Supreme Court Takes Formal Approach and Sides with Taxpayer in Landmark Hybrid Instrument Case
The Netherlands takes a rather formal approach with respect to the tax characterization of a financial instrument, as the form of the instrument is generally decisive for its character for Dutch tax purposes. A substance-over-form exception applies, however, for a debt instrument that (i) has no term or a term in excess of 50 years, (ii) carries a profit contingent interest, and (iii) is subordinated. The Dutch Revenue Service argued that a substance-over-form exception should be made as well with respect to certain debt-like equity instruments, but this argument has been dismissed by the Supreme Court in a February 7, 2014 ruling. The case related to redeemable preferred shares issued by an Australian company to a Dutch company that sought to apply the participation exemption with respect to its income from the shares. The shares had the following characteristics: (i) an entitlement to cumulative and fixed dividends, (ii) seniority over other share classes, (iii) redemption after 10 years, and (iv) limited voting rights. Furthermore, the Australian issuer was entitled to deduct the dividends for Australian tax purposes.
With its decision, the Supreme Court settles a long debate in favor of the taxpayer by rejecting that equity can be recharacterized into debt for purposes of the participation exemption, even if a deduction is available for the issuer. Taxpayers that seek to benefit from this ruling need to be cautious, however, in view of the recent proposals to amend the EU Parent-Subsidiary Directive and the OECD work on hybrid mismatch arrangements, which both seek to deny the participation exemption in case the issuer is entitled to a deduction.
Introduction of New Reporting Requirements for Certain Intra-Group Lending, Licensing, and Leasing Activities
Beginning on January 1, Dutch companies that are predominantly involved in intra-group back-to-back lending, licensing, or leasing transactions and that seek benefits under a tax treaty or the EU Interest & Royalty Directive with respect to their income must report in their tax return that they meet certain minimum substance requirements. If not all requirements are met, the Netherlands will exchange information with source countries. The new substance requirements are the following:
- At least 50 percent of the statutory directors with the authority to vote on the board is Dutch resident, with sufficient knowledge to carry out their duties;
- The company should have sufficient staff—employed by the company or hired from a third party—to carry out its activities;
- The resolutions of the board are passed in the Netherlands;
- The company should manage its main bank accounts from the Netherlands;
- The company should have a Dutch address;
- The company should keep its books in the Netherlands;
- The company is not regarded as a tax resident of another country;
- The company runs a real risk with respect to its activities within the meaning of the law; and
- The company's equity is appropriate in view of its real risks.
Very similar requirements have already been in existence since 2001 for companies that seek to obtain an Advance Tax Ruling and/or Advance Pricing Agreement.