On May 21, 2021 on the website of the Dutch Courts (De Rechtspraak) an opinion of Advocate General Wattel in the Case: 21/00564, Stichting [X] versus de inspecteur van de Belastingdienst/kantoor [P] (the tax inspector/tax office [P]) (ECLI:NL:PHR:2021:440), was published. The opinion concerns questions referred to the Dutch Supreme Court for a preliminary ruling by the District Court of Noord-Nederland.
Before discussing the tax consequences of the restructuring it might be good to get some understanding regarding the position of the taxpayer in the underlying case and why it came in the position it is.
The Vestia Affair
At the end of January 2012 it came to light that Vestia in Rotterdam was in danger of collapsing under the commitments it entered into via its enormous derivatives portfolio. At the time Vestia was the largest Dutch social housing corporation. The potential collapse of Vestia also posed major financial risks for all other Dutch social housing corporations, which were in danger of being dragged down with Vestia in case Vestia would go bankrupt.
The intervention of the Ministry of the Interior, the Central Housing Fund and the Social Housing Guarantee Fund, together with the cooperation of the Bank Nederlandse Gemeenten, the Dutch Waterschapsbank and five large fellow housing corporations, prevented a total collapse of the Dutch social housing corporation system, which exists by virtue of the compulsory mutual guarantee and solidarity of housing corporations.
As a consequence of the Vestia Affair the supervision of Dutch social housing corporations was tightened and rules (a.o. rules regarding the valuation of derivatives) were amended. Were before the Vestia Affair a social housing corporation was allowed to value its derivative portfolio at historical cost in its financial statements, after the Vestia Affair such derivative portfolios have to be valued at fair market value.
The facts of the underlying case
The taxpayer in the underlying case is a social housing corporation. Its appeal concerns the treatment for Dutch corporate income tax purposes of a lump sum redemption payment that the corporation has paid in order to get rid of long-term interest rate swaps (IRSs) with a unfavorable effect.
The corporation had entered into the IRSs in order to manage the interest rate risk it incurred on its loans payable over which a floating interest rate was due (hereafter: floating-rated loans). As a result of the (very) low market interest rate the collateral obligations arising from those IRSs placed such a burden on the corporation’s liquidities that it was in danger of no longer passing a mandatory stress test. Not passing the mandatory stress test would mean that he corporation would lose its status as an institution operating in the interest of social housing under the Dutch Housing Act. Therefore the corporation was forced to redeem the unfavorable IRSs. Simultaneously the floating-rated loans were replaced by fixed-rated loans with the same principal amounts and the same maturity dates as the initial floating-rated loans.
The taxpayer and the tax inspector disagree on whether the lump sum redemption payment amounting to approximately € 20 million is fully deductible in the year of redemption (2014) or whether it should be capitalized and amortized over the period for which the (new) fixed-rated loans have been entered into.
The Inspector is of the opinion that the results of the redemption of the IRSs should be viewed in conjunction with the concomitant replacement of the floating-rated loans by fixed-rate loans. In the Inspector’s view, the redemption payment takes the place of the interest that would otherwise have to be paid in the future. In the Inspector’s view the redemption payment is therefore to be regarded as interest paid in advance. The tax inspector also invokes the Dutch Supreme Court’s currency hedge, option hedge, cocoa bean and market maker rulings. All those cases regard the question whether certain assets and liabilities should be valued coherently or as separate assets and liabilities. According to the Dutch Advocate General however, those judgments on coherent valuation do not directly refer to a case as the underlying in which one or all parts of a hedge are terminated. The simple reason therefore is that something that is no longer there can no longer be valued coherently. According to the Advocate General in that case in principle the main rule of separate valuation of assets and liabilities applies. However, in that case still the question arises whether the matching principle of good business practice means that the lump sum redemption payment must be allocated to future years?
The taxpayer on the other hand is of the opinion that the principles of good business practice allows a taxpayer to fully deduct the lump sum redemption payment in the year the payment was made because in his view the burden is borne in one go and the floating-rated loans have not been continued. For the taxpayer it is therefore clear that there can be no intention of continuation, as which existed for example in the currency hedge judgment. After all, the loans to which the terminated IRSs related have also been terminated.
Questions raised by the District Court of Noord-Nederland and the conclusion of the AG
In an interim-judgment of February 9, 2021 the District Court of Noord-Nederland asked the Dutch Supreme Court to answer the following 4 questions.
Does a generally applicable legal rule ensue from the principles of good business practice, which means that the taxpayer which terminates a multi-year financing contract before its maturity date and in connection therewith concludes a new multi-year financing contract has to always capitalize and amortize the costs that (directly or indirectly) relate to the premature ending of the initial financing contract.
In his conclusion the Advocate General recommends the Supreme Court not to answer this question. The Advocate General states that the question raised is of a too general nature. He adds that to his opinion the consequences of an abstract answer, apart from currently unforeseeable future cases, cannot be foreseen.
Questions 2 and for 4
Since in his conclusion the Advocate General gives a combined answer to the questions 2 and 4 we included these questions in one paragraph.
Do the principles of good business practice oblige a taxpayer, whether or not because of the existence of a legal rule as referred to above under question 1, to capitalize and amortize a lump sum payment made with respect to the redemption of an IRS that is related - as meant in the judgment of the Dutch Supreme Court of November 8, 2019 (ECLI:NL:HR:2019:1721) - with a floating-rated loan, if in connection with the redemption of the IRS the underlying floating-rated loan is refinanced by means of a new fixed-rated loan
In case question(s) 1 and/or 2 is/are answered in a positive manner:
a is the full amount of the redemption payment to be capitalized and amortized? If not, which part of the redemption payment is to be capitalized and how is that part be determined?
b is (the part of) the redemption payment that is to be capitalized to be amortized over the (remaining) term of:
- the redeemed IRS; or
- the old floating-rated loan; or
- thenew fixed-rated loan?
The Advocate General answers the questions 2 and 4 as follows:
(i) an IRS/floating-rated loan combination is actually acting as a fixed-rated loan as defined in HR BNB 2020/13 (IRS-arrest),
(ii) that combination is replaced by a fixed-rated loan, and
(iii) the resulting IRS redemption plus refinancing actually equates to a transfer of a (de facto) fixed-rated loan to a new loan with a fixed, but lower, interest rate and with the same principal amount and a comparable (remaining) term as the settled combination had,
the principles of good business practice obliges to capitalize that part of the (lump sum) IRS redemption payment that is to be allocated to difference in interest and to amortize that amount over:
(i) the period in which the IRS/floating-rated loan combination would have continued to exist if no redemption/refinancing would have taken place: or
(ii) if that is (a little) shorter, over the period until the (slightly) earlier maturity date of the replacing fixed-interest loan.
The remaining part of the redemption payment must be allocated to the termination of liquidity risks caused by possible margin calls and/or breaks and this part can be immediately and fully be taken into account in the taxable year in which the redemption takes place,.
In his conclusion the Advocate General adds, that in his opinion the answer to question 4a (the last six words of the second sentence (how is that part be determined?')) has to be that if from the calculation of the redemption payment it is not clear which part of that payment is to be considered to constitute penalty interest to be capitalized, that part has to be determined/calculated in the same manner as in which penalty interest is usually calculated when comparable fixed-rated loans are being transferred.
Is any of the following important for the answering of question(s) 1 and/or 2 mentioned above:
a. The motive for redeeming the IRS? If so, in what sense? Is a distinction to be made between the situation in which the motive lies solely or partly in government regulations that require the redemption, and the situation in which the motive lies solely in the taxpayer’s own considerations, which for example could be:
- of a financial nature;
- of a business economical nature;
- risk management.
b. whether the new fixed-rated loan is entered into with a different bank than the bank that provided the original floating-rated loan and/or the bank with which the IRS agreement was concluded?
c. whether the new situation (fixed-rated loan):
- in comparison to serving out the old, floating-rated loan in combination with the IRS produces a financial advantage or disadvantage for the taxpayer, only for as far as it regards the interest costs; or
- ultimately has a financial advantage or disadvantage?
With respect to these questions the Advocate General concludes that in his opinion, the answer to question 3 should be:
(a) that the motive for redemption is only relevant insofar as it affects the question, to be assessed by taking into account all relevant facts and circumstances, which part of the lump sum redemption payment should be attributed to the difference in interest ('penalty interest') and what part should be attributed to the termination of the liquidity risk of the IRS;
(b) that it is irrelevant with which bank the replacing fixed-rated loan is entered into; and
(c) that the lump sum payment must be split as specified in the answer to the questions 2 and 4 above.
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