No write-down loss for earn-out receivable
The Supreme Court ruled that the change in value of a receivable obtained in consideration for the sale of a participation is not deductible applying an earn-out arrangement.
12 July 2018
Practice shows that buyer and sellers often disagree on the value of a participation to be sold. To solve this, they often agree that part of the purchase price will depend on profit or turnover to be realised by the entity to be taken over in the future. The respective buyer and seller then agree that eventual price to be paid for the participation also includes a right to future benefits. On top of that, they can agree that part of the purchase price paid will be repaid if results are below expectations.
Changes in the value of rights and commitments ensuing from such an earn-out arrangement are qualified as gains from a participation and therefore come under the scope of the participation exemption. This is done because the legislature wishes to avoid that buyers and sellers base themselves on different estimates when valuating such rights, resulting in endless disputes with the Tax Inspector. The Supreme Court recently clarified the scope of an earn-out arrangement with acknowledgement of indebtedness.
Acknowledgement of indebtedness
The interested party held part of the certificates in private limited liability company (bv) Y together with other companies. It then two times sold one eighth of its certificates to third parties. The certificates were transferred in July 2008. The certificates sold by the interested party belonged to a participation. The contract relating to the transaction stipulated that the purchase price remained due by the buyers. Repayment of the debt depended on the dividends to be distributed. Any remaining debt would be remitted at year-end 2016. In 2012, the interested party wrote down its receivables from the buyers and charged them to the profit and loss account, based on its expectations that they would not be repaid. However, the inspector refused deduction of the writ-down loss, arguing that a contract had been concluded that comes under the scope of the earn-out arrangement.
The Arnhem-Leeuwarden Court of Appeal agreed with the inspector. The Court considered there is an inextricable link between the sale of the certificates and the agreed purchase price on the one hand, and the receivable resulting from the contract of acknowledgement of indebtedness on the other. The Court of Appeal then decided that, given the broad scope of the earn-out arrangement that appears from legislative history, the rights ensuing from the receivable on account of acknowledgement of indebtedness should be qualified as the price within the meaning of the earn-out regulation.
In cassation the Supreme Court first established that the wording of the earn-out arrangement and its legislative history show that the concept of “price” is to be interpreted as that which the seller receives as a consideration for selling the participation. The Supreme Court indicated that this is in line with the scope of the provision, which is to avoid valuation differences in situations in which the total scope of the consideration cannot be determined in advance. The Supreme Court considers that the Court of Appeal’s judgment that an inextricable link exists between the purchase price and the receivable resulting from the contract of acknowledgement does not reflect an incorrect interpretation of the law. Consequently, the change in value of the receivable is not deductible.
Source: HR 29 June 2018, no. 17/03220, ECLI:NL:HR:2018:1019