In this case, the Dutch Supreme Court further outlined the Dutch perspective on the distinction between debt and equity in its already infamous judgments on the so-called extreme default risk loan (EDR loan)
L sold a securities portfolio to B for EUR 5.3 million against B’s acknowledgement of debt to L for the same amount. The debt was then converted into a 10 year loan with an interest rate of 5% and a pledge on the portfolio. Both L and B were then moved to the Netherlands Antilles.
Later on L deducted a EUR 1.2 mill. loss on the loan to B due to a decrease in value of the securities portfolio.
The Dutch Tax Authorities disallowed the deduction based on the argument, that the loan was not a business motivated loan.
The Dutch Supreme Court ruled that in principle civil law arrangement is decisive in regard to taxation. However there are exceptions in which a civil law loan arrangement can be disregarded.
A non-business motivated loan is defined as an intercompany loan that carries an interest rate which – given the terms and conditions of the loan – is not at arm’s length, and which a third party would not have granted given the risk involved. In such cases, any losses arising from the loan are not deductible for Dutch corporate tax purposes. But at the same time, the lender still has to report an arm’s length interest which equals the interest that the borrower would have paid in case it had borrowed from a third party with a guarantee from the lender.
Netherland-vs-Corp-25-November-2011-Supreme-Court-case-nr-08-05323