15 October 2019

2020 budget raises CIT burden and limits using the Netherlands in aggressive tax planning

The Dutch government has released its budget plans for 2020, as well as certain tax proposals. The plans introduce a withholding tax in the Netherlands on interest and royalties paid to related parties in low-tax jurisdictions, as of 2021. The government is also proposing to downgrade the safe-harbour rules for claiming exemptions, such as from Dutch dividend withholding tax, in response to ECJ cases on Danish beneficial ownership. As to corporate tax rates, lower than anticipated cuts will apply in 2020 and 2021. This article addresses the key proposals relevant for international businesses.
Withholding tax on interest and royalties As of 2021, a 21.7% withholding tax will apply to interest and royalties paid to related parties that are resident in a low-tax jurisdiction or that allocate these payments to a permanent establishment in a low-tax jurisdiction (I&R withholding tax). In the case of abusive situations, interest and royalties paid to related beneficiaries that are not resident in low tax jurisdictions will also be subject to this I&R withholding tax. This situation exists if the beneficiary is interposed, through an artificial arrangement, to avoid I&R withholding tax being imposed on another party. This could occur, for example, where within a group of companies, a Luxembourg or Cyprus company (not low-tax jurisdictions) is interposed between a Cayman Island entity (low-tax jurisdiction) and a Dutch interest payer. The burden of proof as to whether such a situation is abusive or not will be determined as discussed below (Role of minimum substance requirements downgraded). If an abusive situation appears to exist, a beneficiary will probably not be allowed to claim a reduction or exemption from the I&R withholding tax under a tax treaty, because most Dutch treaties will contain a principal-purpose test following the entering into effect of the Multilateral Instrument (MLI). It will be possible for taxpayers to obtain an advance tax ruling on the question of whether an abusive situation exists or not. For purposes of the I&R withholding tax, the beneficiary of the income and a payer are "related" if one directly or indirectly holds a qualifying interest in the other, or vice versa, or if another party directly or indirectly holds a qualifying interest in both of them. There is a "qualifying interest" if this "allows a party to exert definite influence over the other party and allows it to determine its activities". This definition is derived from ECJ decisions determining the application of the freedom of establishment under EU law. An interest is a qualifying interest if it represents more than 50% of the voting power. Entities that individually do not hold a qualifying interest in another entity will still be considered "related" if they work together as a group. "Low-tax jurisdictions" are those listed annually by the Dutch government; they include jurisdictions with a statutory corporate tax rate of less than 9% and jurisdictions on the EU list of non-cooperative jurisdictions. Click here for the full list of low-tax jurisdictions. The introduction of the I&R withholding tax marks the end of an era. The Netherlands has never had a withholding tax on regular interest and royalties. This is one of the reasons why Dutch companies have been used for so long as intermediaries in international financing and licensing arrangements. To the extent these arrangements directly or indirectly involve related parties in low tax jurisdictions, the introduction of the new tax will effectively end this practice as of 2021. However, the I&R withholding tax also applies in abusive situations involving related beneficiaries in non low-tax jurisdictions. We believe that many more taxpayers will be affected now and in the future and that they will avoid using the Netherlands in intercompany financing and royalty arrangements as of 2021, unless the application of the I&R withholding tax can be ruled out, for example, through an advance tax ruling. This may be exactly what the Dutch government intends to achieve. For financing and royalty arrangements that continue to exist beyond 2020, taxpayers will need to ensure that all payments subject to this withholding tax will have actually been made before 1 January 2021, because there is no grandfathering rule for interest and royalties accrued before that date. Role of minimum substance requirements downgraded In response to the ECJ's Danish beneficial ownership rulings, the Dutch government will change the role of the "minimum substance requirements". Click here for a full list of these requirements. Under current law, a claim for an exemption from, for example, Dutch dividend withholding tax on dividends from substantial participations in Dutch companies, will not be denied as an abuse of law if the minimum substance requirements are met by the recipient of the income. In the Danish beneficial ownership cases, the ECJ ruled in February 2019 that the question of whether a situation is abusive under EU law must be determined on the basis of all the relevant facts and circumstances. The use of safe-harbour rules, such as the minimum substance requirements, is not compatible with the ECJ's rulings. The Dutch government addresses this in the 2020 budget and tax proposals by downgrading the minimum substance requirements from safe harbours to rebuttable presumptions. This means that, as of 2020, a situation is considered not to be abusive if the minimum substance requirements are met, unless the Dutch tax authorities establish otherwise. It is doubtful in our view whether, with this shift in the burden of proof, the Dutch government complies with the ECJ's rulings in the Danish cases. This is because, in the absence of a challenge by the Dutch tax authorities, an exemption from Dutch dividend withholding tax may be claimed in a situation where the minimum substance requirements are met, even though that situation can be considered abusive based on all the relevant facts and circumstances, such as those not covered by the minimum substance requirements (for example, the obligation to immediately pay any income received to non-EU parties). Increase of corporate tax burden The reductions in the headline corporate income tax rates provided for in the 2019 budget have been changed in the 2020 budget and tax proposals. The headline rate for 2020 will remain at 25% (it was to be reduced to 22.55% according to the 2019 budget). The headline corporate income tax rate for 2021 will drop to 21.7% (instead of the 20.5% rate provided for in the 2019 budget). The proceeds from these measures will, in part, be used to finance a reduction in the tax burden of individuals. In addition to these measures, the government has announced that it intends to increase the tax rate for any income from R&D activities that is eligible for taxation in the innovation box, from 7% to 9%, in 2021. It also intends to curtail the ability of corporate taxpayers to deduct losses from the liquidation of subsidiaries. Earlier this year, the government set up a special committee on the taxation of multinationals. The committee is tasked with recommending options to broaden the Dutch corporate tax base without reducing the attractiveness of the Netherlands as the headquarters of multinational groups. The additional tax burden imposed on businesses in the 2020 budget and tax proposals and the ongoing discussions about this topic are the result of a political debate in the Netherlands about the tax contributions made by, mainly, multinational enterprises. Thin-capitalisation rule for banks and insurance companies Banks and insurance companies will be subject to a thin-capitalisation rule. Under this rule, interest incurred by banks and insurance companies will not be deductible to the extent the leverage ratio (in the case of banks) or the equity ratio (in the case of insurance companies) is below 8%. The leverage ratio and the equity ratio are determined in accordance with the EU Capital Requirement Regulation and the EU Solvency II Directive. Unlike the Dutch implementation rules for implementing the ATAD2's earnings stripping rule into Dutch law, interest disallowed as a deduction under the thin-capitalisation rule for banks and insurance companies may not be carried forward. Definition of permanent establishment codified The definition of permanent establishment (PE) will be derived directly from the definition of those terms in applicable Dutch tax treaties. As a result, a situation in which a PE exists for treaty purposes, but not for Dutch domestic law purposes and which could result in tax avoidance, can no longer occur. For non-treaty situations, the 2020 budget and tax proposals implement the definition of PE contained in the 2017 OECD Model Convention. These definitions include the amendments to the PE definition as a result of BEPS Action 7 (including the amendments dealing with, among other things, commissionaires, which the Netherlands has opted out of under the MLI).