Dutch Court Allows Interest Deductions On A Hybrid Loan

; posted on
May 9th, 2019

The Dutch appellate published the decision on transfer pricing adjustments to hybrid loan. Based on the court decision, the Dutch appellate was allowing interest deductions on a hybrid intragroup debt instrument, rejecting the tax administration’s stance that the deductions were barred by transfer pricing and financial instrument characterization rules.

Background

A Dutch retailer of women’s garments (the X group) acquired by a French private equity fund was entitled to take €27 million in interest deductions on €61.4 million in “convertible instruments” issued to the private equity fund. The court concluded that the instruments should be respected as debts for Dutch tax purposes and that the 13 percent interest rate was not excessive under the transfer pricing rules.The instruments were issued to four of the fund’s investors, each of which was a French investment company treated as tax transparent in France but as nontransparent in the Netherlands.

With regard to the convertible instrument, tax authorities argued that convertible instruments could create €8.1 billion in interest expenses over the 40-year term. The claimed interest deductions — rising from €8 million in 2011-2012 to €10 million in 2013-2014 — created a taxable loss in each year for what would otherwise be a profitable company. Furthermore, according to the government, the practicality of this interest must also be assessed in the light of the value and the value development of the assets financed by means of the convertible instruments.

The government also noted that the instruments were sham as the Dutch borrower had the option of converting the instruments to equity, and there was no real obligation to pay the entire amount owed under the debt.

Decision

The court rejected the government’s argument by underlying these following reasons:

  1. The contracts classified the instruments as debt and taxpayers generally have the right to determine their own financial arrangements. Therefore, the accusations that the instruments were sham loans or should be considered equity for tax purposes were not acceptable.
  2. As part of its transfer pricing argument, the court argued that 13 percent of interest rate was not excessive based on a debt service capacity analysis and a comparison with subordinated debt transactions between unrelated parties.Under its transfer pricing report, the taxpayer has tested the €61.4 million in convertible instruments.
  3. The instrument does not follow from the unusual nature of the convertible instruments that they should be regarded as not being effective. In addition, the court does not consider plausible that there was no certainty for a possible repayment of the convertible instruments — [especially] in view of the (formal) preference [for] the convertible instruments compared to the members' capital. This opinion was taken based on the facts given during the trial.

Based on the judge’s opinion, the court appellate agreed to reject the transfer pricing adjustment to this Hybrid Loan made by the tax authority.

Source: Dutch Government

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