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GT Alert

The Netherlands - Tax Developments in the Year 2003

January 2004
By the Amsterdam Tax Department

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Thin capitalization rules introduced as per fiscal year 2004

By far the most interesting event in 2003 for the Dutch tax practice was the ruling of the European Court of Justice (ECJ) in the case Bosal Holding BV v. State Secretary of Finance on 18 September 2003. In this ruling the ECJ held that the provision in the Dutch Corporate Income Tax Act (CITA), denying the deduction of interest expenses incurred by a Dutch corporate taxpayer in connection with its EU resident subsidiaries was incompatible with the principle of freedom of establishment as laid down in the EC Treaty.

"Following the ECJ ruling, the Dutch legislator abolished the general rule denying the deduction of interest expenses incurred in connection with foreign subsidiaries and introduced thin capitalization rules."

Following the ECJ ruling, the Dutch legislator abolished the general rule denying the deduction of interest expenses incurred in connection with foreign subsidiaries and introduced thin capitalization rules and rules relating to loss compensation by pure holding companies. This legislation was adopted on 18 December 2003 and entered into force on 1 January 2004.

Under the new thin capitalization rules, a taxpayer cannot deduct any interest expenses incurred with respect to so-called “excess debt.” Whether a taxpayer is considered to have excess debt is determined on the basis of the statutory debt-to-equity ratio of 3:1 or the group ratio, if the latter is more beneficial to the taxpayer. An important relaxation of the rules is that the amount of non-deductible interest is limited to the balance of the interest received and the interest due from related entities.

The GT Amsterdam Tax Department has developed a calculation model to instantly establish the excess debt position of Dutch corporate taxpayers.

Furthermore, it is noted that the loss compensation rules are restricted with respect to “pure” holding companies. Detailed rules determine when a company qualifies as a “pure” holding company.

Proposed changes affecting the Dutch participation exemption and the tax treatment of conversion of distressed debt

Introduction

In December 2003 a proposal of law was submitted to the Dutch Parliament, which limits the deductibility of acquisition costs in respect of participations and sharpens the conditions under which a temporary write-off of newly acquired participations can be claimed. Furthermore, it is proposed to change the tax treatment of a conversion of distressed debt into share capital.

Acquisition costs of participations

The Dutch legislator has proposed new rules in connection with the deductibility of acquisition costs. Under the proposed rules the deduction of expenses related to the acquisition of shareholdings qualifying for the Dutch participation exemption is denied. As a result, the acquisition costs should be included in the cost price of the relevant participation.

By introducing these rules with retroactive effect, the State Secretary intends to reverse the effects of an earlier Supreme Court ruling. Tax practitioners are heavily criticizing this retroactive effect, arguing that it is in conflict with the European Convention on Human Rights.

Temporary write-off on newly acquired participations

Under the Dutch CITA a write-off on a shareholding qualifying for the participation exemption is not tax deductible. However, under certain conditions a temporary write-off on a participation is allowed during the first five years after its acquisition. The participation can be written off to the extent the fair market value of that participation falls below the acquisition price. The write-off is however recaptured by disallowing the benefits of the participation exemption during the first five years after the acquisition. If at the beginning of the sixth year after the acquisition the write-off has not yet been fully recaptured, the remainder is recaptured in equal installments in that year and the following four years.

In practice, schemes aiming at the avoidance or postponement of said recapture were widely set up. To counteract these schemes it has been proposed to sharpen the conditions to be met for applying this provision. The proposed measures will, in cases where this facility has been misused, have a retroactive effect.

Conversion of distressed debt

The Dutch CITA currently contains a provision which requires a Dutch debtor to report a taxable profit in the event of amongst others a conversion of distressed debt into share capital. The debtor is deemed to realize a profit to the extent that the book value of the debt exceeds the fair market value of the corresponding receivable of the creditor.

Following extensive criticism it has now been proposed to abolish this provision and to tax only the creditor upon the conversion of debt into share capital. The proposed new provision applies where a creditor has taken a bad debt deduction with respect to a receivable to a qualifying participation. In the event of a conversion or forgiveness of distressed debt, the creditor should include in its taxable income the amount of the bad debt deduction. The profits realized as a result of the conversion are not immediately taxed, but should be added to a special reserve. The reserve needs to be released to the taxpayer’s taxable income to the extent the value of the participation increases after the conversion.

 

© 2004 Greenberg Traurig


Additional Information:

For more information, please review our Tax Practice description, or feel free to contact one of our attorneys.


This GT ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs.