Tax plan 2022 includes changes to transfer pricing, hybrid entity rules
On 21 September 2021, the Dutch government published the tax package for 2022, along with other tax measures, some of which already had been announced. It should be noted that the tax package was prepared by the outgoing government, which is functioning as a “caretaker” pending the formation of a new government. Although the tax package contains fewer policy changes than in previous years, addressing tax avoidance is a priority, with changes proposed to the loss utilization rules, preventing transfer pricing mismatches, subjecting reverse hybrid entities to Dutch corporate income tax in certain circumstances and limiting the crediting of dividend withholding tax. Additionally, changes are proposed to the time stock options become taxable.
Following the release of the tax plan, on 22 and 23 September 2021, the lower house of parliament adopted an amendment to the earnings stripping rules, which limit the deduction of interest expense to 30% of the company’s EBIDTA or the lesser amount of EUR 1 million per year. The 30% limit would be reduced to 20% as from 1 January 2022. The government is also considering an anti-avoidance measure to deter the splitting up of companies to remain within the EUR 1 million threshold and avoid the restriction on the deductibility of interest.
The proposals in the tax package are expected to be finalized and approved in December.
This article looks at the most important proposed tax law changes for businesses. Unless otherwise noted, the new rules would apply as from 1 January 2022 or to taxable years starting on or after that date.
Corporate income tax rates
The corporate income tax rates in the Netherlands currently are 15% for taxpayers with taxable income up to EUR 245,000 and 25% for taxable income exceeding that amount. The amount of taxable income under the first bracket would be increased to EUR 395,000 and, as a result of budget reallocation, the higher corporate tax rate likely would be set at 25.8%.
Loss carryback and carryforward
Losses incurred in a tax year currently may be offset against the taxable income of the previous year and carried forward for offset against taxable income in the following six years. The loss carryback and carryforward rules would be revised as follows:
- To the extent taxable profits for a particular year are EUR 1 million or less, taxable profits could be used in full to set off losses from other years;
- To the extent taxable profits for a particular year exceed EUR 1 million, only 50% of that amount would be available for loss carryback/carryforward; and
- The six-year loss carryforward period would be abolished, so that losses could be carried forward indefinitely. The one-year loss carryback period would remain unchanged.
The new rules would apply to losses incurred in financial years that started on or after 1 January 2013, so that they could not be forfeited due to the expiration of a loss carryforward period. However, if such losses are set off as from 2022, they would be subject to the EUR 1 million limit. The proposed rules are designed to ensure that larger companies pay corporate income tax in profit-making years.
Transfer pricing mismatches
The transfer pricing rules would be amended to address mismatches arising from the application of the arm’s length principle.
The Netherlands requires transactions between related parties to be on arm’s length terms, i.e., companies engaging in transactions with related parties must apply the same prices/conditions that independent parties would have agreed on in comparable transactions. If the prices/conditions of intercompany transactions differ from those that would have been agreed on in comparable uncontrolled transactions, an adjustment (either upward or downward) should be made to the Dutch taxable profit. Under existing law, when the Dutch authorities make a transfer pricing adjustment, it is irrelevant whether the country of the related party makes a corresponding adjustment. The Dutch government has taken the position that this anomaly could lead to potential tax avoidance in that double nontaxation could arise from the Dutch application of the arm's length principle.
The government has proposed measures that would neutralize the potential for double nontaxation in these mismatch situations by disallowing a downward/upward adjustment to the Dutch taxable profit based on the arm's length principle to the extent there is no corresponding upward/downward adjustment of taxable profit in the other country. For example, assume a Dutch subsidiary pays no or a low rate of interest on a loan from a foreign company and the arm’s length interest rate is 5%. Under the current transfer pricing rules, the subsidiary may deduct the higher arm’s length interest rate, but under the proposed measures, the deduction would be disallowed unless the taxpayer could demonstrate that the higher arm’s length interest rate is subject to tax at the level of the foreign parent company. It should be noted, however, that the proposed rules do not seek to neutralize differences in tax rates between countries—they only look at whether an adjustment is included in the tax base.
The tax package contains similar measures that would apply where a Dutch taxpayer acquires an asset (e.g., machinery) from a related party. Currently, a Dutch taxpayer can capitalize the asset on its tax balance sheet at the arm’s length transfer price, even if the parties to the transaction have agreed on a different price. The proposals would require the Dutch taxpayer to value the asset at the agreed transfer price if that price is lower than the arm’s length transfer price. This rule would not apply if the taxpayer can substantiate that the arm’s length transfer price was taken into account in the taxable profits of the foreign related company.
Finally, a rule with further restrictions—including a retroactive effect—is proposed that would address transfer pricing mismatches relating to the acquisition of assets by a Dutch company from a related party during the period 1 July 2019 and 1 January 2022. If an asset is acquired from a related party during this period and the Dutch company is still depreciating the asset after 1 January 2022, the amount of depreciation may be limited.
Reverse hybrid entities
Hybrid mismatch measures were introduced in the Dutch Corporate Income Tax Act on 1 January 2020 to combat tax avoidance using qualification differences between the tax systems of EU member states and between EU member states and third countries. These rules neutralize the effect of any qualification differences between tax systems.
The 2022 tax package includes a measure that would broaden the scope of the hybrid entity rules to subject reverse hybrid entities to tax in the Netherlands. A reverse hybrid is an entity that is deemed to be transparent in the jurisdiction in which it is established, but it is regarded as nontransparent in the jurisdiction where the participants are resident. Because of the different tax treatment in the country of establishment and the country where the investors are resident, the income of a reverse hybrid may not be subject to corporate income tax. An example of a reverse hybrid structure is the “CV/BV structure”; from a Dutch tax perspective, the CV (or limited partnership) is fiscally transparent while from the perspective of the countries where the partners are resident, the CV is nontransparent.
The tax package contains provisions that would treat a reverse hybrid entity as a corporate entity subject to Dutch corporate income tax in certain situations. Additionally, a reverse hybrid entity could be regarded as a withholding agent for purposes of Dutch dividend withholding tax and the conditional withholding tax on interest and royalties.
Controlled foreign companies and foreign tax credits
The Netherlands introduced a controlled foreign company (CFC) regime on 1 January 2019, which prevents a taxpayer from shifting profits to a subsidiary or permanent establishment resident in a country that has a low profit tax rate. Certain “tainted” income categories of a CFC (e.g., royalties) are taxed under the CFC regime in the Netherlands, but it is possible that the same income could be taxed in the country where the CFC is resident. In certain situations, the foreign tax on such income may be credited at the level of the Dutch shareholder. If a taxpayer has several CFCs, the foreign tax credit is calculated separately for each CFC. It is possible that the Dutch taxpayer may be unable to fully utilize the foreign tax credit.
Under current legislation, there is no prescribed method to determine the order in which the credits should be used; the proposed legislation would introduce a specific ordering methodology.
Crediting of dividend withholding tax and gambling tax
To eliminate a potential conflict with EU law, the Dutch government intends to limit the crediting of certain withholding taxes—specifically, the dividend withholding tax and the gambling tax—against the Dutch corporate income tax.
Under existing rules, a Dutch taxpayer may offset Dutch withholding tax against its corporate income tax liability, and if the taxpayer does not have any tax liability for a particular year, a refund of the withholding tax will be issued, allowing the taxpayer to recover any tax withheld during the year. The tax package contains a measure that would limit the ability to credit Dutch dividend withholding tax and the gambling tax; under this measure, crediting of the tax would be allowed only to the extent that Dutch corporate income tax is payable in the relevant tax year. A refund would no longer be possible in these circumstances. Unused withholding tax would be carried forward to be credited in future years. The amount of withholding tax carried forward would be determined by the tax inspector in a decision issued in conjunction with the Dutch corporate income tax assessment and that could be appealed by the taxpayer.
Tax treatment of employee stock options
Under current legislation, a stock option right is taxed at the time the option is exercised. A problem that arises, particularly for start-ups and scale-ups, is that the owners of the option rights do not always have sufficient funds to pay the tax at the time they exercise the options.
The government is proposing to shift the time of taxation to make stock options more attractive, i.e., taxation would take place at the time the relevant shares become tradeable. In that case, the employee could sell the shares to generate cash to pay the tax due on the difference between the value of the shares at the time of exercise and the acquisition price. However, under the proposal, if shares are not immediately tradeable at the time the option right is exercised, the employee could elect to pay tax on the value of the shares at the time of exercise (provided he/she has sufficient funds). The employee ultimately would have to make this election in writing by the time the option is exercised, and the withholding agent would have to record the employee’s election in the payroll administration. Failure to comply with the rules—or if the election is not timely or is taken incorrectly—will result in the stock options being taxed at the time the relevant shares become tradeable.
- Holding company losses: The government intends to introduce legislation to counteract a decision issued by the Dutch Supreme Court on 11 June 2021 on the tax treatment of losses incurred by a holding company that is a member of a fiscal unity.
The court held that losses incurred by a holding company before it became a member of a fiscal unity may be set off against the profits of another newly incorporated company in the fiscal group, regardless of the type of activities that subsidiary carries out. Previously, losses incurred by entities engaged in holding or financing activities could be offset only against profits in the years the entity engaged in those activities. These rules generally were abolished as from 2019. The Supreme Court’s decision leads to situations where losses of holding companies can be offset against profits of other activities in cases where a fiscal unity exists. The proposed legislation would prohibit such losses to offset profits from other activities in a newly incorporated company.
- Withholding tax on dividends, interest and royalties: On 26 March 2021, the government proposed a bill to extend the scope of the Withholding Tax Act 2021 to apply to dividend payments made to affiliated entities in low-tax jurisdictions (the withholding tax on interest and royalty payments that was introduced on 1 January 2021 already applies to payments made to recipients in low-tax jurisdictions and in situations of double non-taxation and abuse). The withholding tax rate on such dividends would be the same as the highest Dutch corporate income tax rate, i.e., 25.8% (the normal dividend withholding rate is 15%). The anticipated effective date of this measure would be 1 January 2024.
- Definition of a permanent establishment: The government also announced that the definition of a permanent establishment would be broadened for purposes of the Withholding Tax Act. As a result, withholding tax on interest and royalty payments would be required to the extent that such payments are attributable to specific Dutch sources of income, such as real estate property located in the Netherlands.
- Changes to non-transparent limited partnership (CV): Significant changes are proposed to the tax treatment of CVs. A CV would no longer be subject to Dutch corporate income tax; instead, it would become tax transparent so that the profits and losses of the CV would be allocated to its participants. The proposed changes to the rules governing CVs would have a major impact from both a domestic and cross-border perspective. Structures in which an “open” CV currently functions as a holding company, for example, would need to be reconsidered, particularly in the context of a restructuring that already has been carried out in connection with the EU Anti-Tax Avoidance Directive 2 hybrid mismatch measures.
- Classification of foreign entities: The Netherlands currently applies the “similarity approach” to classify foreign entities for Dutch tax purposes. In short, this approach means that one looks at the most similar Dutch equivalent of the foreign entity to determine whether it qualifies as a transparent or non-transparent entity. The similarity approach would be retained as the primary classification rule, but two new rules would apply in situations where the similarity approach does not provide a solution. A “symmetry approach” would apply for entities that do not have a clear Dutch equivalent, and under this approach, the Netherlands would follow the classification in the home state of the foreign entity. Foreign entities that tax residents in the Netherlands but that do not have a clear Dutch equivalent would always be considered non-transparent, thus becoming Dutch domestic taxpayers.
It is possible that some of the proposals will be revised during the parliamentary process.
Niek de Haan