Tax Alert December 2011

On 25 November last, the Supreme Court of the Netherlands issued two rulings confirming the existence of the so-called "non-businesslike loan" ("onzakelijke lening"). The concept of the non-businesslike loan was introduced in an earlier ruling of the Supreme Court dated 9 May 2008. In that ruling, the Supreme Court held that a write-off on a loan is not tax deductible to the extent that a subsidiary grants a loan for the benefit of its shareholder under such conditions and circumstances that it runs a credit risk that independent parties would not have accepted. The 2008 ruling created uncertainty among tax practitioners and resulted in ambiguous case law by lower courts. It is therefore good news that the two rulings of 25 November 2011 take away much of the uncertainty caused by the Supreme Court's 9 May 2008 ruling.

In its 25 November rulings, the Supreme Court confirms the existence of the non-businesslike loan, and adds that next to an upstream non-businesslike loan, a downstream non-businesslike loan is possible. In order to qualify a loan as (non)-businesslike, it should be determined whether the interest rate is at arm's length or can be adjusted to an arm's length rate, without becoming profit-participating. This should be a "ceteris paribus" analysis, meaning an analysis based on the other terms, conditions and circumstances of the agreement. If no (non profit participating) arm's length interest rate can be determined because a third party wouldn't be prepared to provide a loan under the circumstances at hand, the entire loan is qualified as a non-businesslike loan. In other words, it is not possible to split a loan in a businesslike amount and a non-businesslike amount. Furthermore, the credit risk on accrued interest on a non-businesslike loan is also non-businesslike;

Furthermore, the Supreme Court provides the following set of rules:

• For tax purposes, a non-businesslike loan is treated as debt and not as equity;
• Whether a loan should be qualified as a non-businesslike loan is determined at the moment the funds are provided. This notwithstanding, a businesslike loan may be re-qualified in a non-businesslike loan as a consequence of a non-businesslike act of the creditor.
• The at arm's length interest rate on a non-businesslike loan is set at the rate that the debtor would have paid if it had attracted the loan from an independent third party under a guarantee of the actual creditor.
• A write-off on a downstream non-businesslike loan, while not tax deductible at first, may ultimately be deductible upon liquidation of the debtor pursuant to the Dutch participation exemption rules concerning liquidations.

While the rulings provide a welcome clarification with regard to the non-businesslike loan, corporate taxpayers should be cautious when granting loans to related parties in order to avoid such loans being qualified as non-businesslike. In any case, each loan should be properly documented through a loan agreement including the repayment obligation, maturity date, rank, interest rate and surety. For more certainty, a transfer pricing study may be conducted to confirm the arm's lengthiness of the loan as well as its conditions.