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The qualification of hybrid equity instruments in the Netherlands
In February 2014 the Dutch Supreme Court ruled in 2 cases concerning the potential qualification of equity into debt for Dutch tax purposes and in connection with the Dutch participation exemption. Taxand Australia and Taxand Netherlands discuss the implications of these rulings and focus specifically on the case involving Australian preference shares.
In both cases there was a restructuring in which debt was converted into equity in order to achieve an exemption of the interest payments under the Dutch participation exemption. In the second case a Dutch company exchanged a shareholder loan to its Australian subsidiary for redeemable preference shares of a newly incorporated group company in Australia. The redeemable preference shares gave an entitlement to annual and cumulative fixed rate dividends and had priority over other classes of shares. Furthermore, the redemption was 10 years and the shares had limited voting rights. In this case the issue was whether or not the income derived from the redeemable preference shares was to be treated as taxable interest or exempt participation income. From an Australian tax and accounting perspective the shares were treated as debt.
In the past the Supreme Court already decided that in the case Dutch Civil Law qualifies an instrument as debt, that this Civil Law qualification should in principal be followed for tax purposes. In the cases at hand the Supreme Court ruled that for instruments that are qualified as shares under Dutch Civil Law this reasoning should also be followed. The Supreme Court decided that in both cases there was no abuse of law because under the Dutch Corporate Income Tax regime a taxpayer should be able to choose freely in the way he wants to fund his business enterprises.
For equity instruments of foreign jurisdictions, like the Australian redeemable preference shares, first a comparison has to be made with the qualification of these instruments under Dutch Civil law. In the case they can be compared to Dutch equity instruments they should be qualified also as equity for Dutch tax purposes. For structures in which a Dutch company holds Australian redeemable preference shares, there is now certainty of the Dutch tax qualification and therefore application of the Dutch participation exemption (under the condition that the other requirements for application are met).
Under Australia’s debt/equity rules, if the issuer of hybrid securities has an “effectively non-contingent obligation” to repay at least the face value of the security (calculated on a discounted basis if the term is greater than 10 years), then it will be treated as debt for Australian tax purposes and a deduction will be available for returns on that security. Redeemable preferred shares would usually qualify for such treatment provided that there is a fixed redemption date and the issuer does not have the ability to convert them to ordinary shares rather than redeem.
Also published in Thomson Reuters' Taxnet Pro, 28 March 2014
In both cases the participation exemption on hybrid equity instruments can be applied and stood up to the scrutiny of the Dutch tax authorities. The Supreme Court made it very clear that equity remains equity for Dutch tax purposes. The fact that debt is converted into equity to benefit from the participation exemption or even to create a hybrid with mismatch is not relevant. These are therefore landmark cases that give much wanted certainty on the application of the participation exemption in tax planning for similar restructurings or cases.
In spite of international discussion on hybrid instruments, it is confirmed that the participation exemption can be applied on such equity instruments, even were the payment in the foreign jurisdiction is deductible. Of course the international discussions on hybrid instruments and tax planning, like the OECD action plan on Base Erosion and Profit Shifting and the proposal to amend the EU Parent Subsidiary directive, should be monitored in this respect.