May 28, 2015
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Dutch Partnership Agreements - Bankruptcy Clause
International structures as used by multinational companies typically could include limited partnerships or general partnerships. If the Netherlands is involved in these international structures, these 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 GT Alert may be helpful in further managing and controlling the tax risks within such structures.
Based on the specific wording in the partnership agreements, the bankruptcy1 of a partner could imply that the partnership becomes a taxable entity for Dutch tax purposes. 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 would be 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 of the partnership, the partnership agreement must be carefully drafted, as set out below.
Dutch Civil Law
Based on the Dutch civil code2 a partnership will be terminated as a general rule by:
- Lapse of time in case of partnerships for a definite period of time;
- Fulfillment of the object of the partnership;
- Termination by one of the partners;
- Death, legal restraint (curatèle), 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 Agreements
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 United States Code shall cause the dissolution of or otherwise terminate the Partnership”
Furthermore, if a (continuation) clause in the partnership agreement would state 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 would practically imply 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 out3 of all other partners. 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. Special rules apply to partnerships that are partners of other partnerships.
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.
Existing partnership agreements should be assessed and, where necessary, amended to ensure that the bankruptcy of a general partner does not lead to the termination of the partnership agreement and trigger adverse tax consequences. This may be achieved by including an appropriate continuation clause and avoiding automatic transfer of the partnership Interest through an automatic transfer whereby only one partner remains.
1 Bankruptcy in this respect also includes the application of the debt restructuring regime for natural persons and any other insolvency procedure what becomes applicable to a Partner, such as “Chapter 11” in the United States.
2 Section 7A:1683 (4°) of the Dutch Civil Code.
3 Refer to the Decree Dutch Ministry of Finance, January 11, 2007, nr. CPP2006/1869M.