European Commission slaps Dutch government on the wrist: the end of AT1 coupon tax deductibility?

Just the other day, the Dutch government announced plans to end the favorable tax treatment of CoCo securities. From 1 January 2019 onward, the tax deductibility of the coupon paid on Additional Tier 1 capital instruments will end. [1] See a Google translation of the announcement here.

Such a change in tax treatment likely constitutes a Tax Event, mainly because these plans are not foreseen. Once unforeseen, the issuing bank can call the instrument. See for example this line in the Terms and Conditions of a recent ABN Amro CoCo: “The Issuer may, at its option, redeem all, but not some only, of the Capital Securities on the First Call Date or on each Interest Payment Date thereafter (the “Issuer Call Option”), or at any time upon the occurrence of a Tax Event or a Capital Event, in each case at their Prevailing Principal Amount plus accrued and unpaid interest (if any).”  This is all perfectly legal [2].

State support

These plans are an interesting U-turn. In 2014, the government bent over backwards to secure the favorable tax treatment. See my comments here.

One explanation for the change of mind is that the Dutch government started realizing that it is insane to treat as debt any instruments that walk and talk like equity. If CoCos cannot be distinguished from equity, then treat them as such. Fair enough.

However, if you ignore the spin that the Dutch government puts on this decision in the accompanying explanation, then it is obvious that this is a European Commission decision about State Support. The Dutch government supports financial institutions without justification. Just look at this letter of the EC, translated here. The Commission does not mince its words: it “… considers these questionable rules offer preferential treatment to banks and insurance companies that raise state aid concerns.”  The Commission then prompts the Dutch government to change the rules without delay … or else it will take drastic measures.

A harmonized approach?

The Dutch government expects the Commission to apply the decision to end tax deductibility of AT1 coupons to all countries. That remains to be seen. Tax harmonization in Europe? Unlikely in my life.

[1] I am indebted to Jeroen van Wensen – thanks for pointing out this upcoming law change.

[2] The relevant prudential rule that explains that an issuer can buy an AT1 or Tier 2 instruments back is CRR Article 78 4. (b): “The competent authorities may permit institutions to redeem Additional Tier 1 or Tier 2 instruments before five years of the date of issue when there is a change in the applicable tax treatment of those instruments which the institution demonstrates to the satisfaction of the competent authorities is material and was not reasonably foreseeable at the time of their issuance.”