More Flexibility for Securitisation Transactions in the Netherlands
On 27 October 2004, the Dutch State Secretary of Finance issued a decree in which the position of the Dutch tax authorities in respect of so-called “loss absorption” clauses in Dutch securitisation structures was clarified. In securitisations, “loss absorption” clauses are included in the debt issued by a special purpose company (SPV) as a means of transferring the risk from the owner of a mortgage portfolio to the holders of those debt instruments.
As a general principle of Dutch tax law, interest payments on a loan are deductible for Dutch corporate income tax purposes, and are therefore not subject to dividend withholding tax. Different rules apply to so-called hybrid loans, however, which have certain equity characteristics. Article 10(1)d of the Dutch Corporate Income Tax Act (CITA), which was introduced on 1 January 2002, provides that a loan will be treated as equity if, amongst other things, the obligation to pay interest is fully or partially contingent on the profits of the debtor and the loan has no maturity date or a maturity that exceeds 10 years. In such a case, payments on the loan and fluctuation in value of the loan will not be tax deductible, and may be subject to dividend withholding tax.
When introducing article 10(1)d of CITA, it was stated in Parliamentary discussions that if the interest payable on a loan is linked to the changes in value of one or more assets of the debtor, and the profit of the debtor is in relative and absolute terms significantly (in betekenisvolle mate) determined by the changes in value of the assets concerned, the obligation to pay interest on the loan is de facto profit contingent. As a result, the question arose whether a loss absorption clause effective at maturity would lead to profit contingency within the meaning of article 10(1)d of CITA. Pursuant to such a loss absorption clause, if the debtor were unable to repay the loan at maturity, any shortfall would be for the account of the creditor.
In response, the State Secretary of Finance stated that a loss absorption clause effective at maturity does not lead to profit contingency. Moreover, it was stated that article 10(1)d of CITA was (and is) not aimed at securitisations and other non-tax driven structures. The question was then submitted to the Dutch tax authorities, whether, in a certain securitisation structured via a Dutch SPV, a loss absorption clause applicable during the term of a loan (i.e. not only at maturity) would imply that the fixed rate interest could de facto be viewed as profit contingent. On 27 October 2004, the State Secretary of Finance issued a decree in which the position of the Dutch tax authorities in respect of this issue was clarified.
In the situation addressed by the decree, a bank had transferred the credit risk on mortgage loans to a Dutch SPV (orphan structure) by way of a credit default swap. The bonds issued by the SPV had a fixed interest rate, however, a loss absorption clause was attached. The loss absorption clause provided that any loss on the mortgages was shifted to the bondholders’ quarterly, by reducing the outstanding principal with the same amount. Whilst interest that had fallen due prior thereto remained due, interest on the “deducted” amount was no longer payable. According to the decree, the State Secretary of Finance confirms that the use of loss absorption clauses in these types of securitisation transactions will not, as such, lead to profit contingency, regardless of whether the loss absorption clause is applicable during the term of the bond, or at maturity only.
In conclusion, as a result of the decree, debt instruments issued in securitisation transactions will generally not qualify as equity. Consequently, no withholding tax will be due on the interest payments in such transactions.