Supreme Court confirms that latent losses fall within the scope of section 20a

Article 20a in brief

Article 20a is a provision that addresses transactions involving so-called loss companies. If there is a change in ownership of 30% or more in a company, the tax losses incurred before that change in ownership took place may, in principle, no longer be offset against future taxable profits. There are several statutory exceptions to this general rule. However, for companies that have reduced their business activities by more than 70% since the earliest loss year or that have always been primarily engaged in investments, these exceptions generally do not apply, and the existing losses are forfeited.

What were the facts of this case?

The proceedings concerned the following facts.

• A private limited company (B.V.) with a real estate portfolio consisting of thirteen office buildings and an industrial building.
• Following the bankruptcy of its shareholder, the company was managed by a bank starting in 2012.
• On December 23, 2015, the shares were sold to third parties. The transaction value of the real estate was €72.5 million, while the tax book value at that time was €89.8 million. Thus, the share transfer already included a significant unrealized loss in the real estate portfolio (approximately €17.3 million).
• Two years later, three properties were transferred to new subsidiaries. This resulted in a tax book loss of approximately €4.3 million. The tax inspector refused to allow this loss as a deduction, citing Article 20a.

The central legal question was: Can Article 20a also limit a loss that is realized only after the change in ownership but that already existed economically prior to that change?

The various courts ruled as follows:

• Ruling by the District Court of North Holland: Article 20a does not apply to unrealized losses. According to the court, the text of the law, legislative history, and legal framework indicated that Article 20a applies only to realized losses.
• Amsterdam Court of Appeal: Article 20a also applies to unrealized losses. The court of appeal followed earlier case law regarding the predecessor to Article 20a and ruled that unrealized losses may also fall under the provision.
• Opinion of the Advocate General: Article 20a also applies to latent losses. It follows from the purpose and scope of Article 20a that losses that are economically attributable to the period of the former shareholders should not be available for use by new shareholders.
• Supreme Court’s Ruling: The Supreme Court’s final ruling is that unrealized losses also fall within the scope of Article 20a.

What does this ruling mean in practice?

The practical significance of this ruling lies primarily in the valuation of tax positions in the event of a share transfer exceeding 30%. Following this ruling, latent losses must also be clearly taken into account.

What tax questions remain unanswered?

The Supreme Court provides clarity on the basic principle but leaves the practical implementation largely open. This could be because, for example, the Supreme Court does not wish to assume the role of the legislature. However, this raises a large number of important questions specifically for practical application. In our opinion, the following points at least deserve attention:

• Should unrealized gains and losses be determined on a property-by-property basis, or may they be offset within a real estate portfolio?
• How should changes in value occurring after the change in ownership be allocated, and how should depreciation be handled?
• Who bears the burden of proof, and what valuation information is required for this? The Advocate General argued that it is up to the tax inspector to demonstrate that a loss realized at a later date must be allocated, in whole or in part, to the period prior to the change in ownership. In our opinion, this is also the case, but the Supreme Court does not make this clear.

The legislature may see this ruling as a reason to establish further rules on this matter, but until then, these questions will have to be assessed on a case-by-case basis in practice.

Implications for Corporate Transaction Practice

In addition to the tax law uncertainties left unresolved by this ruling, the ruling highlights a number of points to consider for the share purchase agreement (SPA) in share transactions involving the transfer of more than 30% of the shares. We list a few of these below.

Due Diligence and Valuation Rationale

Going forward, tax due diligence should explicitly identify not only tax losses that have already been formally recognised, but also latent losses embedded in the target company's assets.

Guarantees and Indemnities

• Existing tax warranties regarding the availability and tax utilisation of carry-forward losses must be reviewed: do they also cover the risk that a loss realized after closing could still be subject to Article 20a because it already existed economically prior to closing?
• It is important for the buyer to clearly define who bears the risk of a dispute with the tax authority regarding whether and to what extent a loss realized after closing should be attributed to the period prior to closing.
• Consider extending the period for tax warranties and indemnities relating to loss utilisation, given the time that may elapse between the change in ownership and the actual realization of a latent loss.

Pricing Mechanism and Closing Mechanisms

Where the purchase price is (partly) based on the assumed tax value of offsettable losses, it is advisable to specify in the SPA how this ruling has been taken into account: for example, through a price adjustment mechanism, an earn-out linked to the actual tax deductibility of certain losses, or by explicitly including the assumptions made regarding loss carryforward as a warranty so that deviations from them result in a claim rather than a post-closing dispute over the purchase price.

Tax Provisions and Cooperation After Closing