Netherlands: Internet consultations launched on reverse hybrid entities and transfer pricing mismatches | Deloitte NL

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Netherlands: Internet consultations launched on reverse hybrid entities and transfer pricing mismatches

On 4 March 2021, the Dutch government published internet consultations on proposals to regulate reverse hybrid entities for Dutch tax purposes and to combat transfer pricing mismatches. Various stakeholders can send comments to the Dutch Ministry of Finance until 2 April 2021. It is our experience that normally no major changes are processed in the course of getting to a formal law proposal. Both proposals are aimed to enter into force on 1 January 2022.

4 March 2021

Reverse hybrid entities treated as tax residents and withholding agent

Background

 

The proposal details potential changes into the Dutch corporate income tax act 1969 (DCITA), the Dutch dividend withholding tax act 1965 (DDWTA) as well as the Dutch conditional interest and royalty withholding tax act 2021 (DCWHTA). The proposal mainly amends legislation that has already been introduced but has not yet entered into force.


Changes to the DCITA

Already due to the Dutch implementation of ATAD2 specific rules relating to the tax liability of Dutch reverse hybrid entities as of 1 January 2022 were adopted. In the consultation proposal these rules are reversed and replaced by similar new rules. According to the proposal, a Dutch reverse hybrid entity (either a Dutch incorporated or Netherlands based partnership) in scope of the rules is an entity that is – without the application of this rule – considered transparent for Dutch tax purposes, whereas at least 50% of the voting rights, capital or profit entitlement is held by related investors that consider the entity to be non-transparent (e.g. a Dutch CV). Such a reverse hybrid entity would become subject to tax in the Netherlands. In order to avoid double taxation, a deduction rule would apply for profits attributable to investors that treat the Dutch reverse hybrid entity as transparent. As a result, the reverse hybrid entity would become subject to tax insofar the income of the entity is not taxed at the level of the investors.

Under the proposal, the reverse hybrid rule would not apply to regulated collective investment funds (UCITs and qualifying AIFs) that are a Dutch incorporated or Netherlands based partnership.

Due to the full tax liability, reverse hybrid entities are considered to be residents of the Netherlands, as a result of which these reverse hybrid entities will also qualify as treaty residents.

Because the reverse hybrid entity will become a Dutch tax resident as from 2022, payments made by a Dutch taxpayer to that entity as from 2022 would no longer fall within the scope of the ‘regular’ anti-hybrid rules effective as from 2020.


Changes to the DDWTA

As already announced, the Dutch reverse hybrid in scope of the DCITA-rule explained above, will qualify as the beneficiary and as such become liable to Dutch dividend withholding tax. In addition, the Dutch reverse hybrid will also become the withholding agent towards its investors insofar as the interest held by the investor will be qualified as a ‘share’. This will only be the case if the investor qualifies the Dutch reverse hybrid as an entity. In order to avoid that by interposing a Dutch reverse hybrid the dividend withholding tax exemption can be applied in full, whereas this would not be the case without the interposed reverse hybrid, an anti-abuse rule is proposed.


Changes to the DCWHTA

Similar to the changes in the DDWTA, the Dutch reverse hybrid in scope of the DCITA-rule explained above, will qualify as the beneficiary for purposes of the DCWHTA. However, the Dutch reverse hybrid will only be liable to tax insofar as the interest or royalties paid to a Dutch reverse hybrid are allocable to the investors that qualify the Dutch reverse hybrid as transparent and a direct payment to the investors would have been subject to the interest and royalty withholding tax (i.e. related party established in a low-tax or non-cooperative jurisdiction). In addition, the Dutch reverse hybrid will become a withholding agent towards its investors (related parties established in a low-tax or non-cooperative jurisdiction) that qualify the entity as non-transparent.

Transfer pricing mismatches

Background

This proposal aims to combat avoidance of (Dutch) corporate income tax through international interpretation differences on the arm’s length principle; also called transfer pricing mismatches which may include informal capital. The intention is to introduce new provisions in the DCITA effective for financial years starting on or after 1 January 2022, that no longer allow a downward adjustments in situations where another state would not allow a corresponding upward adjustment. The new article 8ba DCITA would become applicable to downward adjustments both relating to costs and benefits and is limited to cases where it concerns associated entities. The government expects to raise EUR 173 million of structural annual tax revenue with this measure.


No corresponding upward adjustment

As an example, ForeignCo grants an interest free loan to a Dutch BV. Under current law, Dutch BV would be entitled to deduct an arm’s length interest expense on the loan, irrespective of whether a corresponding interest revenue is taken into account at the level of ForeignCo. If ForeignCo would have been a Dutch resident, a corresponding upward adjustment would need to be made. Under the proposal, BV is only allowed to deduct the interest to the extent that ForeignCo includes an arm’s length interest revenue in its tax base. It is irrelevant whether the deemed interest revenue in the end is effectively taxed provided the jurisdiction of ForeignCo is not a jurisdiction without a profit-based tax. As a result, ForeignCo can be subject to an effective 0% (or low) tax rate, or it can utilize the deemed interest revenue to offset against losses. The application of CFC rules at the level of the shareholder of ForeignCo, following which any deemed interest at the level of ForeignCo is expected to be taxed, is not relevant, as the upward adjustment needs to be made at the level of ForeignCo itself. As a result, the criterion would be that a corresponding upward adjustment is made at the level of the other entity involved.

A comparable reasoning is applied for the situation where Dutch BV would provide a loan to ForeignCo, agreeing on an interest rate that is higher than an at arm’s length rate would have been. In that situation, it would be possible that the interest is deductible against the higher rate at the level of ForeignCo, where current rules would require Dutch BV to make a downward adjustment on the income. For these situations as well, the downward adjustment would be disallowed to the extent no corresponding adjustment is made at the level of ForeignCo.

A transfer pricing mismatch as explained above, may for example trigger a deemed dividend for the amount of the mismatch that arises for Dutch corporate income tax purposes. For these situations it is explained that such so-called “secondary transactions” are not taken into account.


Double deductions

Situations of a transfer pricing mismatch under the proposal may also arise in situations of double deduction. Such situations could exist where costs are incurred and deducted at the level of an entity, where according to local transfer pricing rules the costs would belong at the level of another associated entity (as well). If the Dutch BV would be this other group entity, the deduction would be rejected based on the proposed rules. It would be up to the Dutch resident taxpayer to substantiate that a corresponding upward adjustment is made and that the upward adjustment is included in a profit tax base.


Basis for depreciation

In case an asset is transferred by a group entity to a Dutch BV, the Dutch BV would in principle be entitled to value the asset at fair market value for Dutch corporate income tax purposes. If, however, the book value of the asset is lower than the fair market value of the asset and the transferring entity would only take into account the lower book value of the entity in its tax base, the new provision would require the Dutch BV to take into account that lower book value as the book value after the transfer. The Dutch State Secretary for Finance is of the opinion that ‘assets’ include both operational business assets as well as receivables.


Entry into force and retroactive effect

As mentioned, it is intended to introduce the new legal provisions for financial years starting on or after 1 January 2022. Only in relation to the limitation of the depreciation/amortization base, the rules can have retroactive effect of five years under the following conditions:

  1. The Dutch taxpayer received an asset from an associated entity in a period of five years before the first financial year starting on or after 1 January 2022;
  2. There is still a basis for depreciation at the beginning of that first financial year; and,
  3. The asset would have been valued at a lower amount if the new rules had been applied.


If those conditions are met, the depreciations on the asset will be calculated, as of the first financial year starting on or after 1 January 2022, based on the lowest of the following amounts:

  1. The value the asset would have been accounted for at the time of the transfer if the proposed new article would have been applicable at that time; or,
  2. The book value of the asset at the time immediately before the first financial year starting on or after 1 January 2022.


The retroactive rule only relates to the amount that is allowed for depreciation. It does not oblige for revaluation of the asset concerned.

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