Recent Dutch case law on transfer pricing disputes

In the case, the relevant taxpayer (BV) was part a multinational group headquartered in the US. BV was the Dutch holding company of various domestic and foreign associated entities. BV also held shares in two Dutch companies exploiting (i) a cocoa processing plant (Company 1), and (ii) a soybean press plant (Company 2). Company 1 and Company 2 (Companies) were both full-fledged entrepreneurs. In 2007, it was decided that the operational activities of the group should be reorganized. Consequently, the European and African production sites, amongst which the Companies, would make their facilities for processing raw materials available to the group while being remunerated as ‘toll manufacturers’. The other relevant functions (e.g., the purchase of raw materials, sale of products, hedging of risks, logistics and financial planning) were to be centralized at another group company based in Switzerland (SwissCo). With the reorganization, not only the inventories and the (unexpired) sales and purchase contracts were transferred from the Companies to SwissCo, but also ten to twenty employees including traders were re-employed (the foregoing steps performed by the taxpayer are hereafter referred to as the Reorganization).

In the Lower Court and the Court of Appeal case, the main disputes between the taxpayer and the DTA were (i) whether something of value has been transferred on top of the market value of the assets and liabilities, (ii) how the burden of proof should be divided between the taxpayer and DTA, and (iii) whether the determined value following from a valuation performed by the Expert was based on the correct assumptions.

The initial position of the taxpayer was that the reorganization merely entails a transfer of assets and liabilities from the Netherlands to Switzerland, and therefore BV does not require any significant (additional) remuneration. In its tax return, BV included a remuneration for the reorganization of approximately EUR 1.8mio.

Alternatively, if the Court of Appeal would decide that something of value on top of the market value of the assets and liabilities has been transferred, the taxpayer agreed with the valuation prepared by the Expert as part of the Lower Court case.

The DTA argued that there was no mere transfer of assets and liabilities, but a restructuring in which BV gave up its entire business in exchange for a function as a mere service provider to the SwissCo. According to the DTA, all essential business functions, including profit potential, were transferred contractually and economically. In support of this position, the DTA referred to the functional analysis that was prepared by the taxpayer and the difference in (anticipated) turnover and cash flows before and after the restructuring.

In addition to the above, the DTA argued that the valuation performed by the Expert had the following four flaws:

1. The value was too low as the Lower Court requested the Expert to determine the minimum at arm’s length value. The DTA argued that a correction should be made to the median value.
2. The Expert did not take into account any tax amortization benefit for the acquirer by grossing-up the value (typically it is possible for tax purposes to amortize the purchase price which results in a benefit for an acquirer for which it would typically also be willing to pay). The DTA argued that a gross-up of at least 80% is justified without further details.
3. The Expert used an overly pessimistic turnover forecast. The DTA argued that a turnover growth of 1.5% for Company 1 and 3% for Company 2 would be more realistic.
4. The forecasted inflation of 1% as applied by the Expert is too low. The DTA argued that, based on the expectation as published by the European Central Bank, an inflation of 2% would be more realistic.

The Court of Appeal considered paragraph 9.65 [2] and 9.54 [3] of the OECD Guidelines relevant for the assessment regarding whether something of value has been transferred on top of the market value of the assets and liabilities. In the view of the Court of Appeal, the functional analysis that was prepared by the taxpayer for a ruling request (submitted, but not granted by the DTA) contained a clear and detailed description of the functions, assets, and risks before and after the Reorganization. That this functional analysis was not included in the transfer pricing documentation of the taxpayer was not deemed relevant by the Court of Appeal. The Court of Appeal considered that something of value has been transferred. The Court of Appeal based this on all relevant facts and circumstances considering that (i) before the Reorganization the Companies were full-fledged entrepreneurs that performed the relevant functions (i.e., procurement, production, and sales), assumed all entrepreneurial risks, and earned the profit (potential) related to these functions and risks, (ii) after the Reorganization the function and risk profile of the Companies changed significantly, (iii) besides the transfer of the assets and liabilities to the SwissCo also 10-20 employees were re-employed, and (iv) the profit and cash flow of the Companies decreased significantly after the Reorganization whereas the profit and cash flow of the SwissCo increased.

The Court of Appeal also considered that because the taxpayer entered into discussions with the DTA before filing its tax return and during such discussion (i) the taxpayer presented a valuation which resulted in a value of EUR 7,715,825, and (ii) the DTA did not agree with such value for the transfer (i.e., the Reorganization), the taxpayer was aware or should have been aware that the taxable amount of EUR 1,831,037 was too low at the moment the tax return was filed. In addition, the Court of Appeal considered that the taxpayer’s position was not objectively arguable. That, together with the size of the correction made by the DTA, made the Court of Appeal decide that BV filed an incorrect CIT return and that therefore the burden of proof was reversed and increased towards the taxpayer. The Court of Appeal also ruled that the reversed and increased burden of proof does not discharge the DTA from providing a reasonable estimate for a potential correction.

Appeal also ruled that the reversed and increased burden of proof does not discharge the DTA from providing a reasonable estimate for a potential correction.

Concerning the remarks of the DTA on the valuation performed by the Expert, the Court of Appeal considered the following:

1. The Court of Appeal agreed with the DTA’s view that in making a reasonable estimate in a situation where there is a range of prices, the tax inspector does not necessarily have to take the minimum price at the bottom of the ‘range’. However, the Court of Appeal did find that the Expert aimed for the median due to the set of observations he used in his pricing. Insofar the DTA meant that the median or average of the DTA’s and the Expert’s valuations should be used, the Court of Appeal disagreed with the DTA.
2. The Court of Appeal believes that grossing up the purchase price is not unreasonable. As the taxpayer has not provided any insight in SwissCo’s tax treatment of the Reorganization (while this would have been the responsibility of the taxpayer according to the Court of Appeal), the Court of Appeal agreed with the DTA’s gross-up of 80%.
3. In respect of the growth rates used, the Court of Appeal confirmed the consistency of the Expert in his valuation report and the attention to the specific situation of the taxpayer. According to the Court of Appeal, the DTA did not sufficiently substantiate the alternatively suggested growth rates.
4. The Court of Appeal considered the DTA’s suggested projected inflation expectation of 2% for the remaining period to be reasonable. The DTA has sufficiently substantiated this by referring to the aim of the European Central Bank. In contrast, the taxpayer has not sufficiently substantiated the inflation rate of 1%.
5. Based on these adjustments, the Court of Appeal ruled that the value to be received by BV should be equal to approximately EUR 128mio, which is higher than the value as determined by the Expert for the purpose of the Lower Court case.

A Dutch BV (BV) was incorporated in 2014, by various (corporate and individual) shareholders. In that same year, BV acquired a (rented out) office building (the Acquisition).

BV financed the Acquisition by way of both equity and shareholder loans whereby a Loan-to-Cost (LTC) of approximately 60% was applied. The shareholder loans had the following characteristics:

• maturity 10 years;
• fixed interest of 10%;
• no repayment schedule;
• possibility to make (p)repayments without break costs;
• possibility to make bullet repayment without break costs;
• possibility to defer interest payments in case of financial distress;
• no securities were granted;
• no covenants were included (e.g., no Loan-to-Value (LTV) covenant);

The DTA challenged the at arm’s length character of the interest and levied (additional) tax assessments based on the argument that the at arm’s length interest should be set at 2.59% [6] and the excess should be treated as non-deductible.

The taxpayer argued that the terms and conditions of the shareholder loans (including the interest rate) were at arm’s length. In order to substantiate its position, BV submitted two transfer pricing reports. In the first report (prepared in the year 2016) (First Report), several benchmark studies were included. In the First Report three searches were performed which led to various ranges with the maximum of the three ranges being 6.69%. The First Report then considered (although not specifically mentioned in the case, presumably on the basis of the Commercial Property Lending Report of the De Montfort University) that with a financing mix of senior, junior, and mezzanine funding, the interest rate should lie within a range of 6.69% and 10.9%, and therefore an interest rate of 10% can be considered at arm’s length.

In the second transfer pricing report (prepared in the year 2021) (Second Report), it was concluded – by way of economic modelling with the use of a Monte Carlo simulation – that the internal rate of return (IRR) of the project would be approximately 16.2% which in the view of BV provides evidence for the fact that the interest rate of 10% is considered at arm’s length.

BV further brought forward that it was in its view beneficial to enter into the shareholder loans as third parties would apply rather strict conditions if they would have provided financing at the moment of the Acquisition (with a LTC of approximately 25-40%, a maturity that was limited to the term of the rental agreement (ending in the year 2021) and a LTV covenant whereby the shareholders would be obliged to contribute additional equity in case of a substantial decrease in value of the building). By entering into the shareholder loans, it secured BVs financing position.

The DTA first took the position that the terms of the loan needed to be set at ‘at arm’s length conditions’ (including a so-called LTV covenant and including the assumption that BV provided security towards the shareholders). Subsequently, the DTA argued that the loan should be regarded as a so-called ‘non-businesslike loan’ (onzakelijke lening). On the basis of both positions, the DTA argued that the interest should have been set at 2.59% based on its own assessment [7].

The Court of Appeal ruled that it should first be assessed whether the loan should be considered a ‘non-businesslike loan’, which was the case according to the Court of Appeal. According to an earlier Supreme Court case, the interest on a ‘non-businesslike loan’ should then be set at the interest that the taxpayer would be due if it were to borrow from a third party with a guarantee from the shareholders under otherwise the same conditions and circumstances (Deemed Guarantee Approach).

The Court of Appeal ruled that in establishing whether a loan is a ‘non-businesslike loan’, the contractually agreed upon terms and conditions are decisive and that it is therefore not required to first establish ‘at arm’s length’ terms and conditions (including LTV covenant and assumed security). The Court of Appeal therefore rejected the DTA’s first position.

The Court of Appeal subsequently ruled that the tax inspector – on which the burden of proof lies that the loan is considered a ‘non-businesslike loan’ – was able to convincingly argue that the loan was a ‘non-businesslike loan’. Reasons are that (i) from the benchmarking analyses included in the First Report, it followed that a third party would not have been willing to provide a loan to BV against similar conditions as the shareholder loans, and (ii) the contents of the Second Report cannot be deemed to be prepared in accordance with the at arm’s length principle (also taking into account that such report does not provide for a substantiation of the 10% interest rate). Furthermore, the DTA (and the Court of Appeal) referred to the statements brought forward by BV, where BV argued that third party financing would only be possible with more rigid conditions in respect of e.g., LTC, securities, maturity and inclusion of an LTV covenant.

The Court of Appeal ultimately ruled that the interest on the shareholder loans, while applying the Deemed Guarantee Approach, should be set at 3.09% [8].

1. Besides this case, there are also other recent court cases concerning business restructurings (e.g., ECLI:NL:RBNHO:2023:12635 and ECLI:NL:PHR:2023:226).

2. “An independent enterprise does not necessarily receive compensation when a change in its business arrangements results in a reduction in its profit potential or expected future profits. The arm’s length principle does not require compensation for a mere decrease in the expectation of an entity’s future profits. When applying the arm’s length principle to business restructurings, the question is whether there is a transfer of something of value (rights or other assets) or a termination or substantial renegotiation of existing arrangements and that transfer, termination or substantial renegotiation would be compensated between independent parties in comparable circumstances).”

3. “In order to determine the arm’s length compensation payable upon a restructuring to any restructured entity within an MNE group, as well as the member of the group that should bear such compensation, it is important to identify the transaction or transactions occurring between the restructured entity and one or more other members of the group. This analysis will typically include an identification of the functions, assets and risks before and after the restructuring.”

4. This rule has been laid down in article 15b of the Dutch corporate income tax rule and limits the deduction of interest to 20% of the EBITDA (determined based tax principles) with a threshold of EUR 1 Mio. 

5. It is anticipated that the threshold of EUR 1 million will no longer be applicable for so-called ‘real estate companies’ and this may further limit the possibility of an interest deduction for taxpayers that invest in real estate that is rented out.

6. The case also dealt with the question whether or not BV was able to apply the so-called portfolio management status (fiscale beleggingsinstelling) that is laid down in article 28 of the Dutch corporate income tax act and on the basis of which BV would be tax exempted. We will not further address this aspect here.

7. No details were provided on how the DTA reached this conclusion. 

8. No details were provided on how the Court reached this position. We do note that this interest is slightly higher than the interest rate of 2.59% as determined by the DTA because the Court considered that the DTA did not apply the correct term of the loan (i.e., a term shorter than 10 years).