In its judgment of October 22, 2010, the Supreme Court confirmed that while the re-investment reserve can be used to transfer to new business assets the capital gain realized on the sale of business assets, for non-business assets, such as inventory, profit recognition can be postponed by invoking the case law on exchange of assets.
If a capital gain is realized when selling a business asset, for example, if the proceeds from the sale exceed the book value at the moment of sale, then the recognition of the profit can de postponed by the creation of a re-investment reserve. This re-investment reserve can then be written-off against the acquisition or development costs of the re-invested business assets. The lower book value of the new business assets results in lower depreciation, thereby spreading the postponed capital gain over future years. As such, the re-investment reserve provides a timing advantage.
Requirements for application of the re-investment reserve
The setting-up of a re-investment reserve, and its subsequent write-off, are subject to certain requirements. An intention to re-invest has to be present, and the re-investment reserve can only be written-off against new business assets if the write-off does not result in the book value of the new asset falling below that of the old business asset for which the re-investment reserve was set-up. Furthermore, for business assets that are either not depreciated, or depreciated over a period of more than ten years, a re-investment reserve can only be written-off against these assets if it was set-up as the result of a capital gain realized on the sale of business assets that perform the same economic function within the company.
Supreme Court: case law on exchange of assets applicable to non-business assets
The re-investment reserve is only applicable to business assets. For other assets such as inventory, profit recognition can, however, be postponed by means of exchange, as set out in the case law on exchange of assets. The Supreme Court confirmed this on October 22, 2010. The case in question concerned an investment company that had realized profit on the purchase and subsequent sale of a piece of real estate. Because the real estate qualified as inventory, the Appeals Court of Den Bosch refused to accept the postponement of profit recognition, despite the case law on exchange of assets. According to the Supreme Court this is not correct: the case law on exchange of assets applies to all assets, therefore also to inventory.
Definite replacement plan required
To invoke the case law on exchange of assets the following requirement must be met: at the time of the sale of the asset, there must be a definite plan for the acquisition of one asset that is directly linked to the sale of another asset, whereby both assets have an equivalent functional and economic position in the total assets of the taxpayer. However, the taxpayer had not presented the necessary facts and circumstances to either the Appeals Court or the District Court, for these courts to determine if the requirements of the case law on exchange of assets were met, and therefore could not invoke this case law to postpone recognition of profit. Previously, the Appeals Court of Amsterdam had ruled in another case that the taxpayer in question did not have a definite replacement plan.