The Impact of Fraus Legis on Corporate Recovery Operations

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What is fraus legis?

Fraus legis is a legal doctrine under which the Dutch Tax Authorities (“DTA”) may challenge and deny a specific tax benefit arising from a situation in which a taxpayer structures a transaction technically in conformity with the letter of the law but contrary to its spirit and purpose. Fraus legis de facto serves as an ultimum remedium for the tax authorities to deny a potential tax advantage.

The doctrine could be applied if the following conditions are met:

• A taxpayer uses an artificial structure or arrangement (i) with the aim of obtaining a tax advantage, (ii) where the tax-driven motive is the decisive reason for entering into the transaction, and (iii) where the transaction violates the spirit and purpose of the law.
• This intention (motive) is presumed where the structure or arrangement would yield a foreseeably disadvantageous outcome absent the desired tax advantage.
• The taxpayer may rebut this presumption by demonstrating that substantive, non-tax driven reasons – not merely secondary ones – were the primary basis for entering into the transaction.

If fraus legis is successfully invoked, the tax benefit will be disregarded, and the transaction will be recharacterized in accordance with its economic substance.

By way of background, prior to the 21st century, financing arrangements that generated an artificial tax-deductible interest expense in the Netherlands were typically challenged under the fraus legis doctrine. The Dutch legislator subsequently chose to codify this doctrine in the Dutch Corporate Income Tax (“CIT”) Act 1969, targeting specifically artificial financing arrangements, which gave rise to Article 10a of the Dutch CIT Act 1969.

Under the EU Anti-Tax Avoidance Directive I, all EU Member States were required to transpose a general anti-abuse rule (“GAAR”) into domestic law to counter tax avoidance. The Dutch parliament took the position that the GAAR was already effectively applied in Dutch tax practice through the fraus legis doctrine and therefore declined to transpose it into domestic legislation. Following an explicit request from the European Commission, the Netherlands was compelled to act, ultimately leading to the introduction of Article 29i of the Dutch CIT Act 1969 (effective as of 1 January 2025). Although this codification was not intended to materially change the application of the fraus legis doctrine, it remains to be seen whether the Dutch interpretation will be upheld, given its alignment with the EU GAAR and European case law. 

Supreme Court Case dated 5 September 2025

A relatively recent example of a Supreme Court case in which the Court ruled that fraus legis bars the desired tax advantage, being the tax-deductibility of an interest expense, was the case decided on 5 September 2025 (Supreme Court 5 September 2025, BNB 2026/1). The fact pattern and corporate structure were – briefly put – as follows.

In 2011, private equity funds sought to acquire a Dutch tax-resident group of companies (“TargetCo”) using the corporate structure reflected below.

To finance the acquisition, the Luxembourg parent company (“LuxHoldCo”) issued Preferred Equity Certificates (“PECs”) to the funds as its shareholders. None of these parties held an indirect interest of at least one-third in X BV (implying that these are unaffiliated third parties under Dutch tax legislation at that time). LuxHoldCo then used the proceeds to grant a loan to X BV, which acquired the TargetCo shares through a newly incorporated company (“BidCo”).

Both BidCo and TargetCo were subsequently included in the existing fiscal unity of X BV. X BV sought to deduct its interest expense on the loan owed to LuxHoldCo from TargetCo’s taxable profit. The DTA challenged this position, and proceedings were initiated under Article 10a of the Dutch CIT Act 1969, in combination with the fraus legis doctrine.

Last September, the Supreme Court ruled that the tax deduction of the interest expense was correctly denied under the fraus legis doctrine, as allowing the deduction would be contrary to the purpose and spirit of the Dutch CIT Act. The following reasoning was upheld by the Dutch Supreme Court: 

• Article 10a of the Dutch CIT Act 1969 would not restrict the deductibility of the interest expense, as sound business reasons existed for both the loan and the acquisition of the shares from an unaffiliated third party.
• Based on these sound business reasons, fraus legis in the sense of contradicting the purpose and spirit of Article 10a could therefore, in principle, not be successfully invoked either (Supreme Court 3 March 2023, BNB 2023/61).
• However, the creation of an interest expense – by having a Luxembourgish conduit company grant a loan to X BV – in order to decrease TargetCo’s taxable basis was considered a mainly tax-driven financing arrangement and therefore contrary to the purpose and spirit of the system of the Dutch CIT Act 1969 as a whole.

Further to the above, the conclusion could be drawn that if Article 10a, which codified the fraus legis doctrine (following Supreme Court case law), does not restrict the tax-deductibility of an interest expense, fraus legis could still prevent the interest deduction, even where sound business reasons are in place and/or the taxpayer did not circumvent specific elements of the provision to achieve its non-application based on a literal interpretation. The creation of a tax-deductible interest expense on a loan from a conduit company, may be regarded as mainly tax-driven if the intermediary lacks a pivotal financing function and the interest expense is intentionally positioned to offset newly acquired profits. Allowing the interest deduction for Dutch CIT purposes in this scenario would not be in conformity with the purpose and spirit of the Dutch CIT Act 1969 as a whole. This may have been different if LuxHoldCo, as the lender, had a pivotal financing function within the group (Supreme Court 3 March 2023, BNB 2023/61). The latter is expected to be addressed in an upcoming Supreme Court Decision, which also emphasizes the dynamic nature of the fraus legis concept and the unresolved questions that persist in this area of law. 

Relevance to the corporate recovery practice

Corporate recovery operations, similarly to corporate restructurings, can often be implemented through multiple routes or scenarios. Some routes are tax-efficient, others are less tax-efficient or subject to conditions. To achieve the most tax-efficient route and final structure, it is highly recommended to review tax consequences from the beginning of a corporate recovery operation. The background and non-tax-driven reasons for a specific tax-efficient route or structure may mitigate the risk that a specific step in a corporate recovery operation, the operation itself, or the final corporate structure may be challenged by the tax authorities on the basis of fraus legis. Reviewing the tax consequences early can identify and potentially mitigate this risk.

For illustration purposes: in a corporate recovery operation, it may be considered to continue the business of potentially viable, currently loss-making subsidiaries and to attract financing from private equity firms. In anticipation of loan grants, a private equity party may acquire the shares in the financially healthy subsidiaries (TargetCos) through a newly incorporated BidCo and include these entities in a Dutch fiscal unity. To successfully offset BidCo’s interest expense against TargetCos’ taxable profits from operational activities, the following questions should be addressed:

• Is Article 10a of the Dutch CIT Act limiting the tax-deductibility of the interest expense?
• Could fraus legis be applied within the context of Article 10a of the Dutch CIT Act 1969?
• Could fraus legis be applied within the context of the Dutch CIT Act 1969 in general?

If all three questions are answered in the negative, the risk of the tax authorities successfully challenging and denying a tax-deductible interest expense should be minimal or non-existent. Note that fraus legis is not limited to interest deductions; it may affect any tax benefit. The three questions outlined above should therefore be applied by analogy to the provision that gives rise to the tax benefit at stake.

In summary, the risk of a successful fraus legis challenge by the DTA should be assessed not only in the case of financing arrangements, but also in relation to other tax benefits or tax savings arising from a corporate recovery operation (please refer to my article ‘Dutch Tax Pitfalls and Opportunities in Corporate Recovery Operations’, HERO 2025 / P-039), such as claiming a tax-deductible liquidation loss (as opposed to a non-tax-deductible depreciation expense on a loan receivable). This emphasizes the importance of timely recognition of a potential fraus legis risk, the need for tax lawyers to be involved from the beginning in corporate recovery operations, and the necessity of an overall coordinated approach among tax, legal, and insolvency advisors.