Impact of Changes to Dutch Tax Loss Rules on Restructurings

In 2020, the Dutch government, like many others, implemented various temporary measures aimed at providing immediate financial leeway to the business community to cope with the financial consequences of the pandemic. Such measures include non-tax schemes, like extended governmental business loan guarantee schemes and non-refundable temporary emergency schemes for job retention.

There are also several measures in the area of taxation. Some of these are more of a practical nature (e.g., how to apply tax treaties to cross-border workers who were forced to work from home), while others were designed to enhance companies’ cash flow position. One of the more significant measures concerned the possibility to obtain extraordinary deferral of payment of taxes that should have been paid or transferred during the period as of March 12, 2020.

The end of the third wave of the pandemic seems to herald a return to a more normal situation, in which companies will again be expected to meet all their financial obligations on time. This will apply to payment obligations to suppliers and banks, but also to the tax authorities.

In line with this, the special Covid-19 deferral scheme will no longer apply with regard to Dutch taxes for which payment becomes due for the first time after July 1, 2021. Such taxes will need to be paid within the normal payment periods. Timely payment as of July 1, 2021 will also be a condition to qualify for the generous payment scheme for the outstanding tax as a result of the Covid-19 deferral, which may cover the maximum period from March 12, 2020 to June 30, 2021.

Based on the current regime that (according to parliamentary debates on June 2) the majority of the Second Chamber of the Dutch parliament would like to see relaxed further, repayment of the outstanding taxes will need to start on October 1, 2022, whilst the entire repayment may take up five years. Accelerated payment is also permitted of course, and may also be advantageous for taxpayers that have sufficient financial means, in view of the already-announced increase in interest rates that will be applied by the Dutch tax authorities.

Phasing out of Government Support

The end to the payment moratorium and the phasing out of the government support will make it visible that the balance sheets of many businesses have seriously deteriorated after having relied on government support, government-backed loans and/or having drawn additional amounts on existing loan facilities.

Many businesses, even those that have sustainable business models, may find themselves in a situation of over-indebtedness or impending over-indebtedness. This may trigger the need for businesses to look at reorganizing their operations and a financial restructuring. Such reorganization and restructuring may trigger adverse tax consequences which are capable of offsetting the effects of an otherwise successful restructuring, in whole or in part.

On June 4, 2021, a Royal Decree was published in the Dutch state gazette which enacts new legislation with significant changes to the Dutch tax loss utilization regime. The new rules will have a major impact on future restructuring transactions and will become effective for financial years starting as of January 1, 2022.

The likely consequences for financial restructuring transactions are discussed below, as well as the general Dutch tax implications of debt restructuring transactions, including loan waivers. Possible structures alternatives are also touched upon, bearing in mind that each individual restructuring will have its own specific tax considerations.

2022 Changes to Dutch Tax Loss Utilization Rules

Based on the current Dutch corporate income tax rules, tax losses can be carried back one year, whereas the carryforward period for such losses amounts to six years. The 2022 rules leave the carryback period untouched, but the carried forward back period becomes indefinite. Simultaneously (and the main purpose for introducing these rules) strict limits are introduced for the annual use of losses.

From 2022 onward, tax losses can only be offset against the first 1 million euros ($1.18 million) of taxable profit in a given tax year, and, to the extent that the taxable profit of the relevant year exceeds 1 million euros, losses may only be offset up to 50% of the excess. This means that if the profit for the year amounts to 5 million euros, a maximum of 3 million euros (1 million + 50% of 4 million) can be used to offset tax losses.

For taxpayers with substantial losses, the foregoing means that 50% of their taxable profits, to the extent such profits are above 1 million euros, will actually be taxed at regular Dutch corporate income tax rates. The headline rate for this tax is 25%, whereas the first 245,000 euros, for 2021 (395,000 euros for 2022), is taxed at 15%. Such treatment also applies to profits that are generated outside the scope of a taxpayer’s ordinary business, such as gains realized on restructuring transactions.

The new rules do not provide for special treatment with respect to such extraordinary results. It is also irrelevant whether a taxpayer will reasonably have any future opportunities to set off existing losses. Losses incurred on the occasion of, or in the immediate run-up to, the liquidation of a taxpayer, will for example also be subject to the 50% limit described above.

Waiver Profit Exemption

As a result of the absence of special loss compensation rules for profits to be recognized because of the release of debts, a concurrence with the so-called waiver profit exemption will occur, which may be considered highly undesirable from the market point of view.

This waiver profit exemption operates as follows: if a creditor decides on business motives to waive certain debt, then in the hands of the corporate borrower, assuming this is a Dutch taxpayer (including if a gain is attributable to a nonresident taxpayer’s Dutch permanent establishment), the corresponding gain is exempted to the extent that such waiver profit exceeds the debtor’s available tax losses. This exemption was designed in such a way that the available tax losses would first have to be used before the exemption could be invoked.

Due to the 2022 limit on the use of tax losses, which limit does not impact the amount of the available tax losses but instead the use of such losses in a given year, a profit resulting from a business motivated waiver may lead to a Dutch corporate income tax liability for the debtor, despite the possible existence of a large reservoir of tax losses, because the use of these losses is subject to the 1 million euro + 50% cap. Only if the debtor is in an overall loss position in the year in which the waiver occurs should a tax liability not arise.

Of course, the timing of the introduction of these additional loss compensation limits, at a time when many businesses are dealing with the financial consequences of the pandemic, or at least the absence of a deviating rule for waiver profits, is rather unfortunate. This has also been pointed out several times by stakeholders during the legislative process, so it is clear it is a deliberate choice, which was confirmed during the legislative process. Similar undesirable effects may occur in the case of write-downs of business assets and receivables and unaccompanied business reorganisations.

As a directly related point, the absence of grandfathering rules for existing losses incurred prior to financial years beginning on or after January 1, 2022 will also force businesses to write down their corresponding deferred tax assets, causing a reduction of the equity shown in the balance sheets, which may accelerate the need for a financial restructuring.

The obvious next question is whether parties can consider alternatives to avoid these negative tax consequences in case of business-motivated waivers and similar transactions, including debt to equity swaps. Some alternatives are discussed below.

Timing of the Debt Waiver

If parties are considering a (possible) business motivated debt waiver, which, depending on the circumstances can also occur between affiliated parties, an obvious solution is to have the debt cancellation take place prior to the entry into force of the new rules.

This could spark the idea to change the debtor’s financial year, as the new rules will apply from the first financial year starting on or after January 1, 2022. If, with effect from December 1, 2021, the current financial year (assuming it to be the same as the calendar year) were to be changed to a financial year running from December 1 to November 30, the new rules would only apply from December 1, 2022.

Here, caution is called for. It follows from case law that the effects of the financial year change may be bypassed if the change is only aimed at temporarily avoiding these loss compensation restrictions. It should be possible to provide alternative motives for the financial year change.

Incidentally, a waiver only leads to a tax gain for the debtor if the loan did not already qualify as equity for Dutch corporate income tax purposes prior to the waiver. The relevant classification criteria were developed in case law. The following clear criteria must be applied for corporate income tax purposes when labeling a financial instrument:

• for tax purposes the equity nature of a financial instrument that qualifies as a capital contribution for civil law is respected, regardless of the existence of a (conditional) repayment obligation; and
• if a financial instrument does not qualify as an equity contribution for civil law purposes, then the existence of a repayment obligation in principle causes the instrument to qualify as debt, even if such a repayment obligation is conditional and subordinated.

Three exceptions were formulated to this main rule, leading to an equity qualification for Dutch tax purposes (i.e. hybrid loans):

• sham loans, being loans that are only presented as such, while parties have intended to provide equity;
• bottomless pit loans, being loans that an unrelated party would not have been prepared to make because it is clear from the outset that the loan will never be repaid; and
• profit-participating loans, being loans that have the following cumulative characteristics:
  • interest on the loan that is entirely or almost entirely dependent on the debtor’s profits;
  • the loan is subordinated to all ordinary creditors of the debtor;
  • the loan does not have a fixed term and is only payable in the event of bankruptcy, suspension of payments or liquidation.

In short, if the creditor holds a participation in the debtor, which participation qualifies for the participation exemption, then a waiver results in a recapture of a tax deduction previously enjoyed in respect of a write-down or write-off. However, simultaneously with the recapture a reserve (revaluation reserve) can be created for the full amount of the recaptured tax deduction.

Effectively, immediate taxation of the creditor at the moment of the waiver is avoided this way. This revaluation reserve needs to be released to the benefit of the (former) creditor’s taxable profits if subsequently results are generated by the (former) creditor with respect to the participation in the debtor or if certain tainted transactions occur.

It can be deduced from the above that, under certain circumstances, no tax deduction is enjoyed at the creditor level if this is a creditor subject to Dutch corporate income tax, with respect to the write-down, while at the debtor level taxation occurs as a result of the waiver. This needs to be carefully reviewed on a case-by-case basis.

Debt to Equity Swap

In case of affiliated debt financing, often a debt to equity swap is preferred to a waiver of the loan on the basis that such swap normally does not cause the debtor to recognize a taxable profit. Such debt to equity swap generally takes the form of the creditor subscribing for new shares in the debtor, with the obligation to make a capital contribution being offset against the creditor’s claim under the loan. The 2022 tax loss rules will not bring about any change to the tax treatment of such swaps.

At the level of the creditor, if subject to Dutch corporate income tax, the Dutch corporate income tax treatment is identical to the one applicable to the waiver. In other words, any previous tax-deduction needs to be recaptured and a revaluation reserve can be created for the full amount of the recapture. This applies if the creditor already owns a qualifying participation in the debtor prior to the swap but also if the creditor starts owning a participation as a consequence of a debt to equity swap. The latter is particularly of interest to banks and similar unaffiliated lenders if they are willing to participate in a swap.

If, in short, the creditor already owns a participation in the debtor, a change to a loan’s terms and conditions causing the loan to qualify as a hybrid loan for Dutch corporate income tax purposes (see above), will have the same consequences as a formal issue of shares by the debtor. For completeness’ sake, this does not apply to lenders that do not hold a participation.

Although the conclusion seems to be that a swap is, in many circumstances, a good alternative to a regular waiver, here a careful analysis will also have to be made based on the exact circumstances of the case. Under specific circumstances, if the debtor is a real estate entity, the levying of real estate transfer tax may come into play. In addition, the issuance of shares may lead to a change in the ultimate interest in the debtor of at least 30%, which may result in the extinction of all tax losses. This is the case if the volume of activities has decreased or is expected to decrease by at least 70%, which can of course occur in case of a substantial restructuring.

In addition, if a receivable has its direct origin in a supply of goods or services by the creditor, the value-added tax (VAT) consequences need to be assessed. In case of a waiver, the debtor will be obliged to repay previously recovered input VAT, while the creditor will be entitled to a refund from the Dutch tax authorities of the VAT previously paid in respect of which the debtor has failed to make payment. Generally, a swap will cause the creditor to forfeit its right to a refund from the Dutch tax authorities, whilst the debtor does not need to repay. Whether the same is true in the jurisdiction of a nonresident creditor would obviously need to be reviewed.

Planning Points

The 2022 Dutch tax rules are likely to have a significant impact on financial restructurings that may be necessary to help debtors through the current difficult financial times. This means that, even more than before, all parties involved and their advisers need to carefully review the tax consequences of the various alternatives for all parties involved.

Parties considering a waiver of a loan, if this waiver can be considered to be based on business motives, will generally be well advised to do so before January 1, 2022, provided that the debtor has sufficient tax losses available to offset the resulting waiver gain. After that, the Dutch tax authorities also expect financially unstable taxpayers to contribute their presumed fair share of the funding needed for the public spending.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Anton Louwinger is a Partner with CMS Netherlands.

The author may be contacted at: anton.louwinger@cms-dsb.com