The Court of First Instance of Brussels recently (16 April 2010) ruled that capital losses on shares recharged by a non-resident parent company to its Belgian subsidiary are not deductible. To the best of our knowledge, this is the first time a court has rendered a (negative) decision on this matter. This court decision conflicts with the approach generally adopted in practice by multinational enterprises in respect of global stock option plans.
The facts of the case
A South-African group implemented a global stock option plan under which stock options were granted to some employees of its group companies, including employees of its Belgian resident subsidiary. The underlying shares are listed on the Johannesburg Stock Exchange. The South-African parent company established a South-African special purpose vehicle (SPV) which purchased the shares as well as a trust which exercised and managed the stock option plan. Upon exercise of the stock options, either shares in stock or newly purchased shares were used to settle the stock options. As the exercise price was usually lower than the purchase price of the shares a capital loss was realized which was recharged to the group companies including the Belgian resident subsidiary. Tax deductibility of these recharged capital losses has been rejected by the Belgian tax administration.
In addition to the capital losses, also administrative costs in connection with the global stock option plan have been recharged to the group companies including the Belgian resident subsidiary. The deductibility of these recharged administrative costs has not been challenged by the Belgian tax administration.
Position of the Belgian tax authorities
It is not disputed that the recharged expenses as a general rule meet the general conditions on tax-deductibility of business expenses laid down in Article 49 of the Belgian Income Tax Code (hereinafter referred to as “BITC”). The refusal of the tax authorities to accept the tax deductibility of the recharged capital losses is merely based on Article 198, § 1, 7° BITC. This article generally provides that reduction in value and realized capital losses on shares are not tax-deductible. The tax authorities argued that the recharge of the capital loss on shares to the Belgian resident subsidiary falls within the scope of this provision for the following reasons:
- Article 198, 7° BITC does not contain a condition of ownership or possession of the shares; and,
- The recharge does not alter the legal qualification of the expense as being a capital loss on shares (great importance is attached to the invoice’s description “loss on sale of shares as per agreement”).
Court decision
The Court ruled in favor of the tax authorities, thus rejecting the recharged expenses related to the capital loss on shares.
The Court’s main argument is that application of Article 198, §1, 7° BITC does not contain a condition of ownership or possession of the shares and that the recharge does not change the legal qualification of the cost.
As a matter of principle, the Court stated that Article 198, §1, 7° BITC does not require that the company wishing to deduct the expense has possession or ownership of the shares. Such condition would not be included in the text of the law; reasoning otherwise, an additional condition for the application of the provision would be created according to the Court. The Court furthermore stated that the recharge does not change the qualification of the expense as a non-deductible capital loss on shares.
In view of defending tax deductibility of the recharge, reference was also made to the ratio legis of the law, i.e. the risk on a double deduction (first at the level of the parent company and secondly, at the level of the subsidiary where losses could be set off against future profits). However, the court found this argument irrelevant and furthermore assumed that it cannot be excluded that the capital loss has also been deducted from the profits of the South-African parent company. The court therefore considered that a risk on double deduction existed. Finally, the court also observed that the non-deductibility of the (recharged) capital losses is justified since any (recharged) capital gain on the shares realized by the Belgian resident subsidiary would not have been taxable in Belgium.
Analysis
The court decision goes against the common approach adopted in practice until today. Notwithstanding this court decision, valid arguments can be developed to defend that recharges within the context of a global stock option plan should be considered tax deductible business expenses.
In the absence of definitions of the notions of “capital loss” and “capital gain” in tax law, reference should be made to common law rules and more specifically accounting law to define these notions. The tax treatment follows the accounting treatment to the extent that the tax rules do not explicitly deviate from these accounting rules. From an accounting law perspective, a capital loss or capital gain on shares can only be realized provided the company has capitalized an asset on its balance sheet (quod non, in the case at hand). The Belgian resident subsidiary never recorded the underlying shares as an asset on its balance sheet; it was even legally impossible to capitalize these underlying shares on its balance sheet. In the absence of any realization on an asset, only income and expenses can be recognized by the Belgian subsidiary (but not gains or losses). This position is supported by various court decisions and leading tax scholars.
In the absence of simulation or requalification based on Article 344 § 1 BITC92, the application of Article 198, § 1, 7° BITC would therefore not be possible in the case at hand. Furthermore, the position of the Court that the recharge does not change the legal qualification of the cost cannot be supported in case no economical and fiscal transparency can be applied throughout the entire structure.
Conclusion
Valid arguments can be developed to defend that recharges within the context of a global stock option plan should be considered tax deductible business expenses. It is more likely than not that tax deductibility will be upheld if appeal were to be introduced against this decision of the Court of First Instance.
