Post by gfaroukh on Jul 15, 2009 23:32:08 GMT 4
Netherlands: Supreme Court decides in case on hedge accounting for tax purposes in the Netherlands
Suzanne Boers
The Dutch Supreme Court recently passed judgement on a case regarding, among other things, the need for corresponding valuation of assets for tax purposes.
Legal background
In the Netherlands, the annual taxable income is determined with the application of the principles of the so-called sound business practice. This means that the tax accounts may deviate from statutory accounting in the annual commercial accounts.
The general standard of sound business practice has been established in tax law as an open norm and has been further developed through case law. From this case law it can be derived that the main principles of sound business practice - in order of importance - are the following: sense of reality (also including the principles of realisation and matching), prudence and simplicity. The application of these elements has an influence on the method of profit determination, the recognition of expenses (costs) and the compensation of losses.
A strict application of the principle of prudence could lead to timing advantages for taxpayers, in case of a fully hedged position. Separate valuation of the assets would imply that a (unrealised) loss on one separate asset could be taken into account immediately, while the (unrealised) profit on the corresponding asset could be deferred.
Case law however has shown in the past that the principle of reality requires that a corresponding receivable and debt in a foreign currency should not be valuated separately, because a change in the exchange rate does not result in a change in capital.
It has not yet been further elaborated under which conditions corresponding valuation of assets is prescribed by sound business practice. In particular, it has not yet been decided to what extent there should be a connection between the corresponding assets.
Facts of the case
In the case before the Supreme Court, a Dutch corporation produced semi-manufactured cacao products. These products were sold through forward contracts and the cacao beans that were necessary for production were also purchased through forward contracts.
The forward purchases were always behind on the forward sales (a net-short position). In order to reduce the price risk, the corporation made use of futures on cacao beans that were traded on the London futures market on cacao.
Also, it made use of currency future contracts to reduce the currency risk. The subject-matter of the dispute was whether or not the unrealised losses with regard to the described forward contracts and futures could be taken into account immediately while all unrealised profit relating to these assets could be deferred - or - whether these unrealised profits and losses should be balanced insofar as they are corresponding.
Supreme Court decision
The Supreme Court decided that the principle of reality as part of the sound business practice requires that the forward contracts on sales and purchases and cacao and currency futures and technical inventory should be valued together, to the extent that the following two conditions are met:
* With regard to the price risk on cacao, there is a connection between the forward sales on the one hand and the forward purchases and futures or the technical inventory on the other hand. This needs to be judged by the circumstances, for instance the nature of the contracts in relation to the nature of the actual risks and the intention to hedge these risks.
* The price risk on cacao is highly limited on the date of the balance sheet. This means that the changes in value of the cacao that are included in the various assets will most likely correlate within a margin of 80 to 125%.
In the case the assets are valued together, unrealised losses on a separate asset will only be taken into account if and to the extent that, on balance, all corresponding assets together show an unrealised loss.
In this case, the Supreme Court has provided for more clarity with regard to the question whether or not, and to what extend, corresponding assets should be valued together. The margin of 80 to 125% seems to be based on the international accounting standards regarding hedge accounting for commercial accounting purposes (IAS 39).
The application of this commercially accepted margin for tax purposes leads to further elaboration of the principle of reality of sound business practice. As a result of this decision, hedge accounting for tax purposes will be required more frequently than before.
Suzanne Boers (suzanne.boers@nl.pwc.com)
Rotterdam
Suzanne Boers
The Dutch Supreme Court recently passed judgement on a case regarding, among other things, the need for corresponding valuation of assets for tax purposes.
Legal background
In the Netherlands, the annual taxable income is determined with the application of the principles of the so-called sound business practice. This means that the tax accounts may deviate from statutory accounting in the annual commercial accounts.
The general standard of sound business practice has been established in tax law as an open norm and has been further developed through case law. From this case law it can be derived that the main principles of sound business practice - in order of importance - are the following: sense of reality (also including the principles of realisation and matching), prudence and simplicity. The application of these elements has an influence on the method of profit determination, the recognition of expenses (costs) and the compensation of losses.
A strict application of the principle of prudence could lead to timing advantages for taxpayers, in case of a fully hedged position. Separate valuation of the assets would imply that a (unrealised) loss on one separate asset could be taken into account immediately, while the (unrealised) profit on the corresponding asset could be deferred.
Case law however has shown in the past that the principle of reality requires that a corresponding receivable and debt in a foreign currency should not be valuated separately, because a change in the exchange rate does not result in a change in capital.
It has not yet been further elaborated under which conditions corresponding valuation of assets is prescribed by sound business practice. In particular, it has not yet been decided to what extent there should be a connection between the corresponding assets.
Facts of the case
In the case before the Supreme Court, a Dutch corporation produced semi-manufactured cacao products. These products were sold through forward contracts and the cacao beans that were necessary for production were also purchased through forward contracts.
The forward purchases were always behind on the forward sales (a net-short position). In order to reduce the price risk, the corporation made use of futures on cacao beans that were traded on the London futures market on cacao.
Also, it made use of currency future contracts to reduce the currency risk. The subject-matter of the dispute was whether or not the unrealised losses with regard to the described forward contracts and futures could be taken into account immediately while all unrealised profit relating to these assets could be deferred - or - whether these unrealised profits and losses should be balanced insofar as they are corresponding.
Supreme Court decision
The Supreme Court decided that the principle of reality as part of the sound business practice requires that the forward contracts on sales and purchases and cacao and currency futures and technical inventory should be valued together, to the extent that the following two conditions are met:
* With regard to the price risk on cacao, there is a connection between the forward sales on the one hand and the forward purchases and futures or the technical inventory on the other hand. This needs to be judged by the circumstances, for instance the nature of the contracts in relation to the nature of the actual risks and the intention to hedge these risks.
* The price risk on cacao is highly limited on the date of the balance sheet. This means that the changes in value of the cacao that are included in the various assets will most likely correlate within a margin of 80 to 125%.
In the case the assets are valued together, unrealised losses on a separate asset will only be taken into account if and to the extent that, on balance, all corresponding assets together show an unrealised loss.
In this case, the Supreme Court has provided for more clarity with regard to the question whether or not, and to what extend, corresponding assets should be valued together. The margin of 80 to 125% seems to be based on the international accounting standards regarding hedge accounting for commercial accounting purposes (IAS 39).
The application of this commercially accepted margin for tax purposes leads to further elaboration of the principle of reality of sound business practice. As a result of this decision, hedge accounting for tax purposes will be required more frequently than before.
Suzanne Boers (suzanne.boers@nl.pwc.com)
Rotterdam