Holland collects a 25% withholding tax on dividends paid by Dutch companies to foreign shareholders.  The tax is reduced to 5% by the US-Dutch tax treaty.  There is no withholding tax on amounts paid out as interest.

The Netherlands Supreme Court confirmed in a decision on February 17 that ABN-Amro Bank NV could deduct interest paid on “perpetual bonds.” The bonds had four key characteristics.  First, they were perpetual.  Repayment of principal was due in case of bankruptcy or liquidation of the borrower or, at the option of the borrower, at 10-year intervals starting in 2004.  Second, the bonds carried a fixed interest rate of 8.5%.  Interest was cumulative if not paid.  Third, payment of interest was deferred in years when no dividend was payable by the borrower.  Fourth, the bonds were subordinated to other debts of the borrower.

The issue was whether the lenders “participated to a certain extent in the business enterprise” of the borrower.  In that case, the borrower would not have been able to deduct his interest payments as interest on “debt.” Last year, the Supreme Court said it would recharacterize an instrument as equity only when three conditions are present.  One is the payments on the instrument are contingent on profits of the borrower.  Another is the instrument is subordinated to all other debts.  Finally, the instrument is issued for an indefinite period of time — for example, where repayment may be demanded only in case of bankruptcy or liquidation of the borrower.  All three conditions must be present to rechararacterize.

In this case, the instrument did not meet the requirement that payments be contingent on profits of the borrower.  The fact that interest was deferred in years when the borrower was not paying dividends did not make the interest contingent on profits, the court said.