Tax driven acquisition financing structure qualified as abuse of law

Requalification to equity

Under Dutch tax law, the qualification of the instruments in principle follows the qualification for civil law purposes. Debt is however requalified to equity if the instrument is considered: (i) a sham loan, (ii) a loss financing loan or (iii) a profit participating loan. In this case, the tax inspector argued that the convertible instruments should be considered a sham loan and / or profit participating loan.

The Amsterdam Higher Court ruled that the convertibles instruments cannot be considered either one by applying a strict interpretation in this regard.

Sham loan

With respect to the sham loan, the tax inspector argued that towards third parties, the group insinuated that the Dutch company would be equity financed. The Court ruled in favor of the taxpayer and deemed the presentation of the convertible instruments in the financial statements of the Dutch entity relevant. Furthermore, the Court ruled that certain documents to which the tax inspector referred were not drafted from the perspective of the Dutch taxpayer, but that from the perspective of the investors / French parent companies the Dutch entity was equity financed. The Court did not agree with the tax inspector that an indication of a sham loan can be found in the fact that there is no pick up of the interest income under French tax law due to the hybrid character of the convertibles.

Profit participating loan (PPL)

It follows from Dutch case law that a loan qualifies as PPL if the following requirements are met:

• interest is profit dependent;
• the loan is subordinated to all other creditors; and
• the loan has no fixed term (or the maturity date exceeds 50 years) and will be payable upon bankruptcy, suspension of payment or liquidation.

In the case at hand, the maturity date of the convertible instruments was set at 40 years. It was at the discretion of the Dutch taxpayer to convert the instruments into equity or repay the principal amount and accrued interest. The tax inspector argued a more economic approach – which was followed by the Lower Court – under which also instruments with a maturity date of less than 50 years could qualify as a PPL. The Amsterdam Higher Court prescribed a strict interpretation of the case law under which the PPL is defined. Therefore the convertible instruments have not been requalified to equity for Dutch tax purposes.

Deductibility of interest / Abuse of law

Without going into detail, the Amsterdam Higher Court also ruled that the convertible instruments and the interest rate of 13% should be at arm’s length and that the formal criteria to apply specific interest deduction limitation rules were not met. Therefore, the interest on the convertible instruments should be deductible under Dutch tax law. However, considering the set up of the acquisition structure, the Court ruled that the objective of the financing structure was in breach with the applicable legislation and that the sole purpose of the financing structure was to create a tax advantage. Therefore, although in line with the then applicable legislation, the deductibility of the interest was denied under the application of fraus legis (abuse of law).

Next steps

Appeal may be lodged at the Dutch Supreme Court. The Supreme Court will not (re)consider or examine the facts and is required by law to base its deliberations on the facts as established by the lower court(s). The Supreme Court will therefore render a judicial decision on a point of law, including procedural law.

More information?

For more information, please contact Jimmie van der Zwaan or Maud Kallen.