Transfer Pricing Mismatches in the Netherlands has been saved
Transfer Pricing Mismatches in the Netherlands
Soon to be a thing of the past
In this blog we provide an overview of the new measures related to transfer pricing mismatches in the Netherlands when applying the arm's length principle and particularly their impact on group financing and licensing structures, effective for financial years starting on or after 1 January 2022.
On 21 September 2021, the Dutch Ministry of Finance published the government’s tax plan for 2022. The plan includes several proposals that are relevant for international companies and Dutch taxpayers alike, not the least important of which is a special provision preventing transfer pricing mismatches when applying the arm's length principle. Deemed deductions in relation to interest or royalties, without a corresponding upward adjustment at the counterparty, will no longer be allowed going forward. Multinationals relying on such set-up thus should act quickly to avoid being caught by these new rules. In this blog we provide an overview of the new measures related to transfer pricing mismatches and particularly their impact for Dutch financial services companies (“FSC”), effective for financial years starting on or after 1 January 2022.
FSCs are Dutch resident corporate taxpayers whose main activity (i.e., at least 70%, excluding any holding activities) is to receive and pay interest/royalties, etc. from and to related parties within a Multinational Group.
The FSCs of multinationals are quite a common setup in the Netherlands and could be established for a number of good reasons. The Netherlands, while being a small sized EU country, offers a rare combination of a good finance and payment infrastructure, rule of law and a very educated workforce. And, last but certainly not least, companies established in the Netherlands have access to the Dutch tax treaty network, which is one of the most comprehensive ones in the whole world, provided that substantial activities are performed combined with the presence of appropriate risks.
In the last few years these FSCs, also referred to as conduit and empty postal box companies in mass media, are heavily scrutinized. The Netherlands is currently pro-actively investigating its involvement in facilitating unwanted structures with little to no substance. In 2021, a committee was appointed by the Dutch parliament to conduct a detailed research into FSCs and they were asked to come up with options to combat the FSC’s that are particularly used for tax avoidance. The results of this research should be expected in the upcoming months.
As part of the government’s tax plan for 2022, and in light of the country’s desire to demonstrate active contribution against undesired international tax planning, in late 2021 the Netherlands formally introduced a proposal that aims to combat avoidance of (Dutch) corporate income tax through international interpretation differences on the arm’s length principle, also called transfer pricing mismatches.
Preventing Transfer Pricing Mismatches in Informal Capital Regimes
Previously, any intercompany loans conducted by, inter-alia, FSCs in the Netherlands that did not bear an arm’s length interest rate would be subjected to a transfer pricing adjustment (i.e., for tax purposes) in order to ensure a taxable profit that would meet the arm’s length principle, would be reported in the Netherlands. Below a sample setup is illustrated.
These situations, notional deduction in the Netherlands but no pick-up on the other side as a result of different applications of the arm’s length principle, are now combated by the introduction of the new measures. Effective for financial years starting on or after January 1 2022, no downwards adjustments are allowed in situations where another state does not impose a corresponding upward adjustment on the deemed interest expense at B BV. In the example provided above, B BV is only allowed to deduct the deemed interest expense and limit the net interest income only to the extent that the foreign company providing the loan (i.e., A Co.) includes the interest income in its taxable base with a corresponding transfer pricing adjustment.
Although the situation described above pertains to a financing structure, the measures will also be applicable to other situation where transfer pricing mismatches arise for FSCs, e.g., non-royalty bearing (sub-)licensing, etc., but also for other types of structures and entities, such as regional principal entities and related IP licenses.
TP implications of cleaning up of informal capital structures regimes
Unsurprisingly, these changes have already led to restructurings by multinationals of their current group financing and licensing flows. This is being done by loan prepayments prior to the original maturity date, capitalization of the loan receivables, discontinuation or terminating of the existing licensing agreements, etc. In other instances, arm’s length interest and royalty rates are incorporated in the relevant agreements.
One should be mindful that any form of termination or exit of these financing / licensing activities in the Netherlands before the originally specified maturity date may lead to challenges or an exit fee discussion.
For transfer pricing purposes, it is prudent to conduct a two-sided assessment and consider the options realistically available to the parties when entering into a transaction. Specifically, the OECD Guidelines indicate that any analysis should consider the “options realistically available” to the parties involved in an intercompany transaction. Such approach involves a two-sided transfer pricing analysis in which the alternatives of both parties are considered, including contractual terms and conditions to be agreed by them.
Building on the above, historically the Dutch Tax Authorities have taken the position, especially in an APA context, that any termination of activities should be in accordance with arm’s length behavior and hence, an exit fee might be due for giving up any profit related potential by terminating the financing/licensing activities pre-maturely, i.e., indemnity for losing the related profit potential, associated with the positive historic financing/licensing spread that the Dutch taxpayer enjoyed. The reasoning thereof being that in an arm’s length/market context, a third-party would likely not agree to terminate its profitable activities without an appropriate compensation. Such discussions could result in an exit fee that will be included for Dutch CIT purposes (taxed at 25%, upper bracket as of 2021).
It is therefore advised to thread carefully and diligently when amending the existing structures. In that regard preparing a comprehensive defense file which describes in detail the considerations behind the termination or amendment of the transaction involved is crucial. Having appropriate transfer pricing documentation for the position taken is not only a mandatory requirement it also safeguards that the burden of proof does not shift from the inspector back to the tax payer, similar to the quick fixes implementation on the earnings stripping rules from a few years ago and the common challenges we saw.
How to prepare
In order to properly prepare for potential scrutiny, it is thus crucial to prepare contemporaneous documentation in the form of a Transfer Pricing defense file, which details, inter-alia, the following:
- The business rationale for the restructuring;
- The two-sided perspective and options realistically available to all companies party to the transactions;
- Whether the loan agreements and/or limitation of risk agreements (if applicable) contain relevant clauses for dealing with such scenarios, and might thus have been captured in the price setting of the transactions;
- Transfer pricing assessment of a potential compensation for giving up profit potential or substantial renegotiations of any contracts, consistent with the guidance in Chapter IX of the OECD Transfer Pricing Guidelines dealing with business restructurings.