As most people know, the Netherlands is one of the few countries that does not charge a withholding tax on outgoing royalty payments. This is the basis for the Dutch tax treaty negotiations: The Netherlands does not charge withholding tax on royalty payments to any other country so the Dutch tax treaty negotiators will invariably ask the other country to reduce their royalty withholding tax on payment of royalties to the Netherlands to zero as well, something these other countries are very often prepared to do. Tax treaties, after all, are bilateral agreements.

But these foreign tax authorities increasingly find out that their acceptance of zero taxed royalty payments to residents of the Netherlands is increasingly being abused by companies in third countries that set up a Dutch subsidiary just to benefit from the zero royalty tax rate available for Dutch companies ("treaty shopping").

That is why many of the countries with which The Netherlands is negotiating or renegotiating a tax treaty, are nowadays insisting on inserting anti-abuse clauses in their tax treaties with the Netherlands, especially in the articles that deal with withholding taxes. In some cases the anti-abuse approach goes even further in which case tax treaties even contain so-called "Limitation on Benefits" (LOB) provisions: the advantages of the treaty (including a reduction of withholding taxes) are not available to Dutch companies if:

  1. such companies are not owned by residents of one of the two contracting States but by residents from third countries; this is called the "qualifying persons test'; or
  2. such companies, regardless of who owns them, pay most of the royalties they receive onwards in the form of tax-deductible expenses to legal entities outside the contracting States; this is called the "base erosion test'.

Other countries have in the past insisted on milder forms of anti-abuse provisions, in which case restrictions are put into in the treaty articles that deal with the reduction of the withholding tax rates, i.e. the treaty articles on interest, dividends and royalties. These anti-abuse measures are called "bona fide business purposes test" or "abusive back-to-back structures" etc. There is no uniformity in this area yet, also because the OECD that releases the so-called OECD Model Tax Treaty, on which many actual bilateral tax treaties are based, has so far not been able to come up with suggestions for a uniform wording of these anti-abuse provisions. But a draft on the meaning of the tax treaty requirement of "beneficial ownership" was launched in mid-2011and the many comments the OECD got back from tax scholars, tax authorities and tax advisers, will no doubt lead to a new and better attempt in 2012.

The tax treaty developments mentioned are relatively new and it should be carefully noted that unlike in the past, the Dutch government has recently announced, at the occasion of the ratification process of the new Dutch /Japanese tax treaty, that it will no longer object to anti-abuse provisions in the Dutch tax treaties and that even new LOB type provisions are acceptable. After all, the Dutch tax treaties were not written to be taken advantage of by non-Dutch businesses. We would not be surprised if a restricted form of the LOB provisions becomes part of the OECD beneficial ownership definition in the tax treaty articles that deal with dividends, interest payments and royalties. A LOB type of anti-abuse paragraph in tax treaties, i.e. a combination of the already existing qualifying persons and base erosion tests, will blow up most of the existing Dutch royalty conduit structures.

As a consequence of these developments, very many traditional Dutch royalty conduit companies, which are usually owned by legal entities, resident outside the Netherlands {often even in tax havens) and pay the bulk of the royalties they receive onwards to destinations outside the Netherlands, will within a number of years no longer qualify for tax treaty benefits and companies that generate royalty income as part of their regular business, should therefore reconsider their position rather sooner than later and not wait till the door closes on them.

As royalty tax experts, we have seen these developments come and in thinking them through, we have found fully legal but also workable solutions. Both the "qualifying persons" test and the "base erosion" test can be built into our novel royalty conduit structures and this memorandum serves to shed some basic light on how we envisage the new solutions, which will allow royalty generating companies worldwide to continue using the Dutch tax treaty benefits to their advantage, also in future years, without breaking the law and without violating the new tax treaty restrictions.

One relatively simple way to adjust to the "qualifying persons" test, is for royalty generating companies to no longer own the Dutch royalty conduit company, but to rent one from a Dutch service provider. In such a scenario, the first obstacle, the qualifying persons test, is rather easily overcome: the Dutch entity is now owned by Dutch residents so the company is no longer a "letterbox'' company involved in treaty shopping...

The renting of cars, ships, airplanes, office furniture and what have you, is very common in today's world but the renting of a legal entity is something new. But it works the same way in many respects: the renter can use the company for his own purposes while keeping the company in good (legal, tax and accounting) shape. For the rent he pays a fee. He does not have to bother with ownership issues, his company is no longer related to either the payor or the recipient of the royalties so he can now avoid several nasty tax issues that normally apply to transactions between related entities and he does not have to pay the EUR 18,000 of capital required under Dutch law to set up an entity. The sometimes very burdensome legal and central bank compliance rules (Know Your Customer (KYC) rules) which often delay a speedy execution of the transactions are also not applicable to the rental of legal entities: the service provider manages his own legal entities and is therefore not subject to the many restrictions and reporting and filing requirements of the Dutch Act on the Supervision of Trust Companies. After all, one does not have to own the Dutch royalty conduit company to get royalties out of it; royalties are generated on the basis of agreements, such as a master license agreement or a master lease agreement / head lease agreement.

This then leaves us with the second obstacle: the base erosion test. The Dutch entity, even if it is not owned by the ultimate royalty recipient himself, should still not pay the bulk of the royalties it receives out in the form of an onward payment of the royalties itself or in the form of other tax-deductible items, paid to legal entities outside the Netherlands.

We confine ourselves in this memorandum to inform our readers that we have also found a legal and practical way to overcome this second tax treaty obstacle as well. This memorandum is not intended to disclose all our secrets, but what we can say is, that it is legally and contractually possible to convert incoming royalties into a form of payment that is not covered by the new the anti-abuse provisions (LOB type or other). Details are available upon request for those tax payers that are prepared to consider renting one of our Dutch royalty conduits from us, as part of the new solution we recommend.

In this way, the Netherlands can still be used, like in the past, to collect royalties from abroad against low and often even zero foreign royalty withholding tax rates, even under the upcoming LOB and other anti-abuse provisions in the Dutch tax treaties, and to continue paying them onwards to UBO's anywhere in the world, including in tax haven locations. We charge a (negotiable) gross margin which we deduct from the royalty flow that our Dutch entity pays onwards, for its operating expenses and to realise a modest profit. Such onward payment, like in the past, is not subject to any royalty withholding tax, regardless of destination, because the Netherlands does not have a royalty withholding tax. 5o Ultimate Beneficial Owners (UBO's) may still continue to use countries such as the British Virgin lslands, the Cayman islands, Guernsey, the Seychelles etc. (zero tax countries) as the end station of their royalty income, if they wish.

The bottom line of this flyer therefore is: Dutch royalty conduit set-ups can still be made to work like in the past, despite the flow of new and unavoidable anti-abuse articles in the Dutch tax treaties, but the traditional way in which Dutch royalty and interest conduit entities operated for many decades has attracted very considerable resistance from foreign tax authorities, who have therefore decided to no longer allow treaty benefits to Dutch legal entities in structures that look like treaty shopping set-ups. One therefore needs to find a more sophisticated way to achieve the same results as in the past. The renting of a Dutch legal entity from a Dutch resident service provider like ourselves is the first and necessary - but not the only - step to arrive at what we call "New Age Royalty Conduit Structures".

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.