Companies frequently use derivatives to protect their equity and create predictability in their profit and loss account. For Dutch corporate income tax purposes, a key question is whether positions within a fair value hedge are subject to hedge accounting for tax purposes. Where the relevant conditions are met, hedge accounting is mandatory for tax purposes and prevents a tax loss from being recognised on one leg of the hedge while the corresponding gain on the other leg remains unrecognised. Hedge accounting regularly gives rise to discussions between taxpayers and the Dutch tax authorities.

Selection of key insights for tax teams

  • Hedge accounting requires a hedging intention: the Supreme Court reconfirmed that hedge accounting is only mandatory for tax purposes where a highly effective hedge was both intended and achieved. Unintended hedges are, as a general rule, therefore not subject to hedge accounting. This Supreme Court judgement is addressed in more detail in our website post.
  • Assess hedge accounting per risk: hedge accounting must be assessed for each risk that can be hedged. If the FX risk on a loan is hedged, for example, changes in value of the loan resulting from credit or interest-rate risks fall outside the scope of hedge accounting and therefore create taxable results. Tax teams should carefully assess the scope of the hedge and differences in tax treatment between various types of hedges such as cross-currency swaps, FX forwards and options.
  • Check for taxable gain recognition at inception: entering into a hedge may effectively lock in a pre-existing gain on the underlying asset. Whether that gain must be recognised for tax purposes at inception depends on the precise mechanics of the hedge and conditions of the derivative.
  • Portfolio hedges require matching: where hedges are concluded at portfolio level or where multiple derivatives are used to hedge a single balance sheet item, the derivatives and balance sheet items need to be matched appropriately in the administration. This requires close alignment with treasury and accounting departments to ensure that modifications to the hedge and interim results are administered correctly.
  • Share hedges and gain recognition: hedging instruments such as collars and exchangeable bonds can be used to monetize surplus value in listed shareholdings without an outright disposal. A key tax question is whether the hedge nevertheless triggers recognition of the built-in gain in the shares at inception. This depends heavily on the terms of the instrument. Tax teams should also carefully consider the differences between the commercial and tax treatment of share option hedges.  
  • Settlement method can materially affect tax outcome: fair value hedges can be unwound or amended in various manners, including through cash settlement, a blend & extend and a forward starting hedge. The tax treatment strongly depends on the type of settlement. Tax teams are recommended to compare scenarios numerically together with their treasury colleagues.

The full article (in Dutch) can be found on the website of Nederlandse Documentatie Fiscaal Recht.