Amendments
towards a more competitive tax system
· Reduction of the corporate income tax
rate from 29.6 % to 25.5%;
· Reduction of the dividend withholding
tax rate from 25% to 15%;
· Introduction of a royalty box with an
effective tax rate of 10%;
· Introduction of an interest box for group
interest income with an effective tax rate of 5%;
· Favorable amendments to the so-called
participation exemption, under which benefits derived from participations
(including capital gains realized and dividends received) are exempt.
1.
Executive summary
For decades The Netherlands was well known as attractive
(tax) residency country for international operating groups. Its assets were an
attractive tax climate, a favorable geographic location, a good physical
infrastructure, a highly educated working population and a stable political and
social environment. As a consequence, The World Economic Forum ranked The
Netherlands in the world top five of most attractive countries of residence.
At the same time the OECD ranked The Netherlands also as one
of the top five industrialized countries that supported harmful tax
competition. Also the EU Primarolo Report was rather critical about the Dutch
tax regulations. The Dutch response was generally seen as too much of a good
thing. The result was a descent in the World Economic Forum ranking to a
current 9th place.
In the meantime, other European countries introduced
favorable tax regulations to attract foreign investors, currently often seen as
the start of a “race to the bottom”. With the accession of 10 new countries in
the European Union in 2004 having corporation tax rates averaging 18.5%, it
became apparent that measures had to be introduced to stand up to the
competition.
On May 24, 2006 the State Secretary of Finance submitted a
Bill containing major revisions of the current Dutch corporate income tax. The
intended effective date is 1 January 2007. The Bill contains amongst others the
following proposals:
· Reduction of the corporate income tax
rate from 29.6 % to 25.5%;
· Reduction of the dividend
withholding tax rate from
25% to 15%;
· Introduction of a royalty box with an
effective tax rate of 10%;
· Introduction of an interest box for group
interest income with an effective tax rate of 5%;
· Favorable amendments to the so-called
participation exemption, under which benefits derived from participations
(including capital gains realized and dividends received) are exempt.
The
following paragraphs elaborate on the above proposals.
2.
Introduction
From big multinationals to (relatively) small privately
owned companies, when determining how to set-up their international structures
most of them had The Netherlands on their short-list. This favorable position
had everything to do with the attractive tax climate The Netherlands could
offer new investors. Whether it was for purposes of creating the required
flexibility in their holding structure, obtaining a “gateway” to Europe,
optimizing up-the chain distributions, locating joint-ventures or using a
Netherlands company for foreign branches, The Netherlands was seen as the place
to be. This positive tax climate was amongst others generated by its:
·
advance tax ruling practice;
·
liberal Revenue Service
·
extensive tax treaty network;
·
participation
exemption, exempting all benefits derived from participations (including
capital gains realized and dividends received);
·
exemption system for profits attributable to foreign permanent establishments
(branches);
·
withholding tax system, i.e. no withholding tax on
interest and royalty payments;
·
stable political climate.
This favorable position was put on pressure with the
publication of the OECD Report on Harmful Tax Competition and the EU Primarolo
Report. The response of the Dutch government did not receive critical acclaim.
On the contrary, the drastic change of its tax ruling system in 2001 and the
introduction of various anti-abuse tax regulations was clearly seen as too much
of a good thing.
In the meantime, its European colleagues introduced various
regulations aiming to improve their tax systems towards foreign investors,
either by reducing their corporation tax rates (e.g. Ireland), introducing,
albeit less favorable, participation
exemptions (e.g. UK and Germany), unilaterally reducing withholding taxes (e.g.
Denmark) or disregarding the comments in the two reports and continuing to
maintain bank secrecy rules and criticised tax ruling practices (Luxembourg).
When in 2004 the European Union welcomed Cyprus, the Czech
Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and
Slovenia, it became apparent that measures had to be taken in order to meet the
competitive standards (also) introduced by these new member States. Although,
in general, the current tax systems of these new Members, especially those of
the East-European countries, have recently been amended to meet the European
standards and consequently only for that reason include uncertainties, with an
average corporate income tax rate of approximately 18.5% they offer an
interesting alternative to foreign investors for the “old economy” countries
like The Netherlands.
The Dutch government (finally) realized that this
threatening development required some “counter” measures. On May 24, 2006 the
State Secretary of Finance submitted a Bill (‘Werken naar winst’) to the Dutch
2nd Chamber of Parliament. This Bill contains major revisions of the
current Dutch Corporate Income Tax Act. The proposals still needs to be
discussed in and approved by the 2nd and 1st Chamber of
Parliament in the fore coming period, but it is to be expected that the
proposals will be enacted before years end and will become effective on 1
January 2007. The Bill contains amongst others the following amendments:
a.
Reduction of the corporate income tax rate from 29.6 % to
25.5%.
b.
Reduction of the dividend withholding tax rate from 25% to 15%.
c.
Introduction of an interest box for group interest income with
an effective tax rate of 5%.
d.
Introduction of a royalty box with an effective tax rate of
10%.
e.
Favorable amendments to the so-called participation exemption,
under which benefits derived from participations (including capital gains
realized and dividends received) are exempt.
The Bill, however, also contains certain measures that will
broaden the tax base. These measures are:
a.
Limitation of the tax loss carry back period from three years
to one year.
b.
Limitation of the tax loss carry forward period from
indefinite to nine years.
c.
Limitation of the depreciation on real estate.
d.
Extension of the amortization period for goodwill to ten years
(current usually five years).
e.
Extension of the amortization period for all capital assets to
a minimum of five years.
f.
Less favorable tax treatment of “work in progress”.
g.
Limitation of the tax deduction of costs incurred with issuing
call options (e.g. warrants and employee stock options)
3.
Reduction tax
rates
3.1.
Reduction corporate income tax rate
A crucial element in the proposed amendments is a further
reduction of the corporate income tax rate. For 2006 the 31.5% rate was already
reduced to 29.6%. The Bill proposes a further reduction to 25.5% effective 1
January 2007. The latter rate is applicable to taxable profits in excess of EUR
60,000. In the Bill a rate of 20% is proposed for the first EUR 25,000 taxable
profits and a 23.5% rate for profits between EUR 25,000 and EUR 60,000. It is
assumed that a reduced rate supports the investment climate in the Netherlands.
With the reduction of the corporate income tax rate the Netherlands will have
one of the lowest tax rates of Western Europe and one that is equal to the
average rate in the European Union.
Source: Deloitte Touche Tohmatsu: Corporate Tax Rates
at a Glance 2006
Copied from the Explanatory Notes to the Bill, page 5
To download the complete document (click here)
In the Explanatory
notes to the Bill, the State Secretary of Finance notes that it is not to be
expected that the corporate income tax rate will be reduced even more. This is
to avoid that due to controlled foreign corporation rules applicable in certain
countries (e.g. Japan), the benefit of the Dutch tax rate reduction is undone
by a higher foreign tax.
3.2. Reduction of the dividend withholding tax rate
In addition to a reduction of the corporate income tax rate,
the Bill also proposes to reduce the current dividend withholding tax rate of 25% to 15%.
Effectively, this measure mainly benefits those shareholders
of Netherlands companies that are located in non-tax treaty countries. First,
because when dividends are distributed in domestic situations the parent either
has a full credit of the dividend
withholding tax paid against corporate income tax due or no dividend withholding tax is
levied due to the participation
exemption. Secondly, when dividends are distributed to parents located
in a country with which The Netherlands has concluded a tax treaty, the tax
treaty usually reduces the dividend withholding tax rate to 15%, 5% or even 0%.
The US/NL tax treaty is an example where a qualifying parent may invoke the 0% dividend withholding tax
rate. Finally, in EU-relationships the ‘parent/subsidiary directive’ prohibits
any withholding taxes on dividends between affiliated EU companies in case the
parent company owns more 20%[1]
of the shares in an EU subsidiary.
Obviously, the suggested reduction does have an administrative
benefit. Currently, in order to benefit from the reduced tax treaty rates,
(foreign) parent companies often need to submit refund requests in The
Netherlands. Each year about 200.000 requests are submitted to the Dutch tax
authorities. With afore-mentioned dividend tax reduction, this administrative
burden is eliminated.
4.
Group Interest
Box
Like the Patent Royalty Box (see paragraph 5
below), the Group Interest Box is a new phenomenon in the NL tax regulations.
In the Group Interest Box the balance of the interest proceeds and interest
costs will effectively be taxed at a reduced corporate income tax rate of 5%.
This effective rate is achieved because, briefly put, only 5/25.5 part of the
afore mentioned positive balance should be included in the taxable profit. That
part is then subject to the “normal” corporate income tax rate, resulting in an
effective tax rate of 5%. The Box is only open for interest received and
interest paid on loans from group companies. For this particular regulation a
group is defined as:
·
A company in which the NL taxpayer has a more than 50%
interest; or
·
A company that has a more than 50% interest in the NL
tax payer; or
·
A company in which a 3rd party has a more
than 50% interest, whereby that 3rd party also has a more than 50%
interest in the NL taxpayer.
In case a 3rd party is an individual, additional
deeming provisions exist with respect to the above definition of a group.
The Box is optional, which allows companies to examine
whether the Group Interest Box can be beneficial to them. The Group Interest
Box may be applied following a mutual request by all NL group companies, as
defined. When granted, the Group Interest Box should be applied for a period of
at least three years by all companies in the Group. The (positive) sum of
interest paid and received that can be included in the Box is capped. This
maximum amount is the levy interest percentage, as determined each quarter
(currently 3.75%) on the average fiscal equity of the company in the relevant
tax year. A surplus will be taxed at the normal tax rate (in the proposal 25.5%).
The Patent Royalty Box is based on a similar treatment as
the Group Interest Box. In the Patent Royalty Box, benefits derived from
self-developed intellectual property will effectively be taxed at a corporate
income tax rate of 10%. This effective rate is achieved in a similar way as
with the Group Interest Box, i.e. from the royalties received only 10/25.5 is
taxable. That part is subject to the normal rate, resulting in an effective tax
rate of 10%.
Also the Patent Royalty Box is optional. If the taxpayer
does not choose for this box treatment then all royalties are taxable at the
normal rate. However, the Bill introduces a change compared to the current
situation. All development costs can be charged to expense, i.e. it is no
longer required to (partly) capitalize these costs.
The Patent Royalty Box is only open to intellectual property developed after 2006.
Furthermore the anticipated benefits of the intellectual property for 30% or
more can be attributed to a patent that is obtained by the NL taxpayer.
However, patented trademarks and logos do not qualify for the Patent
Royalty Box.
The choice
for the Box is made by the pertinent taxpayer and not by a group (see Group
Interest Box) and can be made on an asset-by-asset basis.
If an
existing intellectual property is put in the Box, then the relating development
costs that in the previous years were charged to expense should be capitalised.
The resulting profit is fully taxable. Also development costs incurred for an
intellectual property already included in the Box should be capitalised. The
capitalised costs may be depreciated.
Different from the Group Interest Box, the 10% effective
rate applies to all royalties received, whether or not from affiliated parties.
Furthermore, the 10% rate is not limited to royalties received, but it applies
to all benefits derived from the pertinent intellectual property.
Similar to the Group Interest Box, also benefits from the
Patent Royalty Box are capped. Briefly put, during the economic life of the
pertinent intellectual
property only those profits realised with that intellectual property are
effectively taxed at 10%, which in total do not exceed 4x the development costs
relating to that intellectual property. Any excess of profits is taxed at the
“normal” rate (in the proposal 25.5%).
Note that it is not certain whether the Patent Royalty Box
becomes effective on 1 January 2007. The Bill notes that the implementation of
the Box depends on pending discussions with the European Commission to avoid
that the European Commission will mark the Patent Royalty Box as harmful tax
competition and regard it as in conflict with the Code of Conduct.
6.
Adjustments
participation exemption
An important exemption of the Dutch corporate income tax is
the so-called participation exemption. The Netherlands corporate income tax
does not use a credit system to avoid double taxation on benefits derived from
subsidiaries. Instead those benefits are exempt. The Dutch participation
exemption can be applied when a Dutch parent or Dutch permanent establishment
of a foreign parent company holds more than 5% of the share capital of a
subsidiary and certain other conditions are met as well. Aside from certain
anti-abuse regulations, these other conditions currently are:
a.
The shares in the subsidiary may not be held as inventory;
b.
The shares may not be held as a passive investment;
c.
The profit of the subsidiary should be subject to a tax on
income.
Condition (b) does not apply to NL
subsidiaries and foreign EU subsidiaries in which the NL parent has a more than
20% interest and which meet certain other conditions. Condition (c) in practice
only applies to foreign subsidiaries.
It is because of this participation exemption that The Netherlands is frequently used
in international structures. As, when properly structured, capital gains and
dividends are exempt, the participation exemption gives international
structures amongst others the required flexibility.
Through time, however, the current regulations concerning
the participation exemption has become a proliferation of conditions and
exceptions in order to avoid abuse of the regulations, especially in
international settings. Certain of those anti-abuse regulations, however,
appeared not EU proof, as a result of which new regulations were introduced
specifically intended to meet EU legal requirements. Also that development did
not add to an easy implementation and understanding of this exemption.
The Bill aims in simplifying the regulations applicable to
the participation exemption
and making this exemption EU proof. Most eye-catching amendments are:
·
The
general subject to a profit condition is eliminated;
·
The
passive investment condition is eliminated.
Instead, if
a subsidiary is not a low taxed passive investment, then the participation
exemption will in principle apply, even if the profits of that subsidiary are
not subject to a tax.
The Bill
contains regulations stipulating when a subsidiary is deemed to be a passive
investment. If the subsidiary qualifies as a passive investment, then still the
participation exemption may be invoked, however, the NL parent should then
demonstrate that the subsidiary is subject to a tax on profits which results in
a tax levy of at least 10% on profits determined according to Netherlands
tax standards.
If such 10% levy does not take place, then the participation exemption will
not apply. However in that case the NL parent company obtains a credit against
the Netherlands corporate income tax due on the profits of the subsidiary. The Bill contains
regulations how the credit should be calculated.
