Substance over Form and True and Fair View in Accounting Law – New Guidance from the CJEU

A recent CJEU decision sheds new light on practical implications of the ‘true and fair view’ principle in accounting law. Wagram Invest (C-640/18) deals with a rather complex accounting issue arising from a financial transaction between Wagram Invest, a Belgian public limited company, and one of its managers. In a nutshell, by two different agreements, Wagram purchased from one of its managers shares in a third company payable in several six-monthly interest free payments. In order to record this transaction in its accounts, Wagram made the following entries:

1. It entered, at its nominal value, the debt as one becoming due after one year in its balance sheet liabilities;
2. It posted the discount consisting of the difference between the nominal value of the debt and the present value of the fixed asset in the prepayments and accrued income account (the discount rate used was the market rate applicable to debts of that kind at the time when they were first entered in the balance sheet);
3. It entered the shares purchased as an asset at their present value;
4. At the end of each financial year, it recorded a percentage of deferred charges corresponding to the discount on the debt as a finance cost. 

Scrutinizing the tax implications of the transaction, the Belgian tax authority took the view that the discount charges cannot be accounted for and deducted for tax purposes, since recording a fictitious discount and reducing the acquisition price of the fixed asset has the effect of expressing a decrease in value of the securities that is not economically justified. Wagram claimed that the recording of such discount is required under Belgian law and, namely, Articles 67(2)(c) and 77 of Royal Decree of 30 January 2001, according to which a discount on non-interest-bearing receivables or receivables with abnormally low interest must be included in the profit or loss account pro rata temporis on the basis of compound interest. 

Against this background, the CJEU ruled that, in the case of acquisition of a financial fixed asset in which the price is stipulated to be paid in stages over the long term without interest, the principle of a true and fair view must be interpreted as not precluding the use of the method of accounting required under Belgian law.

The findings of the Court are based on three main compelling arguments.

First, in line with its previous ruling in Tomberger ( C-234/94, paragraph 18) and GIMLE (C-322/12, paragraph 32), the CJEU holds the view that the application of the principle of the true and fair view must, as far as possible, be guided by the general principles contained in Article 31 of Directive 78/660. 

Second, the Court notes that, where the purchase agreement of fixed financial assets provides that the price is to be paid in stages over the long term without interest, the transaction, while formally single, includes two different elements: the acquisition of fixed financial assets and an implicit loan agreement. In such circumstances, the purchase price cost of fixed assets is equal to the discounted acquisition price equivalent to the purchase price after the deduction of the discount consisting of the difference between the nominal value of the debt and the present value of the fixed assets. This argument is crucial because, when the purchase agreement of fixed financial assets includes an implicit loan agreement, the recognition of fixed assets at the nominal purchase price would lead to the assets’ overvaluation and the recognition of an unrealised capital gain in the company accounts, contrary to Article 31(1)(c)(aa) of Directive 78/660, according to which only profits made at the balance sheet date may be included.

Third, even though such argument is not applicable to the case in Wagram ratione temporis, the accounting method adopted by Wagram complies with the principle of substance over form introduced by Directive 51/2003, according to which items in the profit and loss account and balance sheet shall be accounted for and presented having regard to the substance of the transaction or arrangement concerned. 

Undoubtedly, the latter argument makes the most innovative part of this judgment and marks a step forward in the Court’s doctrine on a true and fair view principle.

In Wagram, for the first time, the CJEU highlights the key role of substance over form by pointing out that the objective of the true and fair view can be met only on the condition that the accounts are prepared having regard to the substance of the transaction or arrangement concerned. An accounting method reflecting only the formal structure of the arrangement concerned can lead to a misguided representation in the company’s accounts and to the misapplication of the recognition and measurement principles. Therefore, in Wagram, the recording of the acquisition price of the fixed asset on the assets side of the balance sheet after deduction of that discount does not represent a departure from the principle of purchase price or production cost. 

In the light of the above, it seems that the relevance of the judgement in Wagram goes far beyond the facts of the case concerned insofar as it can help define the scope of the principle of substance over form and—given the divergence in its implementation in the Member States—lead to a more harmonised understanding and application of such principle at the EU level. First, based on the judgement in Wagram, it should be accepted that the principle of substance over form must be complied with in every case where it is provided by national law. Second, even though the judgement does not directly deal with this further issue, the Court’s explicit recognition of substance over form as a key principle to meet the objective of providing a true and fair view can help to address the question, very debated in some Member States (eg Italy), as to whether such principle must be applied in every case where the substance of the transaction or arrangement concerned departs from its form, also in absence of a specific law requirement.

A version of this post first appeared on EU LAW LIVE.

Giovanni Strampelli is Full Professor at the Department of Law, Bocconi University, Milan.