On November 25, 2011, the Supreme Court rendered a number of important judgments on what has become known as the non-business motivated loans issue. The judgments follow on from a Supreme Court judgment rendered in 2008. In that year, the Supreme Court ruled on a case in which a subsidiary granted a loan to the parent company, but for which no repayment schedule, security, etc. had been agreed. The subsidiary eventually suffered a loss on the loan, which raised the question whether the subsidiary could deduct the write-down from its taxable profit. The Supreme Court concluded that this was not possible, as the loan conditions were not business motivated.
The practical effect of the judgment was that it raised a large number of questions, at a time when the financial crisis meant that losses were increasingly being suffered on group receivables. Had the Supreme Court’s judgment added a new test to the current tests used for determining when, for tax purposes, a loan must be regarded as capital, by introducing the non-business motivated loan? Under what circumstances is a loan a non-business motivated loan? If a loan is not business motivated, does this have consequences for the interest for tax purposes on the loan? Can a non-business motivated loan be changed to a business motivated loan, and vice versa? If a parent company grants a loan to a subsidiary, can this also be regarded as a non-business motivated loan? If an individual holding a substantial interest grants a loan to their company, can this also involve a non-business motivated loan? Is the total amount of the loan non-business motivated, or can part of the loan be regarded as business motivated? When should a loan be evaluated as to whether it is business motivated or non-business motivated? If the subsidiary is liquidated, can the initial non-deductible write-down still be taken into account?
On November 25, 2011, the Supreme Court answered almost all these questions. The judgments also show how to ensure that a loan is, and remains, business motivated.
The Supreme Court’s answers
No new criterion for differentiating equity and debt
The Supreme Court maintained the current framework for determining whether equity or debt is involved for tax purposes. In principle, it is the civil-law arrangement agreed on by parties that is decisive. However, there are three exceptions to this general rule:
1. a loan exists only in form, while in practice parties intend to arrange a capital contribution;
2. the loan is granted under conditions which, to a certain extent, give the creditor, by way of the money lent, a participation in the debtor’s business, i.e. the participating loan;
3. the loan is granted under conditions whereby the receivable arising from the loan has no value, or only limited value − something which should have been obvious to the creditor from the outset − because the debtor cannot pay back the loan in full or in part, i.e. a loan with no expectation of payment.
According to the Supreme Court, it is not legally acceptable to regard something which clearly takes the form of a loan and to which none of the abovementioned exceptions apply, as an equity contribution for the purposes of calculating the taxable profit.
When is a loan non-business motivated?
A loan can be either business motivated or non-business motivated. To determine this, the Supreme Court applies the ‘arm’s length criterion’, focusing, in particular, on the interest paid on the loan. The question that needs to be answered is what would have been the fixed interest rate that a non-affiliated party would have asked for the loan, given the other loan components, such as size, security, and the term of the loan. This interest is used for the calculation of the creditor’s and debtor’s taxable profit. If the interest rate agreed on by the parties is not at arm’s length, but can be changed to a fixed interest rate that a non-affiliated party would have asked for a loan with similar conditions, then the loan is business motivated. In that case, only the interest would have to be adjusted for tax purposes. Any loss suffered on the receivable can be taken into account in the profit calculation for tax purposes.
The situation changes if no fixed interest rate can be determined under which an independent third party would have been prepared to grant a similar loan; in this case the loan is non-business motivated. Any loss suffered on the receivable cannot be taken into account in the profit calculation for tax purposes, unless exceptional circumstances apply. The Supreme Court did not elaborate on the latter. How should the interest rate for the non-business motivated loan then be determined? According to the Supreme Court, the rule of thumb that can be applied for the sake of simplicity is that the interest rate on a non-business motivated loan should be determined at the interest rate that an affiliated company would have to pay for a third party loan granted under similar conditions and with the parent company acting as guarantor. While the interest rate is then at arm’s length, a loss suffered on the receivable remains non-deductible. The result is the same as where there is a non-business motivated guarantee. The judgments do not deal with the conditions under which a guarantee would be business motivated and whether a loan agreement between non-independent parties could involve a business motivated guarantee. We consider that, at least in theory, a guarantee is business motivated if a third party would, under similar conditions, have been prepared to act as guarantor. This is in actual fact the same test used to determine whether a third party would have been prepared to grant a loan.
Creditors/debtors
For the tax treatment of non-business motivated loans, it is irrelevant whether a subsidiary grants a loan to its shareholder or if the shareholder grants a loan to the subsidiary.
A non-business motivated loan does not only arise in corporate income tax situations, but can also be present in those situations where a substantial interest shareholder grants a loan to their company. In that case, the loan is treated the same way as described above.
The total principal amount and the accrued interest of a non-business motivated loan are tainted
The total amount of the principal falls under a non-business motivated loan, i.e. the loan is not split into business motivated and non-business motivated parts. While the interest accrued on the loan is tainted by non-business motivations, this does not apply to the interest paid on the loan. In addition, the interest receivable cannot be written down against the taxable profit.
When should evaluation take place?
According to the Supreme Court, whether or not a loan is non-business motivated must be evaluated at the time the loan was taken out. However, this does not mean that a loan regarded as business motivated at the time it was taken out cannot have that qualification changed. The Supreme Court concluded that non-business motivated actions of the creditor can result in a business motivated loan becoming non-business motivated. The circumstances under which this would occur are not further explained. Presumably this could refer to situations such as the creditor omitting to take measures when, for example, the debtor’s financial position worsens.
Adjusted acquisition price, acquisition price, and waiver
The non-deductible write-down that the parent company suffers on a non-business motivated loan granted to a participation increases the adjusted acquisition price (opgeofferd bedrag) of that participation (for a loan granted to a subsidiary by a shareholder). This means that the write-down can still be deducted from the taxable profit if the subsidiary is liquidated and if the applicable conditions for deducting the liquidation loss are met.
If the creditor is an individual with a substantial interest in the debtor, the acquisition price of the substantial interest is increased by the write-down.
According to the Supreme Court, any waiver of a non-business receivable results in an informal capital contribution in the debtor. In principle, this will not affect the losses the debtor has available for set-off.