We already informed you earlier about the tax consequences of a non-arm’s length loan within a group. The starting point in such situations is that the tax authorities in principle base their view on the parties’ intention. If the parties have opted under civil law for a loan, the tax authorities follow this position unless there is a so-called non-arm’s length loan.
The Supreme Court recently decided on the converse situation. The party involved had financed an undertaking by providing capital, but in the tax authorities’ view the shareholder’s risk was so limited that this risk had to be equated with that of a party providing a loan. For this reason the tax authorities found that the shareholding had to be regarded as a loan and that the advantage from the shareholding was taxable as interest under the Corporation Tax Act. The district court and the appeal court both found in favour of the tax authorities. Although under civil law there was a case of a shareholding, because of the set of legal acts and the (indirect) furnishing of securities for the shareholder, there was actually a case of financing.
Supreme Court’s opinion
The Supreme Court reached a different opinion[i]. In the Supreme Court’s view, whether there is an advantage that falls under the participation exemption of section 13 of the Corporation Tax Act depends on whether the dividends can be regarded as compensation for the capital paid up on the shares or otherwise for a shareholder’s provision of capital as such. Here too the civil-law form for which the parties have chosen is decisive, therefore. However, unlike a loan, which can be regarded in certain circumstances as the provision of capital, the provision of capital cannot be qualified as a loan.
According to the Supreme Court, the basic principle of the provision of capital is that a capital provider is in all respects subordinated to all creditors in the event the company is liquidated. That was also the situation in the case at hand. The fact that the capital provider’s risk was very limited and the arrangement strongly resembled a loan did not alter this fact. In the Supreme Court’s view, making an exception to the general rule whereby the degree to which a capital provider runs any risk is important to the question of whether the situation involves the provision of risk-bearing capital or the provision of a loan results in legal uncertainty. That is why the Supreme Court is not open to an exception to the general rule.
In short: a loan under civil law can indeed be regarded for tax purposes as capital provision if the loan is not at arm’s length, but a provision of capital under civil-law is always provision of capital, also for tax purposes.
The case
For those who are interested, the case was as follows, simplified significantly here:
A banking syndicate had provided company B B.V. a loan in the past. After this company had repaid the original loan in part, a need for refinancing arose. For this purpose one of the banks set up X B.V. (the party involved), which company was added to the tax entity with the bank. The financier set up a new subsidiary, G B.V. A fund for joint account (the Fund) was also set up. One of the participants in the Fund was X B.V. Although the Fund held cumulative preference shares in G B.V., it ran virtually no risks, because the risks were covered by securities.
[i] ECLI:NL:HR:2014:181, 7 February 2014