In general, interest payments made by a Dutch corporate taxpayer are deductible from its taxable income. Interest deduction is subject to a number of statutory restrictions set out in the Dutch tax law. These restrictions are summarised in the following client memo: “Interest deductions in the Netherlands“. The public consultation proposes to amend two of the statutory restrictions.
The first statutory provision to be consulted on is an anti-base erosion rule that applies to intra-group financing only. Pursuant to this rule, interest paid to a related party is in principle non-deductible if the loan was attracted in connection with a tainted transaction. This includes an acquisition by the taxpayer or by certain related entities of a company that becomes a related entity after the acquisition. The interest is, however, deductible if the taxpayer proves that both the transaction and the financing were entered into for valid business reasons or if the interest is subject to an effective tax rate of 10%.
The second statutory provision to be consulted on is a limitation on acquisition debt financing. This rule limits the deduction of interest on “excessive” acquisition debt from the taxable profits attributable to a Dutch target company. Subject to this rule and certain other limitations, creating the possibility to offset interest on acquisition debt against the taxable profits of a Dutch target is typically fairly easy to achieve by using a Dutch acquisition vehicle. That vehicle either forms a fiscal unity or merges with the Dutch target on or shortly after the acquisition. The limitation in respect of acquisition debt financing is not limited to related-party debt, but also extends to third-party debt.
Whether acquisition debt is excessive is determined on the basis of a loan-to-purchase price ratio. In the year of the acquisition, a maximum loan-to-purchase price ratio of 60% is allowed; this maximum percentage is reduced by 5%-points annually over the course of seven years, down to 25% in year eight and subsequent years. Acquisition debt interest is not deductible from the Dutch target’s taxable profits to the extent that the actual loan-to-purchase price ratio exceeds the acceptable ratio (that is, 60% in year one to 25% in year eight). A de minimis threshold of EUR 1 million applies.
In August 2015, two members of Dutch parliament published the Initiative Policy Document Private Equity: A halt to excesses. This policy document provides twelve measures to halt what they perceive to be excesses in the private equity sector. The Dutch Ministry of Finance responded to the policy document in December 2015 and emphasised the importance of private equity firms for Dutch businesses. With respect to most of the proposals, the Dutch Ministry of Finance did not agree that amendments to existing law are necessary at the moment. This means that no amendments are currently expected in this respect. The Dutch Ministry of Finance did, however, endorse three technical proposals regarding the deductibility of interest payments. These proposals were published in June 2016 and the intention is for the changes to take effect as from 1 January 2017.
The main proposed changes to the interest limitation provisions
- First, the scope of the definition of related entity in the anti-base erosion rule applicable to intra-group financing would be extended. Under the current rules, the following entities are considered related:
- a company in which the taxpayer has an interest of at least 1/3;
- a company that has at least an interest of 1/3 in the taxpayer;
- a company in which a third party has an interest of at least 1/3 whilst this third party also has an interest of at least 1/3 in the taxpayer; and
- a company with which the taxpayer forms a fiscal unity.
- Certain investment structures are arguably not captured by this rule if none of the investment entities providing loans hold a 1/3 or more (economic) interest in the acquisition company or each other. The draft bill provides that these kinds of lenders will also be considered related with the acquisition company and the target if they act in concert, and if they together hold an interest of at least a 1/3 in the acquisition vehicle and target.
- Second, changes to the acquisition debt financing rule would close the alleged loophole for avoiding the annual reduction of the loan-to-purchase-price ratio. This ratio is reduced by 5%-points annually over the course of seven years, down to 25% in year eight and subsequent years. The reduction of the loan-to-purchase price ratio could possibly be avoided by incorporating a new acquisition company in the year after the acquisition and transfer the target company to this new acquisition company. After the transfer of the target company and each subsequent transfer, it could be argued that a new seven-year period starts and that again the maximum percentage could be deducted in the first year after the acquisition. After the proposed change to the acquisition debt financing rules, the transfer of the target company to a related entity will be ignored and no new term will start.
- Finally, the mathematical rule to calculate the non-deductible amount of interest on acquisition debt would be changed. The mathematical rule does not work as envisaged by the legislature in the case of a “debt push down” transaction. By implementing a true debt push down transaction, the acquisition financing moves from the acquisition company to the target company. The background is that on the basis of a technical reading, this rule does not actually apply to the part of the acquisition debt that is effectively transferred to the target entity. In many cases, the proposed amendment to the mathematical rule would make the debt push down not effective anymore.
- The Dutch Ministry of Finance points out that the anti-tax avoidance directive of the EU, adopted on 17 June, also provides for a general interest limitation rule on exceeding borrowing costs: an earning stripping rule. The Ministry of Finance seems to suggest that the acquisition financing rule may be abolished when the earnings stripping rule enters into force, but is silent about the effects on the above anti-base erosion rule and another base erosion rule, not addressed in this alert.
Interested stakeholders can submit their input or propose amendments to the draft bill until 18 July.