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Supreme Court of Iceland: Interest on a loan and carry-forward of losses by acquiring company denied due to lack of real operational purpose

The Supreme Court of Iceland (the Court) gave its decision on 23 January 2014 in the case of Samherji hf. v. the Icelandic Government (No. 529/2013). Details of the decision are summarized below.
(a) Facts. Company F (Co F), which was owned by majority shareholders of Company S (Co S), entered into considerable debt to acquire shares in Co S (i.e. a leveraged takeover). Both companies were subsequently merged with a "reversed merger" in which Co F was the acquired company and Co S the acquiring company. Consequently, the debt taken by Co F transferred to Co S and resulted in a 50% decrease in Co S' equity. Furthermore, Co S wanted to make use of the loss carry-forwards of Co F and deduct the interest relating to the loan taken by Co F. The tax authorities denied the use of the losses of Co F and disallowed the deductibility of the interest expenses including an exchange rate difference relating to the debt transferred from Co F.
(b) Issues. The issues of this case were whether:

- Co S could deduct the interest expenses for the loan and utilize the loss carry-forward following a reversed merger by means of a leveraged takeover; and
- Co S could deduct currency losses arising from the loan if it is required to include the corresponding currency gain in its taxable base.

(c) Decision. The Court ruled that Co S was neither allowed to utilize loss carry-forwards nor to deduct interest expenses from income following a reversed merger by means of a leveraged takeover. Further, all currency gain is to be included in the company's taxable base irrespective of whether the corresponding currency losses are deductible.
The Court stated that the acquisition of Co S' shares by Co F before the companies were merged was solely for the purpose of transferring the ownership of Co S into the hands of the majority shareholders in Co F. For this purpose, Co F entered into substantial debt which by the merger transferred to Co S without any considerable assets being transferred to Co S. This arrangement decreased considerably Co S' equity.

The Court found that the merger had no real and operational purpose and thus it did not meet the requirements set forth in article 54(1) of Act No. 90/2003 on income tax to transfer the loss carry-forwards of Co F to Co S. Furthermore, the Court stated that it was not permissible to deduct interest expenses and set off currency losses against currency gains stemming from Co F's debt that was incurred for the acquisition of the shares in Co S because the debt was not incurred in relation to Co S' operations.

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