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The Impact of Re-characterising Equity as Debt
For both cases an appeal has been lodged with the Dutch Supreme Court.
Although it is currently difficult to predict which conditions the Supreme Court will set for re-characterising equity into debt, and when exactly the final Supreme Court ruling(s) will take place, the long-expected clarity appears to be closer than ever. Contrary to fiscal re-characterisation of debt into equity, no clear rules exist yet to answer the question: If and under what conditions equity must be re-characterised into debt?
The possibility to re-characterise equity into debt may expand interest deduction possibilities in the Netherlands, if the financing recipient is a Dutch corporate taxpayer. An adverse tax consequence may arise, however, if the financing provider is a Dutch taxpayer. In such a case, the remuneration on the financing may not qualify for the Dutch participation exemption, hence being taxed in the hands of the Dutch taxpayer. Taxand Netherlands discusses both the opportunities and risks of re-characterising equity as debt for Dutch corporate tax (CT) purposes creates.
Opportunity: An expansion of the interest deduction possibility
The possibility to re-characterise equity into debt may expand interest deduction possibilities in the Netherlands if the financing recipient is a Dutch corporate taxpayer. If the foreign parent company provides financing to its Dutch subsidiary, which constitutes equity for corporate law purposes, in principle, this financing qualifies as equity for Dutch CT purposes as well. Consequently, the remuneration on this financing would qualify as a dividend, which the Dutch corporate taxpayer may not deduct for Dutch CT purposes. If the possibility would exist to re-characterise equity into debt for Dutch CT purposes, the financing could be structured such that it would qualify as debt for Dutch CT, albeit remaining equity for corporate law purposes.
As a result, the Dutch taxpayer may be entitled to deduct the remuneration on the financing as the remuneration would constitute interest. It goes without saying that it should be reviewed, whether the structuring could create a pick up in the jurisdiction providing the financing, and whether interest deduction rules would not restrict the Dutch taxpayer from deducting the remuneration.
Risk: No application of the Dutch participation exemption
An adverse tax consequence may arise if the financing provider is a Dutch taxpayer. Upon such a re-characterisation, the remuneration on the financing may not qualify for the Dutch participation exemption, hence being taxed in the hands of the Dutch taxpayer.
Re-Characterisation of equity into debt
It is difficult to predict which exact criteria will apply to re-characterising equity into debt for Dutch CT purposes. After all, in both cases currently pending with the Supreme Court, the various courts of first and second instance have applied different criteria. The Advocate General's opinion that has recently been published to one of the two cases provides for other re-characterisation criteria. Furthermore, there is still a chance that the Supreme Court will rule that equity cannot be re-characterised into debt for Dutch CT purposes. As the Advocate General advises the Supreme Court to refer the case back to a Court of second instance for additional research, it is difficult to predict when exactly the final Supreme Court ruling on this matter can be expected.
It is important to be well-informed on this matter, to take advantage of the opportunities that it could create (eg expansion of the interest deduction possibility), and to avoid potential pitfalls that this matter may cause (eg no application of the Dutch participation exemption). Taxand Netherlands will monitor these developments closely and provide updates as the cases progress.
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