The Dutch participation exemption does not only exempt qualifying income (capital gains upon sale, dividends) but allows disallows certain cost deductions. Costs incurred in relation to the acquisition or disposal of a participation in a subsidiary are treated as non-deductible ‘acquisition or disposal costs’. To what extent costs incurred fall within this category has been the subject of much discussion, due to lack of clear guidance in the legal text and history. In a decision published on 7 December 2018, the Dutch Supreme Court has provided rules on how and when to determine which costs will qualify as acquisition or disposal costs. However, even after this decision, much remains unclear.
Supreme Court Decision
In the decision, the Supreme Court states that costs incurred by a taxpayer constitute non-deductible acquisition or disposal costs if there is a direct causal link between those costs and the acquisition or disposal of a specific participation. Such a causal link is present if those costs that would not have been incurred absent the acquisition or disposal of the participation. The existence of such link has to be determined by applying objective standards.
The decision also clarifies that non-deductible acquisition or disposal costs comprise both internal and external costs of the taxpayer. Applying the aforementioned test, regular salary expenses of personnel involved (possibly excluding deal related bonuses) and indirect expenses such as housing expenses could still be deductible.
The Supreme Court furthermore clarifies that costs only qualify as non-deductible acquisition or disposal costs if the acquisition or disposal of a specific participation actually takes place. Consequently, costs incurred in relation to an envisaged acquisition or disposal that is ultimately not completed are deductible.
The decision specifically addresses cases where the initially intended sale of a participation to a potential buyer has failed but later on the participation is sold to a different buyer. In such case, costs incurred in relation to the first, failed disposal attempt qualify as non-deductible disposal costs if and to the extent those costs would still have been incurred had the failed disposal attempt not taken place. To that extent, those costs are considered as non-deductible disposal costs connected to the subsequent, successful sale of the participation.
In the Supreme court case, the sale process took three years. In this respect, the question arose how the costs incurred should be dealt with in a year the sale was not completed yet. The Supreme Court rules that the principles of sound business practice provide that costs incurred in relation to an envisaged acquisition or disposal of a participation must be recorded by taxpayers on their (tax) balance sheet as a transitory asset. This transitory asset has to be maintained until the time it is certain whether the acquisition or disposal will take place or not. At that moment, the transitory asset is written off and the part of the write-off that represents non-deductible acquisition or disposal costs has to be determined in accordance with the rules set by the Supreme Court.
Framework for monitoring acquisition or disposal costs
A first step is to determine to whom the costs incurred should be allocated, in line with the at arms’ length principle. Often certain costs relate to the target acquired or sold. Such costs should be charged on to such entity and the deductibility should be determined at that level.
If costs should be borne by purchaser or seller, in line with the Supreme Court decision it should be determined whether such costs have a direct causal link with the sale or acquisition. If this is the case, such costs will not be deductible under the participation exemption. It should be noted that financing costs and costs related to legal financing documentation generally do not fall within the scope of such costs.
An acquisition or disposal process is often a lengthy process involving a number of phases. A matter still open for discussion is to what extent certain pre-acquisition costs have a ‘direct causal link’ with the acquisition or sale (market research, process to find suitable interested parties, vendor due diligence, etc.) This is likely to give rise to new discussions.