New participation exemption policy decision
In addition to new approvals, the new participation exemption policy decision contains positions and reinforcements of existing policy. The new policy became effective on January 21, 2017.
22 March 2017
The participation exemption is sometimes said to embody the Dutch tax business climate - it is considered a crown jewel. Under this regulation any dividends a Dutch private limited liability company receives from a shareholding of at least 5% in a Dutch or foreign subsidiary, is free from Dutch corporate income tax. Likewise, foreign exchange profits (realized, for instance, upon disposal of the shareholding) are exempted. On the flip side, any losses incurred upon disposal of the block of shares cannot be deducted. The law includes an exception to this though: a loss can be deducted if the subsidiary is liquidated. The Dutch participation exemption is arguably the prime Dutch tax facility in the international tax practice. So, the importance of the participation exemption implementation policy of the State Secretary for Finance can hardly be overestimated. The State Secretary for Finance thoroughly overhauled the policy decision on application of the participation exemption recently. It was about time: the former policy decision had already been around for almost seven years. The new decision counts no less than twenty new components, including a number of important approvals, and applies as from January 21, 2017. This newsletter discusses only two important topics: foreign exchange issues and the liquidation loss regulation.
Foreign exchange results
Shareholdings in foreign subsidiaries outside the Eurozone often trigger foreign exchange issues. Foreign exchange results on a participation, aka forex results, are also subject to the participation exemption. The financial risks involved in such foreign exchange risks are usually avoided through hedging instruments. Their adverse exchange rate fluctuation is meant to (fully or partly) hedge foreign exchange risks. Such hedging instruments are technically not subject to the participation exemption - a tax mismatch that may result in foreign exchange results as yet arising in the taxable profit. The law includes an option to avoid this from happening, though, according to which hedging instruments related to a participation can also be included in the exemption. This requires starting an application procedure for each hedging instrument. If companies regularly enter into hedging instruments they may become entangled in a laborious process. The new policy decision contains the option to conclude a framework agreement with the inspector, to which new hedging instruments can be transferred without interference by the inspector. Of course the policy decision sets administrative conditions for this.
Another new component deserving of a positive qualification is the State Secretary’s approval of the participation exemption applying to a financial position in foreign currencies accrued in the run up to an actual acquisition of a foreign participation. That said, the State Secretary does take a rather rigid position on the hedging of foreign exchange results of indirect participations. The State Secretary considers hedging instruments for foreign exchange risks related to foreign participations held by the subsidiary to be outside the scope of the participation exemption. Central hedging of foreign exchange risks is common practice and because of this position a whole array of hard to answer split and allocation issues may rear their head.
Liquidation loss regulation
As stated, any loss a private limited liability company incurs on a participation if the related subsidiary is liquidated, can technically be deducted. Under the statutory regulation the liquidation loss represents the amount by which the amount paid (to acquire the participation) exceeds the aggregate of liquidation payments. This is taken into account once the liquidation of the subsidiary’s assets has been completed.
The regulation stipulates, however, that the liquidation loss cannot be deducted if the subsidiary is entitled to “any allowance” upon taxation of any unsettled losses of that subsidiary. The State Secretary uses the policy decision to voice his opinion on how to interpret the words “any allowance”. One of the situations where this occurs, states the State Secretary, is when the foreign subsidiary in the country of establishment applies a local regulation according to which the loss can be transferred to another group company. The United Kingdom is one country where such a regulation applies (group relief). Remarkably, the State Secretary takes the position that “any allowance” already occurs if the subsidiary has the mere option to apply such facility, even if the subsidiary does not actually do so. Why the subsidiary would not avail itself of the regulation is apparently irrelevant. Valid reasons can conceivably arise following which it is decided not to apply the regulation, such as other, more onerous effects. After all, the Dutch equivalent - the fiscal unity has its disadvantages, too. Nevertheless, the State Secretary takes the position that there is no right to deduct liquidation losses in such a situation. One can seriously question whether this strict interpretation dovetails with case law by the European Court of Justice. This case law stipulates that the tax authorities must permit private limited liability companies to capitalize a foreign loss in the Netherlands if all local settlement options have been exhausted.
The liquidation loss regulation includes another statutory limitation, i.e., the condition that if the subsidiary is to be liquidated, continuing its enterprise elsewhere within the group is not permitted. Should this still be done, it is not permitted to settle the liquidation loss until the enterprise has ultimately been discontinued (if the enterprise has been continued by the taxpayer itself), or (if the enterprise has been continued by another subsidiary) the other subsidiary is liquidated. The key issue here is therefore whether or not the enterprise of the subsidiary has actually been discontinued. This policy decision likewise includes a note by the State Secretary that it is not permitted to continue any investment activities of the subsidiary either. This interpretation has some basis in the parliamentary debate on the related provision. Still, it shows a major flaw because in many tax law regulations the terms “to enterprise” and “to invest” are each other's complete opposites. Nowhere does the law itself state as to how “to enterprise” or “to invest” should be interpreted, so there is a fair chance of the State Secretary’s position being denied in court if cases come to trial. After all, unless the wording of a dog tax act specifically states that a “dog” is, mutatis mutandis, a “cat”, it is impossible to impose a dog tax on a cat.
Source: Decree of January 20, 2017, no. BLKB2016/803M, Government Gazette 2017, no. 5003