The Netherlands takes a rather formal approach with respect to
the tax characterization of a financial instrument, as the form of
the instrument is generally decisive for its character for Dutch
tax purposes. A substance-over-form exception applies, however, for
a debt instrument that (i) has no term or a term in excess of 50
years, (ii) carries a profit contingent interest, and (iii) is
subordinated. The Dutch Revenue Service argued that a
substance-over-form exception should be made as well with respect
to certain debt-like equity instruments, but this argument has been
dismissed by the Supreme Court in a February 7, 2014 ruling. The
case related to redeemable preferred shares issued by an Australian
company to a Dutch company that sought to apply the participation
exemption with respect to its income from the shares. The shares
had the following characteristics: (i) an entitlement to cumulative
and fixed dividends, (ii) seniority over other share classes, (iii)
redemption after 10 years, and (iv) limited voting rights.
Furthermore, the Australian issuer was entitled to deduct the
dividends for Australian tax purposes.
With its decision, the Supreme Court settles a long debate in
favor of the taxpayer by rejecting that equity can be
recharacterized into debt for purposes of the participation
exemption, even if a deduction is available for the issuer.
Taxpayers that seek to benefit from this ruling need to be
cautious, however, in view of the recent proposals to amend the EU
Parent-Subsidiary Directive and the OECD work on hybrid mismatch
arrangements, which both seek to deny the participation exemption
in case the issuer is entitled to a deduction.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
