Decree on lucrative interest in international situations has been saved
Decree on lucrative interest in international situations
The State Secretary’s Decree on the levy of tax on lucrative interest income in cross border situations provides more clarity.
24 November 2021
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- Non-Dutch tax residence and lucrative interest under a treaty
- Work in one or several countries
- Emigration and indirectly held lucrative interest
In an important decision for the practice, the State Secretary for Finance has published a Decree stipulating how lucrative interest income is taxed in cross-border situations, clarifying the ambiguity that had so far plagued the taxation and allocation of lucrative interest income in international situations. In the Decree, the State Secretary for Finance takes a position on (i) non-Dutch tax residents with a lucrative interest, (ii) treaty application in the case of a lucrative interest combined with work in one or several countries, and (iii) holding an indirect lucrative interest and selling that interest after emigration from the Netherlands.
The lucrative interest legislation aims to tax returns on investments in qualifying shares or other property rights in box 1. The general characteristics are that the capital rights serve as a remuneration for work performed and that the investment is relatively low in proportion to the relatively high profit potential.
According to the main rule, benefits from lucrative interest are taxed as results from other activities because of the nexus with the taxpayer’s work. They are taxed in box 1 (progressive rate of up to 49.5% in 2021).
By way of concession, the law provides that benefits are taxed in box 2 (fixed rate of 26.9% in 2021) instead of in box 1 if:
- the lucrative interest is indirectly held through a holding company in which a substantial interest is held, and
- at least 95% of the benefits from the lucrative interest is earned within the calendar year, classified as substantial interest income (referred to as a dividend payment obligation).
Non-Dutch tax residence and lucrative interest under a treaty
The State Secretary for Finance argues that domestic legislation on non-Dutch tax residents with a directly or indirectly held lucrative interest permits the Netherlands to levy tax on the benefits derived from this lucrative interest provided this interest is also intended as a remuneration for work in the Netherlands. The State Secretary for Finance argues that this is also possible if the company that issued the lucrative interest shares is established outside the Netherlands. Under the tax treaty, the Netherlands’ power to tax can be limited. For the application of the tax treaty and the allocation of the power to tax to the states involved, the State Secretary for Finance considers it important whether the lucrative interest is held directly or through a holding company (indirectly).
In the Decree, the State Secretary for Finance provides the following guidance for treaty application.
- Both if the lucrative interest is held directly and if the lucrative interest is held indirectly without meeting the dividend payment requirement, the tax rate on the benefits from lucrative interest will be allocated under the article for income from employment (article 15 OECD Model Tax Convention, hereinafter ‘OECD MTC’) or the article for directors’ and supervisory directors’ fees (article 16 OECD MTC).
- If the lucrative interest is held indirectly (through a holding company) and the dividend payment obligation is met, the apportionment of the power to tax the lucrative interest benefits for (i) regular benefits (dividend payments) will be made under the dividends article (article 10 OECD MTC) and for (ii) capital gains (sales profit) under the capital gains article (article 13 OECD MTC).
Since the introduction of the lucrative interest legislation in 2009, the question which treaty article applies to lucrative interest income in cross-border situations has been the subject of much discussion and ambiguity. So, taxpayers and the Tax Authorities alike benefit from a clear position.
The State Secretary for Finance’s Decree offers certainty that if an indirectly held lucrative interest is involved, while also meeting the dividend payment obligation, the dividends article and the capital gains article can be applied for the allocation of the power to tax. In line with the application of the dividends article (article 10 OECD MTC), another improvement is that the application of the capital gains article (article 13 OECD MTC) is now formally accepted for indirectly held lucrative interests with which the dividend payment requirement is met.
Still, one could raise the question why this application has not been extended to directly held lucrative interests or indirectly held lucrative interests with which the dividend payment obligation has not been met.
The question is whether the distinction made here will also be followed by the other Contracting State. This seems unlikely and in certain situations this could lead to double taxation.
Work in one or several countries
The Secretary of State for Finance confirms that if the holder of a lucrative interest performs work in several countries, a pro rata approach may be possible under which the power to tax the benefits from the interest is allocated based on the work performed. This pro rata approach seems to be reserved for benefits allocated under the article for income from employment (article 15 OECD MTC) or directors’ fees (article 16 OECD MTC).
Emigration and indirectly held lucrative interest
The State Secretary for Finance argues that if the holder of an indirectly held lucrative interest emigrates, there is no fictitious or actual alienation of the lucrative interest. As far as the substantial interest is concerned, a fictious alienation does take place at the moment of emigration. The State Secretary for Finance acknowledges that if the holder of an indirectly held lucrative interest emigrates, a difference may arise between the acquisition price of the substantial interest and the cost base of the shares relating to the lucrative interest. This ‘mismatch’ may result in the dividend payment obligation not being met. The State Secretary for Finance considers such an effect to be undesirable, so he approves that the protected income from substantial interest can be taken into account as an amount distributed under the dividend payment obligation. This will prevent that the dividend payment obligation cannot be met upon emigration. Fulfilling the dividend payment obligation if a lucrative interest is held indirectly, likewise makes it possible to invoke the dividends article (article 10 OECD MTC) or the capital gains article (article 13 OECD MTC) in accordance with the acknowledgement referred to earlier. The State Secretary for Finance argues that if the dividend payment obligation is not met, the article governing income from employment (article 15 OECD MTC) or directors’ fees (article 16 OECD MTC) will apply.
This is a welcome endorsement from the State Secretary for Finance on the application of the dividend payment requirement. Even so, Deloitte questions the State Secretary for Finance’s position that in all cases the Netherlands may levy tax on the entire lucrative interest income after the emigration of the lucrative interest holder. Situations may arise in which any ties with the Netherlands no longer exist after emigration. Should this occur, one could argue that the Netherlands only levies tax upon emigration.