Global Tax Alert | 7 February 2014

Dutch Supreme Court confirms tax equity treatment of equity instruments with debt characteristics

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Executive summary

On 7 February 2014, the Dutch Supreme Court issued its decisions in two cases concerning the qualification for Dutch tax purposes of equity instruments with certain characteristics of debt. According to the Dutch Supreme Court, the qualification of an equity instrument for tax purposes in principle follows the corporate law characterization, even if the instrument is considered debt under accounting rules. As a result, Australian mandatory redeemable preference shares were considered equity for Dutch tax purposes. Similarly, shares with certain contractual debt characteristics issued as part of a complex refinancing transaction were considered equity for Dutch tax purposes. The Supreme Court did not find reasons for an exception to the main rule in these cases.

It can be derived from these Supreme Court judgments that a deviation from the corporate law qualification of equity instruments for Dutch tax purposes only seems possible in very limited circumstances.

Detailed discussion

Australian redeemable preference shares

An Australian company issued so-called Redeemable Preference Shares (RPS) to its shareholders, including a Dutch company (BV). The RPS had an annual fixed, cumulative dividend entitlement, were issued against a nominal value of AUD 1, carried no voting rights, and were mandatorily redeemable after 10 years. The ordinary shares in the Australian company were subordinated to the RPS. In the accounts of the Australian company, the RPS were considered a long-term debt, in accordance with Australian GAAP. The dividends were deductible for Australian tax purposes. In its Dutch tax return, the BV claimed the participation exemption with regard to the income from the RPS.

According to the Supreme Court, the corporate law qualification of an instrument between a parent company and a subsidiary is in principle decisive when classifying such an instrument for purposes of the Dutch participation exemption. If an instrument is considered share capital for corporate law purposes, then this characterization is in principle also leading for tax purposes. This also held true for the RPS, regardless of the fact that (i) the RPS had an agreed term of 10 years, (ii) an annual, cumulative dividend was paid, (iii) from an accountancy perspective the RPS were similar to a (subordinated) debt, and (iv) the contributed capital was considered debt under Australian and Dutch GAAP. According to the Supreme Court, cumulative preference shares with limited voting rights could be issued by Dutch companies under similar conditions, while still being considered “shares” within the meaning of the participation exemption. Furthermore, the fact that the dividend was deductible for Australian tax purposes did not prohibit the application of the Dutch participation exemption.

Refinancing of bank loans

The second case concerned shares issued by a Dutch company as part of a complex set of transactions and arrangements in order to refinance various bank loans. The Dutch company was initially funded through loans provided by a syndicate of banks. As a result of various transactions involving several parties, the bank loans were “converted” into cumulative preference shares, partly held by the same bank syndicate members. Pursuant to the contractual terms, the new funding had characteristics of a loan with a fixed period of several years, at a fixed remuneration. The question at issue was whether the income received by the bank syndicate constituted a dividend (exempt under the participation exemption) or taxable interest income.

According to the Supreme Court, it was decisive whether the payments on the shares could be considered remuneration for the contributed share capital, or otherwise as remuneration for the capital contribution by the shareholder as such. According to the Supreme Court, the corporate law qualification of an instrument between a parent company and a subsidiary is in principle decisive when classifying such an instrument for tax purposes. The Supreme Court recalled its established case law with regard to the qualification of debt instruments. In this case law the Supreme Court has accepted three exceptions to this rule, resulting in the characterization of debt instruments as equity for tax purposes. However, this case concerned the reverse question, i.e., whether shares could be recharacterized as debt for tax purposes. Based on the relevant provisions of the Dutch Civil Code, the Supreme Court considered that the shares at issue represented risk bearing capital. This character was not limited by the fact that the shareholder could terminate the capital contribution, and that the instrument had certain similarities to debt financing. Therefore, if an instrument is considered share capital according to corporate law standards, this characterization is also applicable for purposes of the participation exemption.

According to the Supreme Court, the risk that the share capital would actually decline due to the repayment of debt by the company was negligible at the moment of the capital contribution, and therefore, there was no material difference between a capital contribution and the granting of a loan. However, these circumstances were not considered a sufficient justification for a deviation from the main rule. In the Supreme Court’s view, making an exception to the general rule depending on the degree of risk would lead to unacceptable legal uncertainty for companies as to the demarcation between providing risk bearing capital and debt financing.

For additional information with respect to this Alert, please contact the following:

Ernst & Young Belastingadviseurs LLP, ITS, Amsterdam
  • Johan van den Bos
    +31 88 407 1457
    johan.van.den.bos@nl.ey.com
  • Helmar Klink
    +31 88 407 1731
    helmar.klink@nl.ey.com
  • Simone Admiraal
    +31 88 407 1242
    simone.admiraal@nl.ey.com
  • Eric Westerburgen
    +31 88 407 2310
    eric.westerburgen@nl.ey.com
  • Roderik Rademakers
    +31 88 407 1601
    roderik.rademakers@nl.ey.com
  • Reinout Kok
    +31 88 407 8505
    reinout.kok@nl.ey.com
Ernst & Young Belastingadviseurs LLP, ITS, Rotterdam
  • Michiel Swets
    +31 88 407 8517
    michiel.swets@nl.ey.com
  • Marc de Louw
    +31 88 407 8490
    marc.de.louw@nl.ey.com
Ernst & Young LLP, Belgium-Netherlands Tax Desk, New York
  • Dirk Stalenhoef
    +1 212 773 3390
    dirk.stalenhoef@ey.com
Ernst & Young LLP, Belgium-Netherlands Tax Desk, Chicago
  • Frank Schoon
    +1 312 879 5508
    frank.schoon@ey.com
Ernst & Young (China) Advisory Limited, Belgium-Netherlands Tax Desk, Shanghai
  • Bas Leenders
    +86 137 0199 4869
    bas.leenders@cn.ey.com
Ernst & Young LLP (United Kingdom), Dutch Tax Desk, London
  • Jelger Buitelaar
    +44 20 795 15648
    jbuitelaar@uk.ey.com

EYG no. CM4166