On the 24th of February, the Dutch Supreme Court ruled that FOREX gains on so-called "tainted group debts" are exempt from Dutch corporate income tax.
Pursuant to article 10a Corporate Income Tax Act 1969 ("CITA"), interest expenses – including foreign exchange results – related to tainted group debts are not deductible. This is an anti-abuse rule that combats the artificial creation of group debt.
Tainted group debt means the borrowing of monies from a related party to finance the following tainted transactions: a profit distribution or repayment of capital to a related party, a capital contribution to a related party or an acquisition or extension of a participation in a related party. The term 'related' refers to an interest in the capital of at least 1/3. If the taxpayer wishes to deduct the interest on such group debt, it must demonstrate that the transaction and the financing thereof are both based on predominantly sound business reasons, or that the interest in the hands of the recipient is subject to tax resulting in a levy of at least 10% calculated according to Dutch tax law.
While FOREX losses on such tainted debt are not deductible on the basis of the legislation, the question at stake was whether FOREX gains should be exempt as the text of article 10a refers to a foreign exchange results and not only to FOREX losses.
2. Course of the proceedings
In the case at hand, the taxpayer made a capital contribution to its foreign subsidiary and financed this out of group debt denominated in US$. The functional currency of the taxpayer was Euro. Upon repayment of the tainted group debt, the FOREX gain exceeded the interest expenses in the same year. In December 2008, the Lower Court of Haarlem decided that the FOREX gain realised by the taxpayer upon repayment of its US$ denominated debt should be exempt. In July 2010, the Amsterdam Court of Appeal ruled that the FOREX gain was taxable, but the taxpayer was allowed to deduct the interest expenses in that year on the tainted debt (up to the amount of the FOREX gain).
The Dutch Supreme Court overruled the decision of the Amsterdam Court on the following two grounds. The term "FOREX results" in article 10a has a broad meaning. Article 10a should therefore include all types of FOREX losses (e.g. foreseeable and unforeseeable losses) which should be non-deductible, and all types of FOREX gains, which should be non-taxable, whether these exceed the interest expenses on the tainted group debt or not. Furthermore, the Supreme Court argued that the rules formulated by the Amsterdam Court would result in unbalanced results depending on the timing of the realisation of the FOREX gain. It would lead to an unreasonable result if in the first year a FOREX loss of 100 would be realised on a debt which is not deductible, and a foreign exchange gain of 100 in the subsequent year on that same debt which would be taxable.
3. Practical implications for Dutch taxpayers
Dutch tax law provides for a function currency ruling (following the taxpayer's commercial accounts) as well as a ruling to exclude foreign exchange results on debts that finance a qualifying participation from the taxable basis. Although these provisions can solve a substantial part of the taxpayer's FOREX issues, these rulings do not cover multiple currencies group financing situations. This decision is therefore much welcomed for these situations.
We have argued in academic literature that FOREX gains on tainted group debt should be exempt. We therefore advised our clients to take the position in their corporate income tax returns that FOREX gains on tainted debt are exempt from corporate income tax. The Dutch tax authorities did not follow this position, and deferred the issuance of final corporate income tax assessments until the Supreme Court would give his final decision. This group of taxpayers may now expect a final corporate income tax assessment confirming the exemption of the FOREX gain.
Taxpayers that took the position that the FOREX gain on a tainted debt is taxable and have not yet received a final corporate income tax assessment may wish to consider filing a revised corporate income tax return.
Taxpayers that filed a corporate income tax return in which the position was taken that an FOREX gain on a tainted debt is subject to Dutch corporate income tax and already received a final corporate income tax assessment are advised to object within six weeks following the date mentioned on the assessment.