Tax accounting impact of enacted income tax measures
The Netherlands tax package for 2022, released on 21 September 2021, has been enacted (for prior coverage, see the article in the November 2021 issue of Corporate Tax News) and the new rules could have an impact on the tax positions recognized in financial statements.
This article sets out the income tax accounting impact of the most significant income tax measures in the package for Dutch companies with cross-border operations. Most of the measures are considered substantively enacted as of 21 December 2021 and enacted on 28 December 2021.
Corporate income tax rates
The Dutch corporate income tax rates for 2021 were 15% for taxpayers with taxable income up to EUR 245,000 and 25% for taxable income exceeding that amount. As from 1 January 2022, the first bracket is increased to EUR 395,000 and the higher corporate tax rate is 25.8%.
These changes to the bracket and the higher tax rate may have consequences on the amount of a deferred tax asset (DTA)/liability. In general, deferred taxes are recognized in respect of temporary differences between temporary book to tax differences, tax credits and/or losses available for setoff. The amount of deferred tax is calculated at the rate applicable per the release/settlement.
Tax loss compensation rules
Under the Netherlands’ previous tax loss compensation rules, a loss could be set off against the taxable profits of the previous year and carried forward for the following six years. As from 1 January 2022, the loss relief rules are revised as follows:
- If taxable profits for a particular year exceed EUR 1 million, only 50% of that amount is available for loss carryback/carryforward; and
- The six-year loss carryforward period is abolished, so that losses can be carried forward indefinitely. The one-year loss carryback period remains unchanged.
These adjustments may also have an impact on DTAs recognized in the financial statements for unused tax losses.
Because the six-year loss carryforward period has been eliminated, companies may have stronger arguments for recognizing a DTA. Future profit forecasts and their substantiation will become increasingly relevant, but since the securitization of the claim for recognition of a DTA still must be probable/more likely than not, only forecasts for the near future generally can substantiate the recognition of a DTA.
On the other hand, the 50% limitation on loss carryforwards for profits exceeding EUR 1 million in a particular year could have the opposite effect, resulting in a DTA being derecognized / a valuation allowance being recognized. It is less obvious in this context that loss carryforwards can be offset against taxable temporary differences. As a result of the EUR 1 million loss limitation, companies with tax loss carryforwards may still end up in a tax-paying position so the current tax position and cash tax management are relevant.
Although the revised rules on losses became effective on 1 January 2022, they apply retroactively to tax losses incurred in financial years that started on or after 1 January 2013, so that losses cannot be forfeited as a result of the expiration of a loss carryforward period. From a tax reporting perspective, the revision of the loss carryback and carryforward rules is substantively enacted as from 21 May 2021 for IFRS purposes and enacted as from 5 June 2021 for U.S. GAAP. Therefore, companies must consider the adjusted loss relief rules when determining the DTA per year-end 2021, as well as during the interim reporting in financial year 2021. Any adjustment to the deferred tax position in relation to previous years will have an impact on the effective tax rate.
Use of holding company losses
In a decision dated 11 June 2021, the Dutch Supreme Court provided an explanation on the interface between the loss carryforward rules and the fiscal unity (tax group) regime. The court ruled that losses incurred before a holding company joins a fiscal unity may be set off against the profits of a subsidiary in the group. As a result of this decision, certain holding companies were able to recognize a DTA for unused loss carryforwards. New rules that apply as from 1 January 2022 counteract the possibility of setting off pre-fiscal unity holding company loss carryforwards against the operating profits of a subsidiary, which could limit the recognition of a DTA for holding company losses.
Earnings stripping rule
The earnings stripping rule limits the deductibility of net interest expense on intragroup and third-party loans. For years up to 2022, this limitation was set at the higher of 30% of the company’s adjusted fiscal result or EUR 1 million. As from 1 January 2022, the limitation is reduced to the higher of 20% of the adjusted fiscal result or EUR 1 million.
Disallowed interest may be carried forward indefinitely and utilized in subsequent years to the extent that future interest expense is lower than the above limits. Therefore, the carryforward interest has a value, potentially qualifying for DTA recognition. Companies should re-examine the extent to which their forecasting substantiates the recognition of deferred tax. The limit on the deduction of interest expense will have a negative effect on a company’s 2021 effective tax rate if prior years’ deferred tax recognition can no longer be supported based on the new rules.
Transfer pricing mismatches
The transfer pricing rules are revised to address mismatches arising from the application of the arm’s length principle. Until 2022, when the Dutch tax authorities made a transfer pricing adjustment, it was irrelevant whether the country of the related party to the transaction made 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 revised rules that apply as from 1 January 2022 neutralize the potential for double nontaxation in these mismatch situations. A downward/upward adjustment to Dutch taxable profit based on the arm's length principle will be disallowed to the extent there is no corresponding upward/downward adjustment of taxable profits in the other country.
A Dutch taxpayer may no longer make a downward adjustment by increasing expenses for tax purposes up to an arm’s length remuneration if that would lead to a mismatch. As a result, the number of permanent book to tax differences and, to a lesser extent, temporary differences will be reduced as from 2022.
Finally, the tax package included a rule that introduces more restrictions on the depreciation of assets. Depreciation of assets acquired in a financial year that started on or after 1 July 2019 may be disallowed due to the new rules to the extent the acquisition price was below an arm’s length price. In such cases, it was common practice to apply a step-up to the fiscal book value of the acquired asset, resulting in a higher fiscal book value than commercial book value. Consequently, a company may have recognized a DTA for this difference. As the new rules disallow depreciation as to the step-up between fair market value and the transaction price, the company may no longer be able to recognize a DTA regarding the additional depreciation potential.
Reverse hybrid entities
Beginning in 2022, a reverse hybrid entity that is established under Dutch law or is resident in the Netherlands will be treated as a corporate entity subject to Dutch corporate income in certain circumstances. Additionally, a reverse hybrid entity may be regarded as a withholding agent for purposes of Dutch dividend withholding tax and the conditional withholding tax on interest and royalties. If a reverse hybrid entity becomes liable to Dutch corporate income tax, a current tax position should be recognized for these entities as of financial year 2022, and if any book to tax differences apply to the opening balance of the reverse hybrid, deferred tax positions also should be considered. A deferred withholding tax liability may be required at the level of the participants if future payments of the reverse hybrid entity are subject to Dutch withholding tax.
Crediting of Dutch dividend withholding tax
To eliminate a potential conflict with EU law, the ability to credit Dutch dividend withholding tax against Dutch corporate income tax is limited as from 2022.
Previously, a Dutch taxpayer could offset Dutch withholding tax against its corporate income tax liability, and if the taxpayer did not have any tax liability for a particular year, the tax would be refunded, allowing the taxpayer to recover tax withheld during the year. The tax package contains a measure that limits the ability to credit Dutch dividend withhold tax, i.e., crediting of the withholding tax is allowed only to the extent that Dutch corporate income tax is payable in the relevant tax year. It is no longer possible to obtain a refund of the withholding tax in these circumstances. Unused withholding tax may be carried forward to be credited in future years, with the amount of the carryforward determined by the tax inspector in a decision issued in conjunction with the Dutch corporate income tax assessment.
The carried forward Dutch dividend withholding tax may result in a tax asset if the expectation is that the tax paid can be offset against future tax payable. As the paid Dutch dividend withholding tax would directly reduce the current tax charge in a future year (and not the taxable amount), the tax asset would be equal to the creditable Dutch dividend withholding tax. In this case, the applicable corporate income tax rate does not directly impact the amount of the tax asset recognized. The new rules may increase tax asset recognition in future years for any creditable Dutch dividend withholding tax.
Koos van der Kemp