Background

Based on long-standing case law, Dutch corporate taxpayers are under circumstances obliged to value balance sheet items coherently for Dutch corporate income tax (CIT) purposes. This means that a taxpayer is not allowed to recognise a loss on a balance sheet item to the extent there is a (built-in) gain on the opposing balance sheet item. Therefore, effectively only the net loss on the overall position can be recognised.

Historically, the Supreme Court applied two cumulative requirements for the obligation to apply coherent valuation: the coherence requirement and the correlation requirement. The coherence requirement is met if there is coherence between two balance sheet items. This requires an assessment of the circumstances of the case, including whether it was intended to hedge risks. The correlation requirement is met if the hedge is highly effective, i.e., it is expected on the relevant balance sheet date that the value movements of the two balance sheet items most likely correlate within a range of 80%-125%.

Based on recent case law of the Supreme Court, the question arose as to whether the coherence requirement still applies. The Supreme Court has now provided clarity on this matter.

Facts and circumstances

The taxpayer in the case at hand applied the Euro as its functional currency and valued its USD-denominated receivables and payables at cost or lower market value for Dutch CIT purposes. This means that the taxpayer recognises foreign exchange (FX) gains only when realised and FX losses as soon as the receivable is valued lower or the payable is valued higher (‘unrealised losses’).

In its Dutch CIT return, the taxpayer recognised realised FX gains and losses, as well as unrealised FX losses. The taxpayer did not recognise unrealised FX gains, based on the argument that there was no obligation to apply coherent valuation of the balance sheet item including the unrealised gain with the balance sheet items on which an FX loss was recognised in the absence of coherence between the two balance sheet items.

Legal question

The dispute inter alia concerns the question whether (intended) coherence is still a requirement for coherent valuation and whether such coherence existed in the present case. The Court of Appeal ruled that there was no (intended) coherence absent a causal-historic link. In his opinion of 24 February 2023, the Advocate-General concluded that the coherence requirement should be abolished. This could have significantly broadened the scope of hedge accounting to cases where there was no intended hedge. 

Supreme Court Judgment

In its ruling of April 17, the Supreme Court reconfirms that coherent valuation is only required in the case of sufficient coherence and correlation between balance sheet items. According to the Supreme Court, the only relevant circumstance in assessing coherence is whether hedging of risks is intended, based on objective criteria. Relevant factors in this assessment can be the nature of the balance sheet items and the related contracts, considered in light of the nature of the relevant risks. The administration, financial statements and economic goals of the enterprise may also be relevant. Differences in maturity of the balance sheet items do not rule out the presence of coherence.

With respect to the correlation requirement, the Supreme Court clarifies that the value of a receivable may depend on various factors (such as the FX rate, debtor risk and market interest rate movements) that can be hedged separately. The Supreme Court reconfirms its view that each of these factors must be taken into account separately when assessing whether there is a related hedging instrument. The burden of proof that the conditions for coherent valuation are met lies with the tax inspector.

The Supreme Court rules that the coherence requirement does not require a historic or causal link. The Supreme Court therefore overturns the judgment of the Court of Appeal and refers the case back to another Court of Appeal to (re)assess the presence of a hedging intention.

Impact

The Supreme Court judgment reconfirms the relevance of the coherence requirement and provides further clarification on how to apply this requirement as well as the correlation requirement. The judgment is helpful for taxpayers that have balance sheet items denominated in a foreign currency on both sides of their balance sheet, in the sense that coherent valuation between these items is only required if they intended a hedge. Nevertheless, taxpayers should be aware that such intention does not necessarily need to stem from the relevant contracts but may also be derived from other (objective) financial and economic factors.

Contact

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