Lankhorst - Hohorst, a company based in Germany, selling boats, etc, received a loan from its sole shareholder, another company which was registered in The Netherlands. Under Art.8(a) of German corporation law, repayment of loan capital would constitute a covert distribution of profits (thin capitalization) if obtained by a company subject to corporation tax from a shareholder not entitled to corporation tax credit. Thus,the dispute which came before the Court concerned the tax treatment of interest paid to “lender” corporation. The German Tax Administration concluded that the interest paid by Lankhorst - Hohorst was to be subject to a tax of 30%. The appellant asked from the …show more content…
“THIN CAPITALIZATION” RULES
As “thin capitalization” is defined a situation where the capital of a company is based mostly on debt than on equity. Practically, many companies try to gain capital by taking loans from their shareholders or their parent company oar a subsidiary. That way the “lender” funds the company with an amount of money which anyway would be given and takes interest instead of dividend as a payback.
At the same time this way of funding has a significant impact on taxation. National tax legislation of the Member States typically allow an amount of deductible interest to be recognized as an expense for the company for tax purposes. As a result, the higher the level of debt and the amount of payable interest in a company, the lower will be its taxable profit. For this reason, debt is often a more tax efficient method of finance than equity.
Many national tax laws often introduce rules that place a limit on the amount of the deduction of interest from a company’s profit for tax purposes. Such rules aim to defeat cross-border shifting of profit through excessive debt, and this way to protect a country’s tax base. Thin capitalization rules typically operate by determining either a maximum amount of debt on which deductible interest can be applied or a maximum amount of interest that may be