Austrian Federal Tax Court (BFG): prohibition on deduction of low-taxed intra-group interest and royalty payments contrary to EU law

On 7 March 2025 the BFG Vienna has ruled in two appeals (RV/7103283/2023 and RV/7102685/2022) that the prohibition on deduction of low-taxed intra-group interest and royalty payments (section 12 para. 1 subsec. 10 Austrian Corporate Income Tax Act (KStG)) is a violation of the EU’s freedom of establishment. An ordinary review of the ruling to the Austrian Supreme Administrative Court (VwGH) is permissible.

Facts of the case

• In the years 2014-2020 an Austrian GmbH made interest payments in the amount of approximately EUR 13.5 million in total to its sole shareholder, a non-transparent private foundation established in Liechtenstein.
• The effective tax burden of the private foundation established in Liechtenstein was below 10% in all years concerned due to a notional interest-deduction on equity, which is why the Austrian tax authority has denied the interest deduction pursuant to section 12 para. 1 subsec. 10 KStG. In one year, the private foundation established in Liechtenstein reported a tax loss, which is why the notional interest-deduction on equity was not applied this year.

Key arguments of the BFG

• The fundamental freedoms granted by EU law apply also to EEA Member States (e.g. also to Liechtenstein).
• The prohibition on deduction pursuant to section 12 para. 1 subsec. 10 KStG is to be assessed with regard to the freedom of establishment. Due to the purpose of the provision of section 12 para. 1 subsec. 10 KStG (“preventing beneficial tax planning of group companies”) the free movement of capital is not applicable.
• Linking the prohibition on deduction to low taxation at the level of the receiving corporation results in hidden or indirect discrimination of cross-border EU situations. In pure domestic situations, the prohibition on deduction is applicable only in exceptional cases (see for example the tax exemptions of section 5 KStG), not comparable to interest and royalty payments to profit-oriented foreign EU companies.
• A justification of such a hidden discrimination is not possible according to the BFG. The BFG has reviewed and rejected the following justification reasons:
  • • prevention of tax avoidance and tax evasion,
    • balanced allocation of the power to impose taxes between the Member States,
    • coherence of the tax system and
    • justification due to reference to current international developments (OECD BEPS action plan, recommendations of the EU Code of Conduct Group)
•  Due to recent decisions by the ECJ in the cases Lexel AB (C-484/19) and X BV (C-585/22), the BFG considered the legal question regarding the incompatibility of section 12 para. 1 subsec. 10 KStG with European Union to be sufficiently clarified, so that no preliminary ruling request had to be submitted to the ECJ.
• Therefore, according to the BFG, the prohibition on deduction pursuant to section 12 para. 1 subsec. 10 KStG in its current form violates the freedom of establishment. Therefore, the BFG applied a so-called adjusted legal situation, which (a) is in line with European Union law and (b) preserves the national tax entitlement as far as possible (“Methode der geltungserhaltenden Reduktion”)”, according to which the prohibition on deduction is limited to abusive arrangements and to cases in which an interest rate above the arm’s length rate is applied (correction of non-arm’s length part).
• Since the BFG did not determine any indications for an abusive arrangement pursuant to section 22 Austrian Federal Tax Code (BAO) and the loan interest rate complied with the arm’s length principle, the appeal of the Austrian GmbH was fully sustained.

Excursus

Apart from the assessment pursuant to EU law, the BFG also made interesting statements regarding the Austrian interpretation of section 12 para. 1 subsec. 10 KStG which are particularly relevant to non-EU matters:

• According to the BFG, the notional interest-deduction on equity of Liechtenstein is considered a harmful tax relief pursuant to section 12 para. 1 subsec. 10 KStG only from entering into force of the 2. Austrian Tax Amendment Act 2014 (2. AbgÄG 2014). Therefore, the prohibition on deduction was also not applicable to the case at hand in 2014 pursuant to a purely domestic interpretation of Austrian law.
• In case of losses of the income receiving corporation, which are not attributable to a harmful tax relief, the prohibition on deduction is not applicable. Pursuant to the wording of the law, the BFG denied the interpretation of the tax authority according to which the prohibition on deduction is not applicable in cases of taxable losses only when the respective income would not be low-taxed also without the loss situation. Therefore, a tax relief that is only hypothetically applicable due to the loss situation is irrelevant.

Implications and Outlook

• According to the BFG, the prohibition on deduction pursuant to section 12 para. 1 subsec. 10 KStG is only applicable to EU and EEA matters in the following constellations:
  • • Misuse pursuant to section 22 BAO: full rejection of interest deduction permissible
    • Interest rate above arm’s length rate: rejection of interest deduction only in the amount of the difference between the arm’s length and the non-arm’s length amount of the interest expense permissible
• An appeal of the competent Austrian Tax Office was already filed.
• Until the supreme courts (Austrian Administrative High Court (‘VwGH’), possibly also ECJ) have come to a final decision, clients with intra-group interest and royalty payments to low-taxed EU/EEA companies are advised – if there are no obvious reasons to assume an abusive arrangement – to disregard the prohibition on deduction pursuant to section 12 para. 1 subsec. 10 KStG through a direct application of the freedom of establishment and to disclose the tax treatment when filing the tax return. The same applies to the non-application of the prohibition on deduction to currently (re-)open assessment periods (e.g. within tax audits) as well as to the demand for a non-application for already assessed periods within the one-year-period (pursuant to section 299 Federal Fiscal Code (‘BAO’)).
• Apart from checking for possible elements of an abusive arrangement, we recommend – if interest and royalty payments are to be treated as deductible pursuant to the above-mentioned ruling – to review and to document the arm’s length nature of the payments (if not already taken care of).

Our experts are happy to advice you on this matter.

Authors: Nikolaus Neubauer, Sophie Schoenhart