Supreme Court NL: loss offset limit includes latent losses

The Supreme Court ruling clarifies that article 20a Dutch CITA applies not only to realised losses but also to losses that are latently present at the time of a relevant change of ownership and are only realised thereafter. This must be taken into account in the event of an ultimate change of ownership, such as a sale to third parties. For example, it can influence a tax due diligence investigation and the determination of the purchase price, as well as the determination and substantiation of positions in the corporate income tax return in the years following the change of ownership. This is particularly relevant for real estate companies where the tax book value of properties exceeds the fair market value, and where the tax claim on the loss may evaporate upon a change of the ultimate ownership of 30% or more. Additionally, it could also play a role in such a change of ownership involving an entity with a latent loss on IP rather than real estate.

Consequently, the tax position of the entity to be transferred is particularly relevant in the case of changes of ownership. In practice, this is addressed first during the due diligence investigation. The issue is no longer solely whether deductible losses are listed on the loss determination decision, but also whether the assets contain a deferred loss at the time of the change in ownership. Additionally, the question arises as to how the deferred loss should be calculated and whether assets containing a deferred loss may be offset against assets containing deferred gains. Any adjustment to the valuation of the loss has a direct impact on the transaction. For instance, a deferred loss likely no longer has a price-increasing effect, because the Dutch tax authorities will not accept the deduction at a later stage. Moreover, the ruling may also be relevant in cases involving deferred gains. The Supreme Court has not established rules for determining the amount of a deferred loss and has not addressed the allocation of the burden of proof. With substantiated documentation at the time of the change in ownership, you are more secure when the loss is realised. Anyone who holds assets or liabilities on the books whose market value and tax book value do not correspond would therefore be well advised to substantiate and document the difference in value for each item prior to a proposed change of ownership.

Article 20a Dutch CITA

Article 20a of the Corporate Income Tax Act combats the trading of loss-making entities. If the ultimate interest in the taxpayer has changed substantially (30% or more) compared to the beginning of the oldest year in which a loss has not yet been fully offset, losses incurred prior to that moment of change are no longer deductible fof future profits. This change in interest may also occur gradually, as the change must be compared with the beginning of the oldest year in which a loss has not yet been fully offset. Exceptions to the general rule exist, but these played no role in this judgement.

Case

The taxpayer owned thirteen leased office buildings and a warehouse, spread across the Netherlands. Following the bankruptcy of its shareholder in 2012, it was managed by a bank under the supervision of the bankruptcy trustee. Due to the unfavourable real estate market, the bank decided to retain the real estate and continue operating it until a suitable buyer was found. On 23 December 2015, the shares were transferred to third parties. A transaction price was agreed for the real estate that was well below the tax book value on that date. When three of the office buildings were transferred to participating interests at the end of 2017, a tax loss of approximately €4.3 million was realised.

Dispute

The core of the matter was whether Article 20a of the Corporate Income Tax Act also applies to latent losses present at the time of the change of ownership that are only realised after that change. Does the provision apply exclusively to losses that have already been incurred for tax purposes and determined by decision, or also to losses that are still hidden in the assets?

The Supreme Court provides no rules for practical application and leaves the allocation of the burden of pleading and proof undiscussed, whereas the Advocate General had explicitly intended to place this burden with the tax inspector. As a result, a series of questions remain open that parties will face immediately following an acquisition or other relevant change of interest:  

• Valuation: it is unclear whether deferred losses must be determined per asset or per cluster of assets, and whether assets with a deferred loss may be offset against assets containing deferred gains. Consequently, it is unclear whether article 20a CITA can restrict loss set-off if deferred gains exceed deferred losses.

• Passage of time: if the value fluctuates between the change of interest and realisation—for example, first rising above book value and then falling again—determining the loss falling under article 20a requires intensive monitoring of the valuation trend.

• Concurrence with the revaluation rule: it is possible to revalue assets to fair market value shortly before a change of interest in order to utilize losses. The question of whether that revaluation may be offset against latent losses remains open.

• Depreciation: it is unclear whether depreciation on assets with a deferred loss is also subject to limitations on deduction.

• Fiscal unity: if multiple companies are acquired and form a fiscal unity for corporate income tax purposes, it must be assessed per entity whether (deferred) losses are lost pursuant to article 20a CITA. It is unclear whether any offsetting of deferred profits and losses is permitted at the fiscal unity level.

• Impact on the other tests of article 20a

• the investment test (no set-off when the taxpayer's assets consisted of more than 50% investments for at least 9 months of the profit and/or loss year),

• the activity test (immediately prior to the change in ownership, the activities from the loss year may not have been reduced by more than 70%), and the intent test (at the time of the change, there may not be an intention to reduce the activities by more than 70% within three years).

These tests are applied at the entity level, and for those tests, the year in which the losses were incurred is relevant, which is not automatically established in the case of latent losses.

Furthermore, it is unclear whether this ruling implies that, even without a change of ownership, a latent pre-consolidation loss of an entity after it has been included in a fiscal unity for corporate income tax purposes, cannot be offset against the profits of the other companies in that tax group.

Given the many questions and uncertainties, we expect new legislation and/or that the tax authorities will respond to this ruling with clarifications. A loss determination decision or similar recording for latent losses and gains could prevent some of these discussions. Therefore, for every share transaction involving latent losses, determine the difference between the tax book value and the market value per item and record the substantiation at the time of the change of ownership. For material tax positions, it is advisable to request certainty in advance.