New regulation for debt cancellation profits

18/09/24

This article was last updated on 17 December 2024.

The concurrence between the loss relief rules in the corporation income tax and the debt cancellation profit exemption may in certain cases make it more difficult for a loss-making company to restructure, namely if the claims against that company are waived. A waived claim results in a debt cancellation profit that is (partially) exempted under certain conditions. Due to the current loss relief rules, this debt cancellation profit can still lead to corporation tax being levied despite the exemption. This is not the intention and leads to problems. That is why there will be a new regulation.

What does this mean for your company?

The restructuring of loss-making companies will become easier, as no corporate tax will be due on the debt cancellation profit.

Background

If a company's debts are waived for business reasons, a debt cancellation profit arises for the debtor. Due to the loss set-off rules amended in 2022, this profit can still lead to the levying of corporate income tax despite the so-called debt cancellation profit exemption. In order to prevent this undesirable effect, a new measure is put in place as of 1 January 2025 to extend the debt cancellation profit exemption, and at the same time to abolish the restrictive loss set-off rules.

How did this unfortunate coincidence come about? To answer this question, we will discuss the operation of both schemes below. After that, we will discuss concurrence and explain the proposal.

Loss set-off rules in corporation tax

As of 2022, the loss relief for corporate income tax purposes is capped. The aim of this measure is to prevent companies with profitable activities from not paying corporate income tax for years on end due to a large amount of deductible losses from the past. On the other hand, from 2022 onwards, losses can be carried forward indefinitely.

The set-off of losses takes place up to a maximum of 50 percent of the profit. However, the first 1 million euros of profit can fully be offsett against losses. In other words, in the event of a taxable profit of more than 1 million euros, corporate income tax is always due, regardless of the amount of the losses that can be carried forward.

The debt cancellation profit exemption

If a company's debts are waived for business reasons, a debt cancellation profit arises for the debtor. This debt cancellation profit is partly exempt for tax purposes if there is a creditor who relinquishes rights and these rights cannot be realised. Of the profit made from the waived debts, only the part that is higher than the losses to be deducted is exempt. There is a partial exemption; the amount of the exemption is linked to the amount of the losses that can be carried forward.

The rationale for the debt cancellation profit exemption is that taxation may not impede the purpose of the debt cancellation (the reorganisation of loss-making companies). The rationale for only being partially exempted from this profit is that the excess can be set off against the carry-forward losses.

Therefore, in the end, no tax is actually levied on the benefit derived from the waived debts, so that the company can continue with a completely clean slate.

The concurrence

Until 2022, debt cancellation profits could be fully offset against the existing carry-forward losses. If there was still an amount of debt cancellation profit remaining and the conditions were met, the remaining debt cancellation profit was exempt under the debt cancellation profit exemption. This meant that, on balance, no corporation tax had to be paid. However, as of 2022, as described above, the rules for loss relief have been adjusted. At that time, no further arrangements were made for situations of business restructuring in which debts are cancelled for business reasons.

As a result of the new loss relief rules, tax will still have to be paid if the profit exceeds 1 million euros, even if this profit arises from a debt cancellation profit. Let's illustrate this with a simplified example which is based on the explanatory memorandum to the bill:

A company has carry-forward losses from the past of 4 million euros

The debt cancellation profit is 6 million euros

The regular loss of the year itself is 500,000

The debt cancellation profit exemption in this case is 1.5 million euros, i.e. 6 million euros minus 4 million euros is 2 million euros and then reduced by 500,000 euros which counts to 1.5 million euros. No exemption applies to the remaining write-off profit of 4.5 million euros, but the losses that can be carried forward can be set off against this profit. Until 2022, this amount could be fully offset against the carry-forward losses and, on balance, the debt cancellation did not lead to a corporate tax amount to be paid.

Under the rules that apply from 2022 to 2024, the annual loss will be settled against the profit. This results in a profit of 4 million euros (6 millions euros minus 1.5 million euros being exempt minus the losses of 0.5 million euros). Subsequently, losses can be offset up to an amount of 2.5 million euros, i.e. an amount of 1 million plus 50 percent of the remaining profit. In this example, corporation tax is therefore due on 1.5 million euros. The remaining carry-forward loss can be carried forward to future years, but it goes without saying that this levy may, in some cases, seriously impede the restructuring of companies in terms of cash flow.

The new rules

In practice, problems did indeed arise with these rules during remediation. The Dutch tax authorities, among others, has indicated this to the legislator. The legislator has therefore decided to solve the undesirable consequences of this concurrence and therefore from 1 January 2025 a separate scheme for write-off profits for corporate income tax purposes will apply.

From 1 January 2025, there will be two systems for corporate income tax:

If the losses from the past to be set off are less than 1 million euros, then this first system applies. The waiver profit is exempt insofar as that profit exceeds the losses to be set off (past losses and the annual loss). In fact, this is the system that applied to all situations until 2022. After all, in these situations there is no problem with the limited set-off of losses, because we remain below the applicable limit of 1 million euros in profit.
If the losses from the past to be offset exceed 1 million euros, a new scheme applies. This new scheme means that the write-off profit after offsetting the annual loss is fully exempt. After that, the carry-forward losses from the past are reduced by the amount of the exempt cancellation profit. As a result, the compensable losses are lost for this amount and ultimately no corporation tax is due in the year of the cancellation. It is noteworthy that this scheme can also apply in situations where there was actually no problem, namely if the profit, including the cancellation profit, remains below the 1 million limit. However, the legislator refers to the amount of losses to be deducted and not to the amount of the profit. However, this does not matter in terms of numbers in this example, as we will see in a moment.

In the example given above, this means that under the new scheme, the debt cancellation profit will be exempted for 5.5 million euros (6 million euros minus 500,000 euros). The 500,000 euros is the loss of the year of the remission. Subsequently, the carry-forward losses from the past (in this case 4 million euros) are set at zero.

There will therefore be a higher exemption, which will then be reversed by a limitation of the losses that can be carried forward. As a result, the taxable taxable amount will be zero.

In fiscal unit situations, the rules may work out differently. There are known situations in which a business restructuring can still lead to payment of corporation tax due to bottlenecks surrounding the rules for loss set-off. We therefore advise you to contact your PwC advisor in such situations.