European Commission challenges certain restrictions of the notional interest deduction regime

On 19 February 2009, the European Commission opened an infringement procedure against Belgium on the grounds that the notional interest deduction regime violates the free movement of capital and the freedom of establishment principles in the EC Treaty.

The notional interest deduction, which became effective as from the beginning of 2007, allows Belgian taxpayers (companies and branches) to claim a notional tax deduction, determined as a percentage of equity. In this context, equity is defined as the accounting equity less certain deductions, including the net asset book value of branch operations and real estate located in tax treaty countries. The notional interest rate is determined based on the 10-year Belgian government bond rate.

The European Commission is challenging the fact that, under the current regime, the net equity corresponding to the net value of a branch or real estate located in a tax treaty is excluded from the basis on which the notional interest deduction is computed. This exclusion does not apply to similar investments made in Belgium.

The EU Commission considers these limitations in breach of the freedom of capital (with respect to real estate) and the freedom of establishment (with respect to branches) principles, because they may dissuade Belgian companies from setting up a branch or investing in real estate in a foreign country.

The European Commission has not asserted that the regime is incompatible with EU state aid rules.

It should be noted that the Commission is not challenging the entire notional interest deduction regime. Also, since infringements of the EU freedoms have no retroactive effect and no challenge is being made under EU state aid rules, there is no risk that notional interest deductions claims that already have been made will be disallowed or may have to be refunded.

On the contrary, the infringement procedure, if successful, and depending on how the Belgian government would amend the regime, might imply an increase of the notional interest deduction against Belgian taxable income by abolishing the above deductions from the notional interest deduction basis. Although premature, it may even provide for a window of opportunity for certain taxpayers, both prospectively and retroactively.

Depending on the response of the Belgian government, the European Commission will decide whether or not to initiate a formal infringement proceeding against Belgium, eventually leading to a referral to the ECJ. Alternatively, Belgium may decide to amend the regime.