Tax treatment litigation costs W&I insurance – March 2024

On 14 March 2024, The Dutch tax authorities’ knowledge group published its policy regarding the tax treatment of litigation costs under a buyer W&I insurance.

The knowledge group policy relates to a buyer W&I insurance taken out in relation to the acquisition of a subsidiary. Buyer made a claim under the insurance policy which was rejected by the insurance company. The dispute resulted in legal proceedings and buyer was ordered to pay the insurance company’s litigation costs. The knowledge group takes the position that the litigation costs should not qualify as (non-deductible) acquisition costs. Consequently, such costs are tax deductible for the Dutch taxpayer.

Tax treatment acquisition costs
Under Dutch tax law, acquisition costs are generally not tax deductible under application of the participation exemption as such costs relate to the acquisition of a subsidiary.

In 2018, the Dutch Supreme Court ruled that transaction costs are non-deductible if there is a direct causal link (in Dutch: “rechtstreeks oorzakelijk verband”) between the costs and the acquisition of a subsidiary. Hence, transaction costs are considered non-deductible to the extent that the costs are incurred as a direct result of the acquisition of a subsidiary.

In 2023, the Supreme Court provided further guidance and ruled that a direct causal link which requires that the costs must be evoked by the acquisition, includes the condition that the costs have such a causal link to the acquisition that they were incurred because they were – objectively viewed – useful or necessary to achieve that acquisition. As a further clarification, the Supreme Court indicates that the costs would not have been incurred otherwise, i.e. without that (intended) acquisition. The intended direct causal link is lacking in the case of expenses that – although – would not have been incurred if the acquisition had not taken place, but which otherwise cannot contribute in any way to the realization of that acquisition. Such expenses are not in a direct causal connection to the acquisition and the expenses are therefore not useful or necessary to bring about that acquisition.

Tax treatment W&I insurance premium
In 2022, the Dutch tax authorities’ knowledge group also published its view on the tax treatment of W&I insurance premiums and payments. Based on the authorities’ internal policy, W&I insurance premiums should not be tax deductible, while payments under the W&I insurance should be tax exempt. The premiums should qualify as transaction costs that directly relate to the acquisition of a participation. As these costs are not tax deductible, a balanced outcome would result in payments under W&I insurance being exempt under the participation exemption.

For more information, please be referred to our tax alert.

Taxand’s take
The tax authorities’ knowledge group policy provides for a welcome confirmation for buyers who have taken out a W&I insurance. We agree with the reasoning behind this policy. The publication provides for additional comfort to take the position that litigation costs incurred in relation to a W&I insurance are deductible for Dutch tax purposes. The example in the published policy relates to litigation costs in relation to an unsuccessful W&I claim, however, it should in our view also apply in relation to a successful W&I claim.