In order to carry out a transaction, taxpayers are generally free to choose between different structures and tax regimes, and to choose the structure or regime which produces the lowest tax burden. But their freedom is constrained by anti-abuse rules or anti-avoidance rules, such as purpose test provisions. These provisions may be generally applicable across different taxes or regimes (GAARs) or specific to, or targeted at, a particular tax, regime or provision (SAARs or TAARs).
European jurisdictions generally employ a combination of both, and, in various jurisdictions, a number of purpose test cases have come before the courts in recent years.
Purpose tests generally tend to rely on subjective conditions relating to the purpose of the transaction or the parties entering into it and objective conditions considering whether the intended tax benefit is consistent with the objective of the relevant legislation.
In order to meet the subjective condition, it tends to be sufficient if obtaining a tax saving is one of the main purposes (so there could be more than one main purpose, e.g., one which is tax-related and one which is commercial); it rarely needs to be the sole or exclusive purpose. One notable exception is the historic French GAAR with an automatic penalty equal to 80% of the tax at stake and which requires an exclusive tax avoidance purpose. The Italian, Portuguese and Spanish GAARs would not apply where the relevant transaction achieves a material (non-tax) economic or business effect.
In many cases, GAARs are also subject to additional taxpayer protections, such as the requirement to obtain the opinion of an advisory panel before a final counteraction notice can be issued. It is also often the case that a GAAR can only be applied where the relevant tax advantage cannot already be counteracted by a SAAR or TAAR.
Across a number of jurisdictions, purpose test cases – whether under a GAAR or SAAR/ TAAR – have come before the courts in recent years. Examples include challenges of:
- intra-group “leverage” transactions, under which third party debt borrowed by an EU parent company to acquire a group is in part reallocated at the sub-holding level for the portion relating to the acquisition of the targets located in the sub-holding jurisdiction (Italy).
- the incorporation of companies to acquire shares held by the respective shareholders, with no immediate payment of the purchase price, allowing to receive proceeds as payments of the sale price and not as taxable dividends (Portugal).
- the choice between a share buyback (where all shareholders would participate on a proportionate basis) and a dividend distribution, which may not have the same tax treatment (France).
- interest deductions of acquisition funding for foreign operations or intra-group lending under the relevant SAAR (UK).
- interest deductions on shareholder loans obtained from (entities of) private equity funds for the purposes of external acquisitions (the Netherlands).
- dividend withholding tax credits, refunds and exemptions that are being claimed in connection with transactions aimed at dividend stripping or dividend withholding tax arbitrage (Germany and the Netherlands), noting that these claims may be primarily based on beneficial ownership considerations while general anti-abuse considerations may be put forward as a secondary argument.
- financing schemes involving intra-group loans between Spanish entities, EU-based conduit lenders and non-EU parent entities, which may trigger penalties if the EU lender is deemed a mere conduit company without real substance and used to take (undue) advantage of the EU withholding tax exemption (Spain).