International structures as used by multinational companies may typically include limited partnerships or general partnerships.
If the Netherlands is involved in international structures, the partnerships may be set up in such a way that they qualify as transparent for Dutch tax purposes. Further, partnerships could be used to manage the recognition of taxable income (for example, the so-called CV-BV structures). This article may be helpful to further manage and control the tax risks within such structures.
Based on the specific wording in the partnership agreements, the bankruptcy of a partner could imply that the partnership becomes a taxable entity for Dutch tax purposes.1 As a result, upfront taxation on any hidden reserves and goodwill may occur. Further, the bankruptcy of a partner may imply that it is no longer possible to manage the recognition of taxable income, which could result in upfront taxation.
Such issues may arise if the partnership is terminated due to the bankruptcy of a partner, or if the bankruptcy of a partner results in an automatic transfer of the partnership interest of such partner. To ensure continuity, the partnership agreement must be carefully drafted, as set out below.
Dutch civil law
Based on the Dutch civil code, a partnership will be terminated as a general rule by:2
- Lapse of time in case of partnerships for a definite period of time.
- Fulfilment of the object of the partnership.
- Termination by one of the partners.
- Death, legal restraint (curatele), bankruptcy (of one of the partners) or application of the debt restructuring regime for natural persons (schuldsaneringsregeling natuurlijke personen). An important aspect in this regard is that bankruptcy of a partner (general or limited) does not trigger bankruptcy of the partnership. However, it results in the termination of the partnership. Bankruptcy of the partnership, on the other hand, does imply bankruptcy of all general partners (beherend vennoten) and, therefore, termination of the partnership.
Wording Partnership Agreement
The above implies that a partnership is terminated due to the bankruptcy of a partner if no special wording is included in the partnership agreement. As a result, upfront taxation could arise.
To prevent termination of the partnership if a partner goes bankrupt, or one or more of the other grounds listed above applies, the partnership agreement should include a continuation clause, which could be worded as follows:
‘Neither the admission, election nor entry of a new partner of the partnership, nor the voluntary or involuntary withdrawal as partner from the partnership, nor the bankruptcy, liquidation, dissolution, of any of the partners or the application of any other insolvency procedure to a partner, including, but not limited to, Chapter 11 of Title 11 of the US Code shall cause the dissolution of or otherwise terminate the partnership.’
Furthermore, if a (continuation) clause in the partnership agreement states that the partnership interest of a partner that has gone bankrupt is automatically transferred to the residual partners, this could still result in an automatic and uncontrolled termination of the partnership.
A partnership needs to have at least two partners. Therefore, if the automatic transfer of the partnership interest implies that only one partner remains, the partnership would still be terminated, regardless of the fact that a continuation clause, as mentioned above, is included in the partnership agreement. Again, upfront taxation could arise as a result of this.
To prevent such a possible automatic termination of the partnership and to prevent possible upfront taxation, an ‘automatic’ transfer of a partnership interest should be prevented. Practically, this could be ensured by stating that, at the bankruptcy of a partner, the partnership interest would be transferred to the residual partners only after written confirmation of this by the residual partners. The residual partner(s) could then ensure that the partnership continues to have at least two partners before consent for the transfer is provided.
Dutch tax law
For Dutch tax purposes, a partnership generally only qualifies as transparent if the admission and transfer of limited partners in the partnership is subject to the unanimous consent (which consent is deemed to be provided if no negative answer is received within four weeks after a written request for consent was sent out), of all other partners.3 This unanimous consent requirement needs also to be met in the situation wherein a partnership interest is transferred as a result of the bankruptcy of a partner.
To ensure that the partnership continues to qualify as transparent for Dutch tax purposes, the continuation clauses or ‘automatic’ transfer should therefore only result in an actual transfer of a limited partnership interest after this unanimous consent has been provided.
Proposed amendment of the Dutch civil code
Currently a legislative proposal implementing new rules for partnerships has been adopted by the Dutch Parliament and is submitted to the Dutch Senate. These new rules are estimated to become effective at the beginning of 2011. Under these new rules, bankruptcy of a partner will no longer cause termination of the partnership, unless the partnership agreement provides otherwise. It may, therefore, no longer be necessary to include the above described continuation clause after the proposed amendment has become effective. The comments regarding the automatic transfer would however continue to apply.