Digest of Recent Important Foreign Decisions-Part II

On 22nd March 2013, the Netherlands Supreme Court (Hoge Raad der Nederlanden) gave its decision in X BV vs. Tax Administration (No. 11/0599; BX6710), on whether or not the Netherlands may tax a reinvestment reserve (herinvesteringsreserve) resulting from the sale of immovable property located in the Netherlands by a company whose place of effective management at that time was located in Luxembourg and thereafter in the Netherlands. Details of the case are summarised below.

(a) Facts. X BV (the Taxpayer), was established under Dutch law and in 1995 it transferred its place of effective management to Luxembourg. In 1998 and 1999, the Taxpayer sold two buildings located in the Netherlands. The profits from the sale were placed in a reinvestment reserve. In 2001, the replacement reserve was converted into an ‘agioreserve’. Thereafter, the tax inspector imposed a supplementary assessment based on the fact that the company no longer had the intention to replace the building. The Taxpayer appealed the assessment.

(b) Legal background. Article 3.54 of the Dutch Income Tax Act (ITA) provides that, in situations where the sale price of the asset exceeds the book value of that asset, the difference may be allocated to a reserve (reinvestment reserve). This reserve may only continue to exist as long as the intention to replace the disposed asset exists, subject to conditions.

(c) Decision. The Court of Appeal held that the amounts placed in the reserve were taxable in 2001, because from the tax return it followed that the replacement intention no longer existed.

In addition, the Court held that it is not incompatible with the Treaty on the Functioning of the EU (TFEU) that sale profits are taxed in a later year than that in which those were realised.

Furthermore, the Court held that as long as the replacement reserve was kept, the Taxpayer was still deriving profits from business activities in the Netherlands.

Finally, due the fact that under the Luxembourg – Netherlands Income and Capital Tax Treaty (1968) (as amended through 1990) the taxing rights with respect to immovable property are allocated to the situs state (the Netherlands), the Court decided that the Netherlands is authorised to tax the replacement reserve after the company no longer intended to replace the buildings.

2. United States; United Kingdom: Tax benefits from structured financial transaction denied for lack of economic substance

The US Tax Court has disallowed foreign tax credits (FTCs), expense deductions, and foreignsource income treatment from a structured financial transaction based on the economic substance doctrine. (Bank of New York Mellon Corporation, as Successor in Interest to The Bank of New York Company, Inc. vs. Commissioner of Internal Revenue, 140 T.C. No. 2, Docket No. 26683-09 (11 February 2013)).

The case involved a US banking company (BNY) and its affiliated group that entered into a complex series of transactions, referred to as the Structured Trust Advantaged Repackaged Securities transaction (the STARS transaction), with a financial services company headquartered in the United Kingdom (Barclays). The STARS transaction was developed by an international accounting firm.

To carry out the STARS transaction, BNY first created a structure, referred to as the STARS structure, by using BNY’s existing subsidiary (REIT Holdings), and organising and funding special purpose entities (InvestCo, DelCo, and BNY STARS Trust). Through the STARS structure, BNY shifted the BNY group’s existing assets, referred to as the STARS assets, to DelCo and the trust.

Since a UK entity became the trustee for the trust, replacing BNY, the income arising from the trust assets were subject to a 22% UK income tax. Members of the STARS structure entered into a series of stripping transactions aimed to accelerate the UK taxes due on the trust income.

In addition, BNY and Barclays entered into a series of agreements and transactions, referred to as the STARS loan, including subscription agreements, forward sale agreements, a zero-coupon swap, a credit default swap, and security arrangements. The net effect of such transactions was to create a secured loan from Barclays.

On its US consolidated return, BNY reported the income from the STARS assets as foreign-source income. BNY also claimed FTCs of approximately $200 million for the UK taxes paid on the trust income. BNY further claimed deductions for interest, fees and transactions costs related to the STARS transaction.

The US Internal Revenue Service (IRS) reclassified the income as US-source income, and disallowed the FTCs and the deductions on the basis that the STARS transaction lacked economic substance.

The US Tax Court, in applying the economic substance doctrine to the present case, followed the law of the US Court of Appeals for the Second Circuit, in which an appeal of the present case would be heard.

The US Tax Court stated that, in analysing the economic substance of a transaction, the Court of Appeals for the Second Circuit evaluates both the objective prong of the test (i.e. whether a transaction created a reasonable opportunity for economic profit exclusive of tax benefits) and the subjective prong of the test (i.e. whether a taxpayer had a legitimate non-tax business purpose) as factors to consider in an overall inquiry, rather than as discreet prongs of a “rigid two-step analysis”, i.e. a finding of a lack of either economic profits or a non-tax business purpose can be but is not necessarily sufficient for a court to conclude that a transaction is invalid.

As the first step in the inquiry, the US Tax Court bifurcated the STARS transaction and decided to focus on the STARS structure. The US Tax Court explained that the disputed FTCs were generated by circulating income through the STARS structure, and that the STARS loan was not necessary for the STARS structure to produce the FTCs. The US Tax Court held that the STARS structure lacked objective economic substance because it did not increase the profitability of the STARS assets, and, to the contrary, it reduced their profitability by adding substantial transactional costs, e.g. professional service fees and foreign taxes.

The US Tax Court found that the STARS assets would have generated the same income regardless of being transferred to the trust because the main activity of the STARS structure was to circulate income between itself and Barclays, the net result of which was effectively nothing, and because BNY continued to manage and control the STARS assets after the transfer of the assets to the STARS structure.

The US Tax Court further held that the STARS structure lacked subjective economic substance, rejecting BNY’s claim that the STARS structure was used to obtain a low-cost loan from Barclays. The US Tax Court held that BNY’s true motivation was tax avoidance based on its findings that the STARS structure did not bear any reasonable relationship to the loan in terms of banking, commercial, or business functions, and that the STARS loan was not low cost and instead was significantly overpriced and required BNY to incur substantially more transaction costs than a similar loan available in the marketplace.

Then, the US Tax Court held that, considering the above-mentioned findings, the STARS transaction would still lack economic substance even if the STARS structure and the loan were evaluated as an integrated transaction. The US Tax Court stated that any income from investing the loan proceeds was not income arising from the integrated STARS transaction, but rather from a separate and distinct transaction, and therefore any such income, and BNY’s expectation of such income, should be excluded from the economic substance analysis.

The US Tax Court determined that the STARS transaction should be disregarded for US tax purposes because it lacked economic substance. Accordingly, the US Tax Court denied the claimed FTCs for the UK taxes paid on trust income, as well as the deductions for the expenses related to the STARS transaction, including the UK taxes for which FTCs were denied.

In addition, the US Tax Court rejected BNY’s argument that the US Congress intended to provide the FTC for transactions like STARS. The US Tax Court stated that Congress enacted the FTC to alleviate double taxation arising from foreign business operations. The US Tax Court held that the UK taxes at issue did not arise from any substantive foreign activity, but instead were produced through prearranged circular flows from assets held, controlled, and managed within the United States.

The US Tax Court also rejected BNY’s position that the income from the trust is treated as foreign-source income under a “resourcing” provision in article 23(3) of the former US-UK treaty (1975). The US Tax Court held that the income should be treated as being derived by BNY within the United States, and thus the US-UK treaty was not applicable.

In the present case, the US Tax Court considered the foreign taxes paid in furtherance of the invalidated transaction as expenses in calculating the pre -tax profits of the transaction. The US Courts of Appeals for the Fifth and Eighth Circuits have held to the contrary in IES Industries Inc. vs. United States, 253 F.3d 350 (8th Cir. 2001) and Compaq Computer Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001) (see United States-1, News 14 January 2002).

The present case concerned the 2001 and 2002 taxable years, and thus predated the codification of the economic substance doctrine in 2010 as section 7701(o) of the US Internal Revenue Code (see United States-1, News 15 September 2010). As a result, section 7701(o) was not directly ap-plied by the US Tax Court, although the court did note that the legislative history to section 7701(o) supported the bifurcation approach used in the court’s analysis.

3.    Canada; Bahamas: Canadian Federal Court up-holds requirement for information in transfer pricing case

The Canadian Federal Court gave its decision on 20th March 2013 on the Applicant’s motion in the case of Soft-Moc Inc. vs. The Minister of National Revenue. The application was for judicial review of a decision of the tax authorities to issue a Foreign-Based Information Requirement (Requirement) requiring the Applicant to obtain and provide to the Canada Revenue Agency (CRA) certain foreign-based information and documents sought by the tax authorities in order to, inter alia, determine whether or not consideration paid to four corporations located in the Bahamas that are wholly owned by the 90% shareholder of the Applicant was at arm’s length.

The Applicant’s motion argued that the Requirement should be set aside on account of being unreasonable on the basis that:

(1)    it is overly broad in scope;
(2)    it requires the production of information and documents that are not relevant to the administration and enforcement of the Income Tax Act; and
(3)    it requests certain information that cannot be obtained or provided by the Applicant because such information is confidential and proprietary, non-existent, or otherwise unavailable. In the alternative, the Applicant sought to revise the Requirement to delete certain questions.

The Federal Court of Canada dismissed the motion. It found, inter alia, that:

(1) the information was not overly broad. It accepted the evidence of the tax authorities that the information was necessary to conduct the transfer pricing audit. In particular, it was necessary to determine whether certain services were performed in the Bahamas or Canada and, if in the Bahamas, how the services were provided, and to determine the appropriate transfer pricing methodology to be applied so that the Minister could ascertain whether the transfer price paid was an arm’s-length transfer price;

(2)    the information is relevant. S/s. 231.6 of the Income Tax Act makes it clear that “foreign-based information or document” means any information or document that is available, or located outside of Canada and that “may be relevant” to the administration or enforcement of the Act, including the collection of any amount payable under the act by any person. The case law provides that the threshold for the tax authorities to overcome is fairly low and their powers broad. Further, there is no evidence that the Requirement captured irrelevant business dealings of the four companies in the Bahamas; and

(3)    there was no evidence the information was confidential, proprietary or sensitive. The Court, in particular, rejected the Applicant’s argument that the information could not be disclosed because the four companies in the Bahamas were refusing to provide the information. Since the majority shareholder of the Applicant owned the other four companies this was tantamount to the shareholder of the Applicant refusing to provide the information. Further, there was no evidence that providing the information would require extensive effort or destroy its value.

4.    Belgium; United States: 1970 Treaty between Belgium and US – Belgian Supreme Court decides that reduction of tax credit for foreign interest by multiplication with a debt financing coefficient is compatible with treaty

On 15th March 2013, the Belgian Supreme Court (Cour de Cassation/Hof van Cassatie) decided two cases (recently published) on the avoidance of double taxation on interest under the former Belgium-United States Income Tax Treaty (1970) (as amended through 1987). Details of the case are summarised below.

(a)    Facts. Belgian companies received interest from US companies under the 1970 treaty with the United States. The receiving Belgian companies had debts. Therefore, the amount of the fixed credit for the withholding tax on interest was reduced as it was multiplied with a debt financing coefficient

(see below).

(b)    Legal background.

Domestic law

For foreign interest a fixed tax credit corresponding to the actual amount of the foreign tax paid is granted, with a maximum of 15%.

The amount of the credit calculated must be multiplied by a debt financing coefficient, i.e. a coefficient which takes into account the amount of interest charges incurred by the company in proportion to the total income received.

Therefore, the credit must be multiplied by the following fraction (article 287 of the ITC):

– the numerator is the total income (including the gross business income) less capital gains minus the difference between the income from movable property and capital less distributed dividends; and
– the denominator of the fraction is equal to the total income (including the gross business income) less capital gains.

An example to clarify:
Assume that (in EUR):
–  total income: 5,000;
–  capital gains: 500;
– financial charges relating to foreign-source interest: 250;
–  foreign-source interest: 500; and
–  foreign tax at source (10%): 50.

The foreign tax credit is calculated as follows:

–    first step: actual foreign tax credit

(foreign-source interest minus foreign tax at source x foreign withholding tax rate at source with a fixed maximum of 15%)/(100 minus foreign withholding tax rate with a maximum of 15%)

The amount under the first step is, therefore:

(500 – 50) x 10/(100 – 10) = 50.
–    second step: debt financing coefficient

(total income minus capital gains) minus financial charges relating to foreign -source interest/(total income minus capital gains)

The debt financing coefficient under the second step is, therefore:

((5,000 – 500) – 250)/(5,000 – 500) = 4,250/4,500 = 0.944.

The foreign tax credit would then be 50 x 0.944 = 47.2.

Situation under tax treaties

Most Belgian tax treaties provide for a credit in accordance with the rules under Belgian domestic law. Some treaties, like the former 1970 treaty with the United States, provide that later changes to the domestic method on the avoidance of double taxation are only taken into account to the extent that those do not amend the principles of the tax credit.

(c)    Issue. The issue was whether the restriction of the fixed foreign tax credit by the multiplication with a debt financing coefficient is compatible with the treaty.

(d)    Decision. The Court rejected the companies’ argument that the debt financing coefficient is incompatible with the principles behind the fixed foreign tax credit. The companies based this argument on the fact that, due to multiplication with such coefficient, the credit varies per taxpayer and per assessment year. Furthermore, the Court rejected the argument that the debt financing coef-ficient should not take all debts of the company into account but only the debt financing of the interest-bearing debt claim.

The Court followed the argument of the government that the introduced debt coefficient system constitutes an amendment of the credit calculation, which does not deprive the credit from its fixed character because it is determined by a fixed formula and set parameters.

Consequently, the Court held that the restriction of the fixed foreign tax credit by means of a debt financing coefficient is compatible with the former tax treaty with the United States.

5.    Finland; United States: Finnish Supreme Administrative Court rules on tax liability of beneficiary in a US discretionary trust – details

The Supreme Administrative Court of Finland (Korkein hallinto-oikeus, KHO) gave its decision on 27 March 2013 in the case of KHO:2013:51. Details of the decision are summarised below.

(a)    Facts. Taxpayer A (A), who resided in Finland, was a beneficiary in a trust which was originally set up in the United States by his grandmother (the Settlor). After the Settlor died, the trust was sub-divided per capita among six beneficiaries including A’s father (i.e. 1/6). After A’s father died, the sub-trust was further sub-divided per stirpes (i.e. 1/6 x 1/3) among three beneficiaries including A. Under the trust rules, the trustee, who was a US bank, was entitled to decide on whether, when and how much to distribute funds from the trust to the beneficiaries (i.e. discretionary trust).

A applied for an advance ruling from the tax administration on various aspects of the tax treatment of the income he would receive from the trust. The tax authorities took the view that setting up a trust meant transferring assets inter vivos without consideration to the beneficiaries and hence would be regarded as a gift for tax purposes. They, however, refused to give any advance ruling in the case due to the fact that the gift had already been received at the moment the trustee had received information on the death of A’s father in 1988.

(b)    Legal background. Finnish law does not entail the concept of trust but the tax authorities have issued guidance on the tax treatment of trusts. Under the Inheritance and Gift Tax Law (the Law), the liability to pay gift tax is when the donee receives the gift.

(c)    Issue. The issue is when a beneficiary in a discretionary trust receives the trust assets and consequently becomes liable to gift tax.

(d)    Decision. The Court ruled that the tax liability of a beneficiary in a discretionary trust begins only after the beneficiary acquires the ownership to the trust funds and has the assets at his disposal. The Court emphasised that under the trust deed the trustee had the sole discretion over which assets, if any, would be distributed to the beneficiaries. The beneficiaries were not the legal owners of the trust assets and did not have any powers to decide on the distribution of the assets. As A’s father was not under US law regarded as the legal owner of the trust assets, he could neither have donated the trust assets nor those assets would belong to his estate after his death. Hence, A had not received a gift within the meaning of the Law and the tax authorities did not have a right to refuse to give an advance ruling. The case was referred back to the tax administration.

6.    United States; Switzerland: Treaty between US and Switzerland – image right payments are exempt from US tax as royalties

The US Tax Court held that the compensation paid to a Swiss resident for use of his image rights in the United States is royalty income that is not taxable in the United States under the US-Switzerland treaty (Sergio Garcia vs. Commissioner of Internal Revenue, 140 T.C. No. 6, Docket No. 13649-10 (14 March 2013)). The US Tax Court also determined the proper allocation of income received under the endorsement contract between the image rights and the personal services that were required to be performed.

The petitioner in the present case was a world-renowned professional golfer, who was a Span-ish citizen but was a resident of Switzerland for the purpose of the 1996 US-Switzerland treaty (the Treaty). The petitioner entered into an endorsement agreement with a US company, TaylorMade Golf Co. (TaylorMade) to allow TaylorMade to use the petitioner’s image rights (i.e. his image, likeness, signature, voice, etc.) in promoting TaylorMade’s golf products worldwide.

The petitioner also agreed to perform personal services, including using TaylorMade’s certain products both on and off the golf course, playing in golf events, testing TaylorMade’s products, and making personal appearances. The relevant endorsement agreement included a provision assigning 85% of the endorsement fees to the use of the petitioner’s image rights and 15% of the fees to his personal services.

The petitioner then sold his image rights licensed by TaylorMade for use in the United States to a Swiss company, which in return assigned the US image rights to a US company. Both companies were established, and more than 99% owned, by the petitioner.

The petitioner filed his IRS Forms 1040-NR (US Nonresident Alien Income Tax Return) and reported a portion of the personal service payments as his US source income effectively connected with a US trade or business. However, he did not report any of the image right pay-ments. The US Internal Revenue Service (IRS) issued the petitioner a notice of deficiency.

The US Tax Court first discussed (part II of the opinion) the question of allocating the endorsement fees between payments for image rights and payments for personal services, and determined that 65% of the remuneration should be allocated to the use of the image rights and 35% of the remuneration should be allocated to the personal service. The US Tax Court analysed and compared other endorsement contracts by professional athletes, and stated that the allocation was made in the present case considering all the facts and circumstances.

The US Tax Court then held (part III of the opinion) that the petitioner’s image rights are a separate intangible that generated royalties, as defined by article 12(2) of the Treaty. Article 12(1) of the Treaty grants a right to tax royalties exclusively to a state of the beneficial owner’s residence. Therefore, the US Tax Court concluded that the compensation for use of the petitioner’s US image rights was not taxable to the petitioner in the United States, even if the compensation were income to the petitioner, rather than to the Swiss company owned by him.

In reaching this conclusion, the US Tax Court rejected the IRS’s argument that the petitioner’s image right payments are governed by article 17 of the Treaty (Artistes and Sportsmen), which allows income derived by entertainers or sportsmen to be taxed in the contracting state in which they perform their personal activities.

The US Tax Court relied on the US Technical Explanation to article 17, which assigns income to article 17 or to another article of the Treaty, in this case article 12, based on whether the income is “predominantly attributable” to the services or to other activities or property rights. The US Tax Court determined that the income from the image rights was not predominantly attributable to the petitioner’s performance as a professional golfer in the United States and therefore properly dealt with under article 12.

The US Tax Court noted that, because the parties agreed that the remuneration for the use of the petitioner’s image rights outside the United States is not taxable in the United States, this issue did not need to be discussed.

The US Tax Court further held that the petitioner was liable for US tax on all of his US source personal service income. The US Tax Court declined to consider the petitioner’s claim that his income for personal services, other than wearing TaylorMade products while golfing, might not be taxable in the United States under the Treaty. The US Tax Court explained that, because the petitioner raised this issue for the first time in his post-trial opening brief, it was prejudicial to the IRS and thus was too late.

Accordingly, the US Tax Court determined that none of the petitioner’s royalty income is taxable to the petitioner in the United States, but that all of his US source personal service compensation is taxable to the petitioner in the United States.

7.    United States: US Court of Appeals disallows favourable dividend treatment for Subpart F income

The US Tax Court of Appeals for the Fifth Cir-cuit has held that taxpayers’ Subpart F income attributable to earnings of a controlled foreign corporation (CFC) invested in US property should be taxed as ordinary income, rather than as qualified dividend income eligible for reduced rates of taxation (Osvaldo Rodriguez and Ana M. Rodriguez vs. Commissioner of Internal Revenue, No. 12-60533, 5 July 2013)

The taxpayers were Mexican citizens and permanent residents of the United States (i.e. green card holders) who owned all of the stock of a CFC incorporated in Mexico.

The taxpayers included earnings of the CFC that were invested in US property as part of their US gross income as required by IRC sections 951 and 956. IRC sections 951 and 956 are provisions of IRC Subpart F, which are intended to prevent CFC shareholders from deferring US tax obligations by keeping the CFC’s earnings abroad instead of repatriating such earnings through the payment of dividends. In particular, IRC section 956 treats earnings of a CFC that are invested in US property as if they had been repatriated to the United States, and therefore subjects US shareholders of the CFC to current taxation on such earnings.

The taxpayers took the position that the amounts included in income under IRC sections 951 and 956 (“section 951 inclusions”) constituted “qualified dividend income” under IRC section 1(h)(11) and thus were entitled to a lower tax rate (i.e. 15% for the taxpayers) than a tax rate applicable to ordinary income (i.e. 35% for the taxpayers).

The Internal Revenue Service (IRS) issued a notice of deficiency to the taxpayers, based on its determination that section 951 inclusions should be taxed as ordinary income. After the US Tax Court ruled in favour of the IRS (see United States-1, News 14 December 2011), the taxpayers filed this appeal.

IRC section 1(h)(11)(B)(i)(II) defines qualified dividend income as including dividends received from qualified foreign corporations. IRC section 316(a) defines a dividend as any distribution of property made by a corporation to its share-holders, thus implying a change in the manner in which the property is owned, i.e. a change from ownership by the corporation to owner-ship by the shareholders.

The US Court of Appeals held that section 951 inclusions do not qualify as actual dividends because section 951 inclusions do not involve any transfer of ownership or any distribution to shareholders, and instead are calculated purely on the basis of CFC-owned US property and the CFC’s earnings, with the ownership of the property remaining in the hands of the corporation.

The taxpayers argued that they could have caused the CFC to make an actual dividend payment of the earnings, in which case the dividend would have unquestionably been treated as qualified dividend income eligible for the lower tax rate, a point that the IRS conceded. The US Court of Appeals rejected the taxpayers’ argument, however, on the basis that the taxpayers had effectively chosen to proceed as they did.

The US Court of Appeals further held that section 951 inclusions do not qualify as deemed dividends because, when Congress decides to treat certain inclusions as dividends, it explicitly states so, but Congress has not so designated the inclusions at issue in the present case.

Accordingly, the US Court of Appeals affirmed the judgment of the US Tax Court that the taxpayer’s section 951 inclusions did not constitute qualified dividend income subject to a lower tax rate.

8.    Finland; Estonia: Finland’s Supreme Administrative Court rules on using location savings in TP cases

The Supreme Administrative Court of Finland (Korkein hallinto-oikeus, KHO) gave its decision on 4th March 2013 in the case of KHO:2013:36. Details of the decision are summarised below.

(a)    Facts. A Oyj, a company resident in Finland, had a fully owned subsidiary in Estonia, B AS, which operated as a contract manufacturer for A Oyj. The remuneration A Oyj paid to B AS was determined by using the Transactional Net Margin Method and included a cost-plus margin of 7.95% as established in a transfer pricing (TP) analysis. The cost-plus margin took into consideration all the costs of the manufacturing activities corrected by the location savings (i.e. savings obtained by locating activities to Estonia where the price level was lower than in Finland). In an ordinary assessment of A Oyj for the tax years 2004 and 2005, the tax authorities approved deductions only for the actual expenses of B AS added with a 7.95% cost-plus margin. A Oyj appealed and required that the location savings should also be taken into account when setting the correct price.

(b)    Issue. The issue was whether or not the location savings should be taken into account when setting the appropriate price between the Finnish A Oyj and its Estonian subsidiary.

(c)    Decision. A Oyj’s appeal was partly rejected. The Court emphasised that the location savings could not be considered in the pricing of the goods because the activities by B AS were not comparable to the activities previously performed by A Oyj. A Oyj’s activities had mainly been handcrafts made at home using simple tools, whereas the manufacturing in Estonia was suited for industrial production. Consequently, the location savings principle could not be applied as suggested by A Oyj. The Court, nevertheless, increased slightly the amount of acceptable deductions by A Oyj as it found the cost-margin of 7.95% low.

Furthermore, the Court made a reference to the law proposal text where it was stated that the OECD Transfer Pricing Guidelines have the status of an international standard in the field of TP and can thus be regarded as an important source when interpreting the arm’s length principle. The Court emphasised that although chapter 9 on TP issues in business restructurings was added to the OECD guidelines in 2010, it could still be used when interpreting a case regarding tax years 2004 and 2005 because it did not include fundamentally new interpretative recommendations for chapter 1, which was already in force in 2004.

9.    The Netherlands: Supreme Court: alienation costs for the sale of a substantial shareholding are not deductible

On 13th January 2013, the Netherlands Supreme Court (Hoge Raad der Nederlanden) gave its decision in X BV. vs. Staatssecretaris van Financiën (No. 12/01616, LJN:BY0612), which was recently published. The case concerned the deductibility of alienation expenses for the sale of a substantial shareholding. Details of the decision are summarised below.

(a)    Facts. X BV (the Taxpayer), formed a fiscal unity with a 100%-owned subsidiary. On 21st November 2008, all shares of the subsidiary were sold and the fiscal unity was dissolved. The Taxpayer made costs for the sale of the subsidiary. Those costs were incurred after the signing of the letter of intent to sell the shares, but for the date of transfer of the shares by notarial deed.

The Taxpayer deducted those costs from its 2008 taxable profits. The tax inspector rejected the deduction of the costs due the application of the participation exemption of article 13(1) of the Corporate Income Tax Act (CITA).

(b)    Legal background. Article 13(1) CITA provides that costs from the acquisition and alienation of a participation in a resident or non-resident company are not deductible if the participation exemption applies. The participation exemption provides, under conditions, for an exemption of income and capital gains derived by corporate taxpayers from qualifying participations of at least 5% in the capital of the domestic or foreign subsidiary.

Under the fiscal unity regime of article 15 of the CITA, a parent company and its subsidiary are treated as one taxpayer for corporate income-tax purposes if the parent company owns a participation of at least 95% in the subsidiary. The main consequences include:

– the corporate income tax return is filed on a consolidated basis;

– losses of one company are set off against profits of another company of the fiscal unity; and

– assets, liabilities and dividend distributions can be transferred between companies of the fiscal unity without tax consequences.

The fiscal unity is (partially) dissolved after the sale of shares of a subsidiary. Article 14 of the Fiscal Unity Decree (the Decree), provides that the sale is deemed to take place after the dissolution of the fiscal unity. This means that the companies concerned are again treated as separate entities, as a result of which the participation exemption applies to the case at hand because the conditions were met.

(c)    Decision. The Court confirmed the decision of District Court Breda that the costs are not deductible. The Court held decisive that costs made for the sale of participation are not deductible under the participation exemption. Due to the fact that, based on article 14 of the Decree, the sale is deemed to take place after the termination of the fiscal unity, the participation exemption applied in the case at hand.

Therefore, the Court held that the alienation costs were not deductible. The Court held irrelevant that costs were already made when the fiscal unity still existed because of the direct link between the costs and the sale.

In addition, the Court considered that the legislator could not have intended that those costs are deductible.

In this context, the Court confirmed the decision of the District Court that alienation costs related to participation must be treated the same as acquisition costs. Therefore, the Court decided that, based on earlier case law, the Taxpayer’s view cannot be upheld because it would mean that costs from the alienation of the subsidiary which was part of a fiscal unity would be differently treated than costs made for the acquisition of the subsidiary, which afterwards is included in a fiscal unity.

Note. The outcome of the decision seems logical because otherwise a mismatch would arise. This is because the costs would then be deductible while the sale proceeds are exempt under the participation exemption.

[Acknowledgement/Source: We have compiled the above summary of decisions from the Tax News Service of IBFD for the period 18-03-2013 to 16-07-2013.]