Qualification capital contribution explained in more detail by the Supreme Court

Publication date 11 February 2014

On February 7, 2013, the Supreme Court rendered judgment in two cases that dealt with whether a payment should be regarded as interest or as exempted participation dividend. In both judgments, the Supreme Court put the civil law qualification first when answering the question. The Supreme Court formulated three exceptions to the rule for loans, whereas no exceptions are made for share capital. If capital is regarded as such from a civil law perspective, then it is also regarded as capital for tax purposes. The Supreme Court also ruled that utilizing the freedom of choice provided by the law to taxpayers who wish to finance a company in which the taxpayer participates, is not contrary to the aim and the spirit of the law.

Civil law qualification as capital contribution

A bank syndicate had originally financed its acquisition holding with a loan, which it later converted into cumulative preference shares. The new financing method is quite similar to a three-year loan with a fixed interest. In dispute is whether the payment received by the bank syndicate should be regarded as interest or as participation dividends. According to the Supreme Court, the civil law qualification is, in principal, decisive, although three exceptions do apply for money loans. The Supreme Court ruled that in the reverse situation – where it is regarded as share capital from a civil law perspective – there are no exceptions to the general rule. An exception that depends on the level of risk would lead to a legal uncertainty as to when financing is regarded as the issue of risk-bearing capital or is regarded as a loan. The payment relates to a capital contribution from a civil law perspective and therefore falls under participation exemption. Abuse of law does not change this.

Redeemable preference shares

A fiscal unity initially granted a loan to an Australian company. For the purposes of changing the financing structure, the loan was repaid and the fiscal unity obtained direct redeemable preference shares (RPS) in the Australian company. A fixed payment is made on the RPS and the nominal value is repaid after ten years. The Amsterdam Court of Appeals ruled that the RPS are similar to cumulative preference shares to a degree that the payment made on the RPS qualifies as exempt dividends. The Amsterdam Court of Appeals also ruled that no abuse of law was involved. The Supreme Court confirmed the Court's position.

Commentary KPMG Meijburg & Co

Old case law showed that the Supreme Court considers that the civil law qualification is, in principle, decisive. An exemption applies to loans if a sham loan, loan with no expectation of repayment or a participating loan is involved. The judgments rendered on February 7, 2014 made clear that the Supreme Court does not allow for an exception to be made on the civil law qualification as share capital, in view of the significant legal uncertainty this would cause. Foreign forms of company finance in which a participation is held will need to be assessed by civil law standards. The law offers a freedom of choice regarding the financing of a company in which a participation is held. Utilizing this freedom cannot constitute an act contrary to the aim and the spirit of the law, i.e. abuse of the law.

Please contact your advisor at KPMG Meijburg & Co if you wish to know more about the consequences of these judgments.

Click here to download the memorandum in pdf format

   

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