As part of the tax package 2022 (for coverage of the package, see our article in the November 2021 issue of Corporate Tax News), the Dutch government proposed measures that would neutralise the potential for double nontaxation in transfer pricing mismatch situations arising from the application of the arm’s length principle. If approved, the proposed measures would apply as from 1 January 2022.
The Netherlands requires transactions between related parties to be on arm’s length terms. If the prices/conditions of intercompany transactions differ from those that would have been agreed on in comparable uncontrolled transactions, a unilateral adjustment (upward or downward) should be made to the Dutch taxable profit. Such an adjustment leads to a difference between the commercial result and the fiscal result. Based on longstanding case law of the Dutch Supreme Court, such adjustments result in the recognition of either an informal capital contribution or a deemed dividend distribution for corporate income tax purposes. Under existing law, when transfer pricing adjustments are made for corporate income tax purposes, it is irrelevant whether the country of the related party involved in the intercompany transaction(s) 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 recognition of an informal capital contribution.
The government has proposed a set of measures that would neutralise the potential for double nontaxation in mismatch situations by disallowing a downward adjustment to the Dutch taxable profit to the extent there is no corresponding upward adjustment of taxable profit in the other country. For example, assume a Dutch entity pays no or a low rate of interest on an intercompany loan from a foreign company and the arm’s length interest rate is 5%. Under the current corporate income tax rules, the borrower may deduct the arm’s length interest rate (as a deemed interest expense), but under the proposed measures, the interest expense would be deductible only if the borrower could demonstrate that the arm’s length interest rate is subject to tax at the level of the lender. That is, the burden of proof to demonstrate that a corresponding adjustment is subject to tax at the level of the related party involved in the intercompany transaction(s) would be on the Dutch taxpayer.
The proposed rules do not seek to neutralise differences in tax rates between countries, as they only look at whether an adjustment is included in the tax base (i.e., a zero tax rate would qualify as “subject to tax”). The same rules would apply if the income is subject to an exemption or a setoff against losses. The denial of the downward adjustment generally would not be applicable to the extent a corresponding adjustment is included in the tax base at the level of the foreign participants in a hybrid entity (i.e., an entity that is transparent for Dutch tax purposes).
Another proposed measure relates to depreciable business assets that were transferred from a related entity to a Dutch entity during fiscal years starting on or after 1 July 2019 and before 1 January 2022. If the transfer price was below the arm’s length value of the depreciable business asset, the proposed legislation would recognise a transfer at the (higher) arm’s length value but would limit the depreciation base of the asset for Dutch tax purposes in fiscal years starting on or after 1 January 2022, effectively limiting the annual depreciation costs. The depreciation base for the business asset as per 1 January 2022 and subject to this transitional measure would be the lower of (i) the commercial value agreed between the Dutch taxpayer and its foreign affiliate at the time of the acquisition (than arm’s length value), or (ii) the fiscal value of the asset on the opening balance sheet of the Dutch entity for the fiscal year starting on or after 1 January 2022.
Dutch entities should begin to evaluate the treatment of profit-reducing transfer pricing adjustments that are made for corporate income tax purposes in order to comply with the arm’s length principle. As from 2022, a tax deduction followed by an informal capital contribution resulting from a transfer pricing adjustment in the Netherlands would be allowed only if the Dutch taxpayer demonstrates that a corresponding adjustment is or will be subject to tax at the level of the related party.
In addition, the depreciation base of business assets that are acquired by a Dutch entity during fiscal years starting on or after 1 July 2019 and before 1 January 2022 would be limited as from 2022 in cases where the transfer price of the business asset was below the arm’s length value.
The legislative proposals are being discussed by parliament and may be revised during this process.