Up to now the Ministry of Finance has only dealt with the problems of tax returns; the other said aspects will be examined on the basis of existing rules and case law.
TAX RETURNS
The income and expenditure of the central government, and its administration will, in principle, continue to be denominated in guilders up to and including December 31, 2001. On January 1, 2002 at the latest, the government will convert to the euro. Other (lower) government and civil law bodies are expected to follow suit.
In accordance with central government policy, the tax administration will continue to use the guilder as the unit of account up to and including the tax year 2001. The tax administration will nevertheless give taxpayers the choice of submitting their returns in euros as early as the tax year 1999. This will apply for important taxes such as income tax, corporate income tax, wage tax, turnover tax, excises and import duties. The tax administration will itself ensure for conversion to guilders. Submission of tax returns will, however, be subject to the condition that returns are fully filed in one currency unit for the practical administration of returns. From January 1, 1999 final amounts in returns may be given in both guilders and euros. The calculations underlying these final amounts will, however, still be calculated in guilders up to 2002.
One of the reasons for this is the fact that the amounts stipulated in the relevant tax laws, such as tax-free sums, tax brackets, the brackets for application of the investment deduction, etc., will be denominated in guilders up to the tax year 2001. Returns and other documents relating to tax years subsequent to 2001 will be solely denominated in euros. Returns may be submitted in guilders up to and including the periods commencing in 2001, even if these returns are submitted at a later date (which is generally the case in practice). For instance, in the year 2003 it will still be possible to submit a T-form for the tax year 2001 in guilders. However, restitution's of tax will then be made in euros. As of the tax year 2002 all returns must be filed in euros.
Tax returns may, as mentioned above, be filed in euros from the tax year 1999 but whether taxpayers will be able to pay their debts (by funds transfer) in euros from that time will depend on banking developments. Payment of tax debts in euros cannot be made compulsory before the end of the period in which the guilder and the euro are both legal tender ( this period will, it is expected, end on July 1, 2002).
DEDUCTION OF COSTS
The main rule is that costs may be deducted from the taxable profit in the year of expenditure. Application of the prudence concept, an element of sound commercial practice, entails, however, that even costs which may only lead to positive income in a later year may be deducted from the taxable profit in the year of expenditure. However, expenditure which presumably relates to a future year, such as, for instance, rental paid in advance, etc., has to be deducted from the profit in the year in question. Advertising expenses, for instance, are generally deductible in one sum. However, if an advertising agency is paid a lump sum to draw up an advertising campaign spanning a number of years, partial capitalisation of that amount will have to take place.
Examples of costs relating to the introduction of the euro are, for instance, costs incurred for the adaptation of computer software and equipment, training and instruction of personnel, etc. To determine whether these costs can be entirely deducted in the year of expenditure or should be spread over a number of years, a distinction has to be made between maintenance costs and costs to improve business assets. Maintenance costs can be directly deducted, whereas improvement costs have to be capitalised. The costs capitalised can then be depreciated.
The introduction of the euro will also serve to emphasise the difficulty in practice of determining which exact costs have been incurred for maintenance and which for improvement.
COST EQUALISATION RESERVE
Another important question is whether costs relating to the introduction of the euro can now be (partly) charged to the current profit through the formation of a tax-free cost equalisation reserve. The Ministry of Finance has not yet taken a standpoint in this respect.
The use of a cost equalisation reserve means that costs and charges incurred in any one year on behalf of business operations may be proportionally deducted from the profit in that year, despite the fact that the related expenditure is only made in a later year. An example from case law is the "survey reserve" for the maintenance of ships which must undergo major repairs once every so many years. The requirements for the formation of this reserve are as follows:
- Regular bookkeeping with regulated annual balancing.
- The costs have to be divided equally over the years and additions must also be made in loss years. The term "costs" indicates that this does not include investments.
- A peak in the expenditure has to be involved.
- The additions made each year to the reserve should clearly relate to the business operations in that year.
Based on the latter condition, the Supreme Court rejected the formation of a cost equalisation reserve for the costs of a jubilee to be celebrated in a subsequent year, but also for the costs of a voluntary or compulsory relocation of business, for the costs relating to an anticipated future business stagnation, for future dismantling costs of an oil drilling installation, etc. In other words, a cost equalisation reserve formed for costs relating to a future event will not be accepted.
This latter condition will presumably impede the formation of a cost equalisation reserve for costs relating to the introduction of the euro: the required causal link between these costs and the current business operations costs is absent. The introduction of the euro is, after all, a future event.
TAX PROVISION
In view of the foregoing, the logical question then is whether a tax provision can be formed for the costs relating to the introduction of the euro. The formation of such provisions is intended to cover future obligations or costs for which an amount may now be deducted from the profit in the current year, as dictated by sound commercial practice. Examples from case law suggest that to claim a provision, the following conditions must be met:
- a legal relationship should exist;
- the chances that the (resulting) obligations will arise should be substantial; and
- in accordance with sound business practice, the obligations should be borne by the current profit.
An obligation does not therefore have to be legally claimable; it is sufficient that the obligation results from an existing legal relationship at balance sheet date, for instance, the obligation to issue a guarantee for supplies carried out at an earlier date. From recent case law (including the so-called "Mestarrest" (Manure case) in 1996) one could conclude that the Supreme Court favours the correspondence with the economic compulsion to incur costs in a subsequent year. The above-mentioned "Mestarrest" concerned the necessity to incur costs in a subsequent year in order to drain off manure reserves. Based on the principles of sound commercial practice, a provision may be formed to the amount of such costs, incurred as a result of the production in any year but only leading to expenditure in a subsequent year.
Where the introduction of the euro is concerned, however, taxpayers cannot (yet) claim a legal relationship pursuant to which an obligation to introduce this coin exists. Furthermore, the costs for which taxpayers may wish to make a provision have to be incurred as a result of business operations in the year in question. In the case of the euro, this latter requirement will again be unfulfilled.
Therefore, even if a legal obligation to introduce the euro were implemented, which could only arise if it is definitively decided that the Netherlands will partake in the EMU, the requirement that the future costs must relate to the current business operations would still mean that no provision can be formed for the introduction costs.
EARLY DEPRECIATION
Certain business assets may lose their value as a result of the introduction of the euro. Coin machines, for instance, will require replacement in the year 2002. The economic lifetime of these business assets will be shorter on the introduction of the euro than was conceived at the time of purchase of these assets. Consequently, the depreciation term, the basic assumption for the calculation of the annual depreciation, will be shorter as well. The introduction of the euro will bring about a change in circumstances in this respect. A shorter residual economic lifetime than was initially assumed may therefore lead to an increase of the depreciation percentages over the remaining years. Recapture of previously below average depreciation percentages but only now brought to light, is, however, not permitted.
In addition, a value decrease which can be reasonably assumed to be permanent may be expressed in a lower residual value of the business asset. Consequently, the total amount to be depreciated during the remaining years will increase, increasing in turn the amount of the annual depreciation.
WRITE-DOWN
The method of depreciation can be changed if the going-concern value of a business asset is demonstrably lower than the cost price reduced by the deprecations (book value). It follows in that case from the prudence concept of sound commercial practice that the business asset in question can be valued at the lower going-concern value (minimum valuation rule). It is assumed that permanent value reductions are involved, which, moreover, arise unexpectedly. If the decision to have the Netherlands to participate in the EMU is made, as a result of which the euro will finally be introduced in the Netherlands, a decline in the going-concern value of certain business assets may arise. This devaluation can be charged to the profit in the current year.
CONVERSION RESULTS
For Netherlands tax purposes the taxable result should be calculated in guilders. Changes in currency rates therefore lead to either profits or losses, thus affecting the taxable result in the Netherlands.
An exception to this general rule is formed by the introduction as of January 1, 1997 of a provision enabling the taxable result to be calculated in a currency unit other than the Netherlands guilder, under further conditions to be stipulated by the Under-secretary. Since these conditions are only expected in the course of the 1997 summer, little can be said on this facility at present. The prudence concept entails that on the calculation of the annual profit unrealised profits do not yet need to be taken into consideration. On the other hand, demonstrable, unrealised losses can be directly deducted from the results. This applies both to the asset and liability side of the balance sheet. The main rule is that assets have to be valued at historic cost price ( reduced by the deprecations applied thereon) or at the lower going-concern value. Debts in foreign currencies have to be valued at the original exchange-rate or, if this entails a higher valuation, at the current exchange rate. Unrealised currency profits do not need to be directly expressed, whereas unrealised exchange losses can be directly deducted in the year in which they arose.
The following scenario is conceivable. A company has a long-term debt in French francs. In the period since the debt arose the French franc has devalued vis-…-vis the guilder. If the devaluation appears to be permanent, the Dutch company therefore needs less guilders to redeem its debt than calculated at the time the debt was entered into. This entails a latent positive exchange result on the debt. Latent, since up to the time of redemption any rate increase of the French franc vis-…-vis the guilder will result in a decrease of the unrealised profit or may even convert it to a loss. Pursuant to the prudence concept the company need only take this currency result into consideration at the time the debt is redeemed. Taxation of the exchange profit is thus deferred until this is actually realised. After all, early taxation on unrealised profits could lead to liquidity problems for the taxpayer.
On January 1, 1999, the exchange rates of the states participating in the EMU will be fixed. As a result there will no longer be uncertainty on the future exchange ratios between the currencies of the participating member states: these ratios will be fixed from that moment on. Any exchange profits will also be fixed. The question is whether this currency profit will also have to be considered as realised for tax purposes.
The European Commission has instructed its member states to inform taxpayers whether the introduction of the euro will result in a taxable benefit. It has, however, appeared from contact with the Ministry of Finance that this announcement will only be made after the European Council (i.e. the government leaders and heads of state) have determined whether the Netherlands will participate in the EMU. We must therefore await the Ministry of Finance's views on this matter.
Until that time it is therefore uncertain whether the conversion profits will, as a result of the introduction of the euro, be considered realised for tax purposes at the time of introduction. If fiscal neutrality is assumed in the sense that introduction of the euro should not in itself result in the levy of taxes, then a currency profit should only be considered realised at the time the profit is actually obtained. In the above example therefore, on redemption of the debt.
ROLE OF TAXATION IN THE EMU
The introduction of the euro will mean, among other things, that citizens such as entrepreneurs and (portfolio) investors within the territory of the EMU no longer run currency risks on their foreign investments or other business activities. Exchange rate adaptations will, after all, no longer arise, and losses in this respect will become a thing of the past. Consequently, another impediment to economic cross-border traffic will have been removed.
Furthermore, as the national currencies will be replaced by a uniform currency unit, the internal market will gain in transparency. Differences between the member states, such as, for instance, differences in salaries, yield on shares, bonds and other securities, will be markedly sharper. This may mean that, even more so than is the case at present, companies will be forced to relocate their (labour intensive) production to a location more favourable from a cost and labour saving perspective within the EMU territory. Employees can be expected to do the opposite; i.e. they will relocate to areas where the highest real salaries are paid. Investors not wishing to run currency risks will be presented with a much broader choice than has been the case up to now.
Moreover, it will become even clearer that major differences in taxation exist between member states. It is not inconceivable that this will have consequences for the labour market. After all, employees comparing salaries will be looking at the net salary. One glance will be sufficient to show from which income level member states apply the national top rate and how high the tax-free sum in the state in question is. Not only employees but also entrepreneurs will have a better overview of the size of the wage tax to be paid and the employer's contribution for social security premiums. In other words, the increased transparency will mean that the level of taxes and premiums will play an even more important role than at present, and will form a criterion of economic transacting between market parties.
The use of one coin will also mean that the system of internal transfer prices applied by internationally operating groups will become more transparent.
It remains to be seen whether member states will make increasing use of fiscal instruments to promote economic growth and employment, perhaps even giving rise to competitive tax systems between member states. Several Ministers of Finance have expressed their concern in this regard. This lead to the decision during the Ecofin Council meeting of January 1997 to establish a task force bearing the impressive name "Taxation Policy Group". The object of this task force is to address the "question of tax competition". The term harmonisation is meticulously avoided in this context, owing to the fear of losing fiscal sovereignty to community institutions.
NOTE: The content of this contribution is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
KEYWORDS: Netherlands / Europe / EC / European Union / KPMG Meijburg & Co / Euro / EMU / Income taxes / Provisions / Tax returns / Cost deduction / Conversion.
Further information can be obtained from Mr. P. te Boekhorst, KPMG, Meijburg & Co, Amsterdam (Netherlands); fax 31 (20) 656 1247.
