On 27 November 2015 the government of the Netherlands announced that it will appeal against the EU Commission’s (‘the Commission’) decision from 21 October 2015 that the Advance Pricing Agreement (‘APA’) concluded between a Dutch BV and the Dutch tax authorities qualifies as forbidden State Aid. The main reason given for the appeal is the fact that the Dutch tax authorities consistently apply internationally accepted methods and that the Commission’s approach raises a lot of questions.
According to the Netherlands, the Commission uses criteria that deviate from art. 9 of the OECD Model Income Tax Treaty (the at arm’s length criterion) and the OECD transfer pricing guidelines that are based on article 9 of the OECD Model Income Tax Treaty. According to the Netherlands, the approach used by the Commission has no basis in the internationally accepted principles. The Netherlands also provided a summary of the EU Commission’s decision. In its statement from 27 November 2015 the Dutch government reiterates its position that international tax avoidance should be tackled without harming the Dutch investment climate. In this respect the Dutch government announces a couple of new initiatives.
Summary of the EU Commission’s decision
The summary contains a couple of interesting aspects. The main focus of the Commission is the question whether a selective advantage has been granted to the Dutch BV. In this respect, the position of the Commission is that the non-binding OECD Model Tax Treaty should not be used as a relevant point of reference. The same applies to article 8b of the Dutch Corporate Income Tax Act (which contains the at arm’s length principle) and the Dutch Transfer Pricing Decree. Instead the European principle of equality should serve as a point of reference. Under the principle of equality, enterprises that are factually and legally in the same position should receive the same treatment. According to the Commission, equal treatment in similar circumstances is a business principle, which according to the Commission is equal to the at arm’s length principle.
According to the Commission, the APA does not result in a reliable approach of the outcome in a market situation and as a result does not meet the business or at arm’s length principle. The Commission lists the following elements which lead to this conclusion:
- The APA uses the Transactional Net Margin Method (TNMM), whereas the OECD Guidelines and the Dutch Transfer Pricing Decree state a preference for the Comparable Uncontrolled Price Method (CUP).
- Even if the use of TNMM method would be considered an acceptable method, the APA leads to taxable profit of the Dutch BV which is too low.
According to the Commission, application of the CUP would have lead to an increase of the taxable profit of the BV in the Netherlands since the royalty paid by the BV to a UK based entity for the use of know how, is too high. In addition, according to the Commission the price paid for certain raw materials by the BV to a Swiss group company is also too high.
The Commission gives the following substantiation of its position that the royalty paid is too high.The size of the royalty is variable and depends on combining the accounting profit of the Dutch BV with the remuneration agreed upon in the APA in the form of a fixed lift-up on the operational costs of The Dutch BV. As a result, it is not possible to judge whether the size of the royalty meets the business principle. In addition, according to the Commission, application of the CUP should lead to a royalty payment of zero. The Commission bases this position on analysis of several comparable agreements for the production process that the concern concluded with other producers from all over the world. In addition, the Commission mentions that The Dutch BV apparently does not benefit from the use of the production process IP. An independent company would not have been willing to pay for a license if it would not be able to recover the royalties paid. According to the Commission, the position of the Netherlands that the UK based entity runs the economic risk of the loss of stock cannot be accepted for a number of reasons. First of all this could lead to the situation where it would be possible to surpass the economic reality, either on the basis of arguments or on the basis of contracts. In addition, according to the Commission the UK based entity does not have the capacity to carry the risk of loss of stock, since it does not have any employees of its own. According to the Commission, the size of the royalty payment can also not be justified by the amounts the UK based entity pays to the concern for technology.
The cost price of green beans
The Commission lists a couple of circumstances which should lead to the conclusion that the price paid for the raw materials is not at arm’s length. The Commission specifically pinpoints to a significant price increase in 2011. Basically the Commission questions the consistency and the business character of the figures supplied by the concern.
According to the Commission, instead of The Dutch BV, the UK based entity should have been considered the entity with the least complex function. The UK based entity does not have any employees and has a very limited operational capacity. The activities performed by The Dutch BV exceed the activities typically performed by a routine producer.
According to the Commission, even if section 8b of the Dutch Corporate Income Tax Act and the Dutch Transfer Pricing Directive should be used as relevant rules of reference, the APA does not lead to an outcome that is in conformity with the business principle. The summary of the Commission’s position does not provide a further substantiation of this position.
New initiatives announced by the Netherlands
On 27 November 2015 the Netherlands also listed a couple of existing and new initiatives within the framework of its ongoing effort of tackling international tax avoidance whilst maintaining a favorable investment climate in the Netherlands.
- In spring 2016, the Netherlands will publish a legislative proposal which will forbid trust companies to supply services if these services relate to the implementation of structures that are designed to maintain the anonymity of the ultimate beneficiary. From the announcement it is not clear whether this proposal only focuses on cross border situations or whether purely internal Dutch situations are covered, too.
- A study will be performed on the difference in treatment between NV’s, BV’s and Cooperatives for the application of the Dutch dividend withholding tax in an international context.
- During its upcoming EU Presidency, the Netherlands is going to aim at a further increase of tax transparency. As part of this initiative, the Netherlands is going to push for publication of the guidelines of the EU Code of Conduct.
Observations by Meijburg & Co
The appeal of the Dutch government against the Commission’s decision in the State Aid case is a welcome development. The relevant issue is whether the position of the Commission is correct that for State Aid purposes the EU’s principle of equal treatment can override the internationally accepted OECD transfer pricing rules. Should the ECJ uphold the Commission’s position, the question then becomes how the ECJ will interpret the state aid criteria, especially the selectivity criterion, in a tax case which concerns the setting of prices for services performed between related group companies. Should however the ECJ hold that the OECD transfer pricing guidelines should be used as a point of reference also for application of the EU state aid rules, the question then is whether according to the ECJ the Commission has the authority within the framework of the State Aid rules to monitor application of these rules in individual cases and to override judgments by the national tax authorities or national tax courts. The ECJ’s decision will no doubt be a landmark decision. The decision will most likely also have an impact on the ongoing debate between the EU institutions, including the EU Parliament, and individual Member States on the issue on tax sovereignty.