Deduction of share exchange related issue costs disallowed for permanent establishment

Dutch version

Introduction

The interested party was an SA established in France that owned a permanent establishment in the Netherlands as of 1 July 2007, in respect of which it classifies as a non-resident taxpayer in the latter country. The capital of this permanent establishment consisted solely of shares in a Netherlands-based limited liability company (hereinafter ‘NV’), acquired through a public exchange offer in 2007. At the time, the NV qualified as a fiscal investment institution (fii) (fiscale beleggingsinstelling, fbi). In the exchange, the interested party issued both new shares and convertible bonds called obligations remboursables en actions (ORAs). In return, the NV’s shareholders had a choice between the ORAs or the new shares in the interested party.

The interested party incurred issue costs to be able to issue both the ORAs and the shares (EUR 9,424,557 for the ORAs and EUR 34,700,000 for the shares). In imposing the 2007 corporate income tax assessment, the Tax Inspector refused to allow deduction of the issue costs relating to the ORAs from the profit of the permanent establishment.

Dispute

The parties disputed whether the interested party is allowed to deduct the issue costs for the ORAs and the shares from its profits taxable in the Netherlands. A key issue in this context is whether the ORAs should be characterised as debt or equity.

Judgment of the Court

The Amsterdam Court of Appeal (hereinafter ‘the Court’) ruled that the ORAs do not qualify as debt capital due to the lack of an enforceable repayment obligation. Since the issue costs for the ORAs do not relate to third-party financing raised by the interested party, the Court argued that these costs cannot be attributed to the permanent establishment as debt capital costs.

In addition, the Court held that the issue costs (of both the ORAs and the shares) should be considered costs associated with the company’s legal form that cannot be allocated to a particular profit centre or business unit. This precludes allocation of the issue costs to the permanent establishment in the Netherlands. The Court also concluded that the Netherlands-France tax treaty of 16 March 1973 and the Commentary on the 1963 OECD Model Tax Convention did not provide a basis to still allocate the issue costs to the Dutch permanent establishment.

Grounds for cassation

In its appeal in cassation, the interested party argued as follows:

1. The Court erred in holding that the ORAs should not be classified as debt but as equity.
   
2. The Court erred in ruling that the ORAs’ issue costs qualify as costs associated with the company’s legal form that are not attributable to the permanent establishment in the Netherlands.
3. The Netherlands-France tax treaty provides that issue costs are to be allocated to the Dutch permanent establishment.

Supreme Court ruling

The Supreme Court stated that as a rule, the civil-law form is decisive for the qualification of a provision of funds for tax purposes. The qualification of a provision of funds as debt capital requires the presence of a repayment obligation. This applies even if that repayment obligation is conditional and the repayment uncertain, and equally so if the agreement provides that, in the event of bankruptcy or dissolution and liquidation of the borrower’s assets, the lender ranks pari passu with the holders of preference shares. The Supreme Court followed the Court’s judgment that the ORAs do not constitute a debt instrument. After all, the holders have no enforceable right to payment or repayment in cash, but only an enforceable right to payment or repayment in shares. The first plea therefore fails.

The Supreme Court further ruled that the issue costs qualify as costs of capital changes as referred to in Article 9(1)(d) of the Dutch CITA. Such costs are inherent to the legal form of a company with a capital divided into shares. They are neither related to benefits to be achieved by the capital company in such a way that they can be attributed to those benefits, and thus, nor to benefits attributable to the permanent establishment. On this point too, the Court’s judgment was found to be correct.

Finally, the Supreme Court held that neither the Netherlands-France tax treaty nor the OECD Commentary 1963 contain any indication that issue costs - which are inherent to the legal form of the company with a capital divided into shares as costs associated with the company’s legal form - must be deemed to be incurred (also) for the benefit of the permanent establishment under Article 7(3) of the treaty. Therefore, this provision does not require that the issue costs be charged to the profits of the permanent establishment.

The conclusion was that the interested party’s appeal in cassation was unfounded. The issue costs cannot be deducted from the taxable profit of the Dutch permanent establishment.

Source: HR 17 May 2024, 21/00415, ECLI:NL:HR:2024:706