Netherlands: Interest deductions in acquisition structures (Dutch Supreme Court)

The Supreme Court (Hoge Raad) on 15 July 2022, issued two judgments on the deduction of interest on loans that served to finance external acquisitions by private equity funds.

In both judgments, the Supreme Court addressed the issue of when there is a so-called “unbusinesslike diversion within a group” under Article 10a of the Corporate Income Tax Act 1969.

The first case concerned an acquisition structure in which a Dutch takeover company was indirectly held through a Luxembourg parent company by various separate sub-fund bodies of investment funds A and B as well as by various co-investors. In 2011, the Dutch takeover company bought the shares in the target group's Dutch holding company. This external acquisition was financed, among other things, with a loan from the Luxembourg parent company. The Luxembourg parent company had raised these funds from the above-mentioned sub-funds by issuing preferred equity certificates (PECs).

After the acquisition, a number of the acquired Dutch target group companies were merged into a fiscal unity with the Dutch takeover company. In dispute was the deduction of the interest on the loan from the Luxembourg parent company.

The Court of Appeal of The Hague held that interest on the loan was not deductible on the basis of Article 10a of the Corporate Income Tax Act 1969, because there was an unbusinesslike diversion within the group of the funds used for the acquisition. To this end, the Court of Appeal considered that the circumstance that the PEC holders did not qualify as affiliated entities within the meaning of Article 10a(4) of the Corporate Income Tax Act 1969 is not decisive when assessing whether there is an unbusinesslike diversion within a group, but that an unbusinesslike diversion can also take place via other parties involved (i.e. not qualifying as affiliated within the meaning of Article 10a, paragraph 4, Wet Vpb 1969).

The Supreme Court held that for the assessment of whether there has been an unbusinesslike diversion within a group of the funds used for the acquisition, only entities that qualify as affiliated entities within the meaning of Article 10a(4) of the Vpb Act must be considered. In this case, according to the Supreme Court, this means that the PEC holders do not belong to the same group as the Dutch takeover company, as a result of which the resources used by that Dutch takeover company for the external acquisition have not been diverted.

The second case concerns an acquisition structure in which a Dutch takeover company was indirectly held through a Luxembourg parent company by various separate sub-fund bodies of investment funds as well as by various co-investors. In 2010, the Dutch takeover company bought the shares in the target group's Dutch holding company. The capital raised from the investors was lent through various separate sub-fund bodies and by the co-investors to the Luxembourg parent company, which had issued PECs for that purpose. The funds raised with the PECs were paid up by the Luxembourg parent company for approximately €43 million as capital, and the remainder was lent to the Dutch takeover company. The Dutch takeover company then used the funds for the external acquisition of the existing Dutch holding company of the target group and the refinancing of existing debts of that target group.

After the acquisition, a number of the acquired target group companies were merged into a fiscal unity with the Dutch takeover company. In dispute was the deduction of the interest on the loan from the Luxembourg parent company.

The Amsterdam Court of Appeal held that interest on the loan was not deductible on the basis of Article 10a of the Corporate Income Tax Act 1969, because the loan was used for the acquisition and originated from the various sub-funds of the investment fund, which created an unbusinesslike diversion within the group of the funds.

The Supreme Court held, with reference to the judgment discussed above in case 1, that there was no intra-group diversion of the funds used for the acquisition because none of the (indirect) PEC holders qualified as an associated entity within the meaning of Article 10a, paragraph 4 of the Wet Vpb 1969.

However, since the Court of Appeal ignored the essential statement of the inspector that the interest deduction created was not only in conflict with the aim and intent of Article 10a of the Vpb Act 1969, but also with the aim and intent of the Act as a whole (fraus legis), the judgment of the Amsterdam Court of Appeal was not upheld. The Supreme Court referred the case to the Court of Appeal of The Hague for further handling and decision with due observance of its judgment.

Read a July 2022 report prepared by the KPMG member firm in the Netherlands