The Supreme Court has ruled that the additional interest earned by a director-major shareholder ("DMS") when borrowing money from his own company, and subsequently placing it in an internet savings account at a higher interest rate, is not taxable in Box 1. Earlier, the Court of Appeals in The Hague had come to a different decision in this case.
This case took place in 2003, when the company had significant liquid assets. The DMS borrowed money from his company on the basis of a current account agreement, at an interest rate equal to the rate the company would normally receive from a bank on monthly deposits and on a high yield business savings account. In 2003 that was 2.5%. This interest was considered at arm's length for corporate income tax purposes. The DMS then placed the money he had borrowed from his company in an internet savings account, from which he received an average of 3.6% interest, resulting in a profit of 1.1%.
According to the tax inspector the difference in interest received by the DMS should be taxed in Box 1 as income from employment and home ownership. The DMS considered that the difference in interest received by him was income from savings and investments which is taxed in Box 3. As the amount on the internet savings account would be equal to the debt to his company, the tax payable in Box 3 would be nil. The District Court in The Hague agreed with the DMS and the case was then brought before the Court of Appeals in The Hague.
Priority rule
The Court of Appeals applied the “priority rule” to determine which income category in Box 1 would apply to the additional interest income. Only when the income in question cannot be categorized as income in Box 1, does Box 3 come into play. The Court of Appeals concluded that the additional interest could not be classified as business profit or as wages. That left the last income category in Box 1 for the Court of Appeals to consider: income from other activities.
The Court of Appeals: the additional interest is income from other activities in Box 1
In order for income to be included in the income from other activities category, it must be earned as a market participant, there must be a subjective intention to make a profit, and there must be an objective and reasonable expectation that this profit can be made. The Court of Appeals considered that by borrowing and then lending the money the director-major shareholder was participating in market activities. The Court of Appeals also ruled that the DMS had the intention to make a profit, and that this profit could reasonably be expected. The Court of Appeals stated that by having full control over the company, the DMS was able to make a personal profit from activities which exceeded normal and active property management. The additional interest the DMS received was accordingly taxed in Box 1 as income from other activities.
The Supreme Court: no activities exceeding normal and active property management
The Supreme Court has now ruled, contrary to the Court of Appeals, that the additional interest income is not taxable in Box 1. The Supreme Court took the position that placing money in a savings account does not exceed normal and active property management. The fact that the DMS borrowed money from a company he controlled was of no consequence in this matter. Finally, knowledge about savings account interest rates, is not a special kind of knowledge which would lead to a classification of income from other activities, according to the Supreme Court. The amount on the internet savings account and the corresponding debt to the company are therefore taken into account in Box 3.