Currently, the Dutch corporate income tax act allows a Dutch tax resident company to form a fiscal unity with its Dutch subsidiaries if it holds at least 95% of the legal and economic ownership of the subsidiaries. Forming a fiscal unity brings many advantages: tax losses can be offset against taxable profits, and profits on intercompany transactions can be eliminated, essentially allowing the tax-free transfer of assets and liabilities between all fiscal unity members. This can result in a lower effective tax rate.
In this case, an Israeli tax resident parent company directly and indirectly owned two Dutch tax resident subsidiaries. The Israeli concern filed a request to form a fiscal unity between the two subsidiaries. The tax inspector denied this request because, under Dutch law, a fiscal unity was not permitted between Dutch companies that have a foreign parent. The lower court upheld the decision of the tax inspector, but the court of appeal ruled otherwise, concluding that the Dutch law conflicts with the Netherlands/Israel tax treaty’s non-discrimination clause. This clause reads as follows:
‘”Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which other similar enterprises of the Netherlands are or may be subjected.”
The tax inspector’s defence was mainly based on the 2008 commentary to the OECD model tax convention. This commentary states that the effect of the non-discrimination rules cannot force the state to allow identical treatment to foreign companies with rules that allow consolidation, transfer of losses, or a tax-free transfer of property between companies under common ownership. Therefore, if the domestic tax law of a state allows a resident company to consolidate its income with that of a resident parent company, that state should not have to grant identical treatment to a resident company and a non-resident parent company.
The court of appeal, however, decided to apply a static interpretation of the OECD commentary instead of an ambulatory interpretation, and said that since the Netherlands/Israel tax treaty dates back to 1996, the OECD commentary applicable in 1996 is leading, not the 2008 commentary. The court concluded that denying the fiscal unity was a violation of the non-discrimination clause in the treaty.
The court went on to say that even if the 2008 OECD commentary applied, a fiscal unity should still be allowed between the sister companies since the request only involves the consolidation of Dutch subsidiaries, not the consolidation of a resident company and a non-resident company.
The case may have wider implications, though. The court’s decision appears to require the Dutch government to expand the applicability of the Dutch fiscal unity regime to other structures with foreign parent companies if the state of the foreign parent company and the Netherlands conclude a double tax treaty with a similar non-discrimination clause. Most of the tax treaties of the Netherlands have similar clauses.
Earlier, in December 2014, in response to European Court of Justice cases like Papillon, the Dutch State Secretary of Finance issued a decree allowing fiscal unities, among other entities, between: (i) Dutch sister companies with an EU/EEA parent, and (ii) a Dutch indirect subsidiary and a Dutch grandparent if the indirect subsidiary is held through one or more EU/EEA intermediary holding companies.
A legislative proposal is pending that, if adopted in its current form, will allow both fiscal unities. However, the decree and the current legislative proposal do not allow fiscal unities with non-EU/EEA subsidiaries or parent companies.
Following the court’s ruling, it appears that the decree must be expanded to allow groups between subsidiaries of foreign parents that are not from the EU/EEA to form a fiscal unity if the applicable tax treaty includes a non-discrimination clause. We assume, however, that the State Secretary of Finance will go to the Supreme Court to challenge the decision of the Dutch Court of Appeal.