On July 10, 2017 the Deputy Minister of Finance, Mr. Eric Wiebes, published a document for internet consultation aimed at the introduction or amendment of a number of anti-tax avoidance measures. These measures include the introduction of an interest deduction limitation and changes to the participation exemption and are prescribed under the European Anti-Tax Avoidance Directive (ATAD1). The changes must take effect on January 1, 2019.
Overview of proposed measures
The European Anti-Tax Avoidance Directive (hereinafter: ATAD1) prescribes that the Netherlands implement five measures against the avoidance of corporate income tax:
- limit the deductibility of interest by way of earnings stripping rules;
- exit tax rules;
- a general anti-abuse rule (GAAR);
- rules for foreign companies and permanent establishments (controlled foreign companies; CFCs);
- a measure against hybrid mismatches (hybrid entities and hybrid financing).
The consultation proposal only covers the first, second and fourth measures. The third measure has not led to a proposal for additional legislation, because the Cabinet believes this measure has already been implemented through the abuse of law principle (fraus legis). The fifth measure does not have to be implemented until the end of 2019 (unlike the first four that, in principle, have to be implemented by the end of 2018) and will therefore be deferred until a subsequent internet consultation.
Basis for implementation
Because of the caretaker status of the present Cabinet and the coalition negotiations surrounding the formation of a new government, the consultation document (draft bill) is based on the implementation of the minimum required. It is up to a following Cabinet to take a position on the explicit options offered by ATAD1 and to go beyond the minimum required.
Interest deduction limitation
The consultation document proposes an interest measure (the new Section 15b Corporate Income Tax Act 1969; “CITA”) which stipulates that interest expenses are non-deductible insofar as the excess interest expense (i.e. the difference between deductible and taxed interest) exceeds 30% of the EBITDA for tax purposes (i.e. the taxable profit increased by the excess interest expense and the amount of write-offs). Interest income and expenses are not taken into account insofar as these are allocable to a foreign permanent establishment. Several concessions are proposed:
- an exception for a taxpayer that is not part of a group within the meaning of Section 2:24b Dutch Civil Code and that does not have any affiliated entities (with a 25% affiliation criterion applying) or a permanent establishment;
- a provision providing for the excess to be deductible up to an amount of EUR 3,000,000 if that is higher than the 30% of the EBITDA for tax purposes;
- a group escape with two variants. Under the first variant, the limitation does not apply if – in short – the ratio of equity to total assets of the taxpayer is at most 2 percentage points lower than the corresponding group ratio. Under the other variant, the percentage of 30% as it applies in the EBITDA rule is replaced with the ratio of net group interest income to pre-tax result of the group, if that ratio is more than 30%.
- the carry forward of non-deductible interest (unlimited)
The consultation document chooses not to make an exception for financial institutions and for public infrastructure projects, nor has it opted to use grandfathering for loans entered into before June 17, 2016.
The consultation document only mentions in passing “the possibility of reconsidering some existing specific interest rate limitations”, whereby this probably refers to Sections 13l and 15ad CITA. However, no proposals about this are made.
The exit tax prescribed by ATAD1 is already contained in Dutch tax legislation and, as such, the law does not have to be amended. However, some changes are necessary in respect of the provisions on the deferral of payment of exit taxes. The Tax Collection Act currently provides for a deferral spread over a 10-year period; according to ATAD1 this should not be more than 5 years. For corporate income tax purposes, it has therefore been proposed shortening the deferral to five years (the 10-year period is retained for personal income tax purposes).
The CFC measure (Section 15ba CITA) will apply to a taxpayer’s controlled entities and permanent establishments. There is a controlled entity if the taxpayer, whether or not together with an affiliated entity or affiliated individual (with a 25% affiliation criterion applying), directly or indirectly has an interest of more than 50% (based on nominal paid-in capital, statutory voting rights or profit). To be regarded as a controlled entity requires that the particular entity is not subject to a profit tax that is fair according to Dutch standards. A tax rate of less than 12.5% on the taxable profit determined according to Dutch standards is, broadly speaking, not considered a fair tax. With regard to whether a taxpayer’s permanent establishment falls under the scope of the CFC rules, this should be determined solely on the basis of the fair tax test.
For controlled entities or permanent establishments that fall under the CFC measure, ATAD1 provides for two potential consequences: application of model A or model B. When applying model A, consideration should be given to the type of income received by the controlled entity or permanent establishment. This concerns interest, royalties, dividends, capital gains on shares, benefits derived from financial leasing, benefits derived from insurance, banking or other financial activities or specific invoicing activities (‘tainted benefits’). When applying model B, the focus is on the transaction underlying the manner in which the entity or the permanent establishment realizes income (artificial transactions primarily aimed at obtaining a tax benefit). In accordance with the wishes of the Lower House, the consultation documentation has opted to apply model A, but it is possible that a new Cabinet will ultimately choose to apply model B.
When applying model A, the tainted benefits derived by the controlled entity (to the extent not distributed by the controlled entity prior to the taxpayer’s year-end) or the permanent establishment are allocated to the taxpayer. These benefits will thus become part of the taxpayer’s Dutch profit. It is crucial that this allocation should also take place if the controlled entity is part of a chain of companies where, at the taxpayer, the participation exemption applies to the first link in the chain; for example, on the basis of the intention test, the subject-to-tax test or the assets test.
In accordance with ATAD1, the CFC measure will not apply if 70% or more of the benefits derived by the controlled entity or permanent establishment consist of benefits other than tainted benefits or if this involves a regulated financial institution (provided certain conditions are met). The measure will also not apply insofar as the controlled entity or permanent establishment performs a significant economic activity, supported by staff, equipment, assets and premises. The Netherlands has chosen not to use the option included in ATAD1 to limit this exception to EU and EEA situations. Accompanying measures are proposed as regards the interaction with the participation exemption as well as the granting of a tax credit for foreign tax levied on a controlled entity or permanent establishment.
Meijburg & Co comments
With regard to the text of ATAD1, the consultation document holds few surprises. Important practical matters still remain. In the area of the interest deduction, this especially concerns the extent to which existing measures will be maintained after implementation. In the area of the CFC measure, this concerns the precise implementation and application of the exception clause for significant economic activities. Depending on the scope of that exception, existing structures may have to be restructured before January 1, 2019.
We will keep you updated on further developments.