Supreme Court responds to requests for a preliminary ruling on the redemption of interest rate swaps has been saved
Supreme Court responds to requests for a preliminary ruling on the redemption of interest rate swaps
The interested party need not capitalise and amortise the loss incurred through the redemption of interest rate swaps. In this case, the replacement fixed interest loans cannot be said to essentially continue the original combination of variable interest loans and interest rate swaps.
3 March 2022
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- Redemption of interest rate swaps
- Conclusion Advocate-General (A-G)
- Response to requests for a preliminary ruling
- Agreements on fixed interest loans
Redemption of interest rate swaps
The Supreme Court has responded to requests for a preliminary ruling that the Court of Noord Nederland submitted, on the tax treatment of the redemption of interest rate swaps. The housing corporation in question had entered into various interest rate swaps whose value had turned significantly negative due to falling interest rates. The resulting obligations to provide collateral (so called ‘margin calls’) put such a strain on its liquidity position that it threatened to fail the compulsory stress test. To get rid of the margin calls, the interest rate swaps were redeemed. At the same time, the loans with a variable interest rate - for which the interest rate swaps had initially been entered into - were replaced by fixed interest loans.
The dispute is about the tax treatment of the redemption sums. Sound business practice suggests that as much as possible costs should be charged to the period in which the related revenue is recognised (matching). The interested party wanted to charge the redemption sums to its profit in full. After all, the interest rate swaps and the variable interest loans had been terminated, so matching with future profits was not an issue. The Inspector’s position, on the other hand, is that the redemption sums should be capitalised and amortised. In their opinion, the redemption should be assessed in conjunction with the refinancing.
Conclusion Advocate-General (A-G)
Earlier on, A-G Wattel had concluded that the combination of a variable interest loan and an interest rate swap actually functions as a fixed interest loan. In his opinion, the redemption of the interest rate swaps and the refinancing can be compared to the refinancing of a fixed interest loan. Hence, in his view the part of the redemption sums of the swaps that can be allocated to the interest rate difference should be capitalised and amortised over the period in which the variable interest rate loans would still have existed. The Attorney General argues that the remaining part of the redemption sums, relating to elimination of the liquidity risk, may be charged directly to the profit.
Response to requests for a preliminary ruling
The Supreme Court does not follow the same line though. Our highest court of justice’s primary argument is that, if the variable interest rate loan connected to the interest rate swap (the swap combination) is terminated as well, sound business practice does not oppose recognising a loss in the year of redemption because in that case it results in a definite loss. The motive for the redemption is irrelevant in this respect.
If, on the other hand, the debt is replaced by a loan with a lower fixed interest rate than the swap rate plus any interest surcharge on the terminated variable interest loan, it should be assessed whether the swap combination is essentially continued. If so, the redemption paid must be capitalised and amortised over the remaining life of the original loan. In this case, though, there is no such continuation because the liquidity risk linked to the swap combination (in the form of margin calls) does not arise with the replacement loan. Hence, the housing corporation may charge the full redemption paid to the profit in the year of redemption.
Agreements on fixed interest loans
The Supreme Court also deals with the situation in which a taxpayer agrees, against payment of a lump sum, with a fixed interest loan provider to pay a lower interest rate in the coming years if the market interest rates fall. In that case, the amount paid must be capitalised and charged to the profit over the remaining term of the loan (amortisation).
Another situation requiring capitalisation and amortisation is if, against payment of a lump sum, early repayment of a fixed interest loan is agreed, which is then replaced by a loan with a lower fixed interest. This is subject to the condition that the new loan essentially qualifies as a continuation of the old loan. The characteristics of both loans and any related financial instruments need to be assessed to see whether this is the indeed the case. Another relevant issue in this respect may be whether the new loan is used to finance the same or a functionally similar asset. The Supreme Court argues that the new loan not being taken out with the same lender or the term (or remaining term) of the loans being different, does not preclude the conclusion that it essentially is a continuation of the old loan. In that case amortisation should take place over the remaining term of the original loan, or the term of the replacement loan if this is shorter.
- HR 25 February 2022, 21/00564, ECLI:NL:HR:2022:312
- Conclusion A-G Wattel 30 April 2021, 21/00564, ECLI:NL:PHR:2021:440