefore, the company argued, the objective of the loan is to keep the income-generating assets, i.e. to ‘maintain taxable income’.

In the first case, the courts accepted in principle that interest borne in the framework of a leveraged distribution can meet the above condition for tax-deductibility provided that the demonstrated objective of the loan is indeed to avoid having to sell income-generating assets. However, the courts finally disallowed the interest deduction because they considered that this objective was not/insufficiently documented in the corporate documents established within the framework of the distribution.

In the second case, the underlying justification/documentation for the loan was submitted, but the interest deductibility was nevertheless denied. The court of appeal argued that the main objective of the loan was (not to allow the distributing company to keep its income-generating assets, but) to allow its corporate shareholders to reimburse the bridge loans that were granted to them to fund the prior delisting of the distributing company. The taxpayer lodged an appeal with the Supreme Court, but the judgement is currently still pending.

The outcome will obviously be crucial for the success of leveraged distributions (whether or not decided in an M&A context). Irrespective of this outcome, one important lesson learnt is that increased attention must be paid to the justification of the loan in the underlying corporate documentation.

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