A Dutch private limited company receives a dividend from its Chinese subsidiary. It values the dividend receivable in euros at the closing exchange rate for the month preceding the transaction, as stipulated by the group guidelines. The tax inspector considers that the company should have used the daily exchange rate and issues a supplementary tax assessment. The adjustment amounts to just over €7.4 million. Is the private limited company’s valuation system in accordance with generally accepted accounting practice?
Dividend from China
The private limited company is the Dutch branch of a listed logistics group and holds interests in more than 200 subsidiaries worldwide. In August 2015, a Chinese subsidiary declared a dividend equivalent to just over €106 million. The payment is not made until November, as approval from the Chinese tax authorities for a reduced withholding tax rate is delayed. The company capitalises the dividend receivable at the closing price for July 2015 and values the payments received at the closing price for October 2015. This results in a capital loss of almost €2.5 million.
Inspector wants daily rates
The inspector does not agree with this approach. He argues that the private limited company should have used the spot rate on the day of the transaction, in which case it would not have recorded a loss but a capital gain of almost €5 million. The adjustment of over €7.4 million results in a supplementary tax assessment for 2015, with implications for 2016. The inspector argues that the private limited company’s valuation system contravenes generally accepted accounting practice, the participation exemption and the total profit principle. Furthermore, the internal group agreement is said to be uncommercial.
Why the closing price?
The company explains that all group entities are bound by an internal banking agreement and by group-wide accounting policies. These stipulate that transactions in foreign currencies are valued at the closing rate of the preceding month. The valuation system has valid commercial reasons: currency risks are concentrated at the head office’s in-house bank. Furthermore, this ensures that the accounts of all group entities are properly aligned. This facilitates the preparation of the consolidated financial statements. The company has been applying this system consistently for decades.
Good business practice
The court rules that the private limited company’s valuation system is in accordance with sound business practice. Business economics and the reality under civil law are the guiding principles, provided there is no conflict with an explicit statutory provision. This is not the case here. After all, the private limited company has not received more dividend than the amount declared in its tax return, so there is no conflict with the participation exemption or the total profit principle. The fact that the exchange rate of the Chinese yuan against the euro is volatile does not alter this. The system complies with both the reality principle and the principle of simplicity. Furthermore, the tax inspector has not demonstrated that the private limited company is systematically forgoing profits as a result of the system. The court sets aside the additional tax assessments.