INTRODUCTION
On April 23, proposed legislation was sent to the Dutch Parliament which includes measures of great importance for the Dutch business community. These measures, previously announced on January 29, 1996, can be divided into two categories. First, there is a group of provisions directed at the improvement of the Dutch business climate. Second, there is a group of provisions directed against improper erosion of the tax base of Dutch entities. If the Bill passes through Parliament it will be applicable as from the first calendar or accounting year commencing on or after the date of enactment. It is therefore expected that for taxpayers whose financial year coincides with the calendar year the provisions will be applicable from January 1, 1997 at the earliest.
The Bill as published, although rather detailed (in particular in relation to the group finance facility) is not entirely clear on all issues. Also, in relation to some essential issues, it refers to public rulings which have not yet been published (this applies, for example, to the functional currency facility), In view of this, the following memorandum only provides a general description of the proposals.
A.PROVISIONS IMPROVING THE BUSINESS CLIMATE
1. Risk-Reserve For Internationally Operating Companies
A Dutch resident entity which is part of an international group may, upon request, form a risk-reserve for specific risks associated with its international operations. The risk-reserve is meant for risks relating to finance activities and the holding of participations. To qualify for the facility, it is not necessary for the finance activity to be the sole activity of the Dutch entity, nor is it necessary to incorporate an entity for that purpose. The finance activities can only be conducted from the Netherlands. Whether the group has other finance entities outside the Netherlands is not relevant.
To qualify for the facility an entity must meet each of the following two tests: an activities-test and a countries-test.
The Activities-Test
The entity needs to perform finance activities for the benefit of the group. The term "finance activities" is broadly interpreted and includes, for example, the financing of affiliated entities (irrespective of whether or not they qualify for the participation exemption), as well as finance and operational leases. The countries-test To qualify for the facility, the entity has to perform the finance activities on behalf of group companies which are established in at least four countries or on two continents. In addition, under the four-countries-test it is required that affiliated entities in each of the countries contribute at least 5% of the taxable gross income of the Dutch entity. Under the two-continents-test, affiliated entities in each of the continents are required to contribute at least 10% of the taxable gross income of the Dutch entity. Under this countries-test a limited income-pooling will be possible.
In addition, the entity may also (but is not required to) finance Dutch group entities, although within certain ratios. For example, not more than10% of the funds used for the finance activities may be deployed in the Netherlands.
The Addition To The Reserve
Annually, 80% of the taxable profits from the finance activities, the income from certain participations and the income from short term investments which are made in connection with possible future acquisitions, can be deducted from the profit and added to the reserve of the Dutch entity. The taxable profits (as referred to above) from the finance activities do not include profits which are exempt by virtue of the participation exemption or profits which are exempt under double taxation relief rules Furthermore, the maximum annual addition to the reserve should not exceed80% of the taxable income of the Dutch entity; however, the size of there serve is otherwise unlimited.
THE RELEASE OF THE RESERVE
The reserve can be released in a number of ways:
A) By Means Of A Taxable Release
Losses allowed in relation to risks for which the reserve is created (for example: write-downs of loans supplied or liquidation losses), trigger a taxable release of the reserve to the extent of the write-downs or losses allowed.
B) By Means Of A Tax-Free Release
In a number of specific circumstances, the facility allows for a tax-free release of the reserve:
- The entity may release from the reserve 50% of the amount of the capital contributed to a participation or 50% of the price paid for a participation. On the other hand, the amount of the release reduces the cost price of the participation (relevant for the calculation of the liquidation loss).
- The (full) amount of a capital contribution to a group entity relating to the assumption of a liability by the group for a risk which has arisen in that entity and cannot be borne by that entity itself.
- The (full) acquisition cost of a participation which, in the opinion of the Minister of Finance, entails extraordinary risks, either on account of its activities or because of the place where these activities are performed.
c) Finally, the facility provides a possibility for voluntary release. With such a release, the reserve is released on a straight line basis over a five year period at a special tax rate of 10%.
2. Tax Return In Functional Currency
The proposed legislation also addresses the ability to file a tax return in a functional currency other than the Dutch Guilder. This part of the legislation aims to reduce the administrative burden for taxpayers who keep their books in a currency other than the Dutch Guilder. Upon the request of the taxpayer and subject to certain conditions, the profit of a Dutch entity can be reported in the entity's functional currency, which may be other than the Dutch Guilder. The conditions are still to be determined. The ability to report in a functional currency also supplies to Dutch permanent establishments of non-resident taxpayers. It is
subsequently possible at any time to change the functional currency back to the Dutch Guilder.
3. Liberalization Of The Participation Exemption
The Bill contains two provisions in relation to the applicability of the participation exemption as follows:
The Bill allows a Dutch entity to write down its investment in loss-making participations during the first five years after acquisition of that participation, provided that the Dutch entity owns at least 25% of the shares in the participation. This not only applies to newly incorporated participations, but also to acquired participations. This facility offers only a temporary advantage since the write-down will have to be reversed within a specific period. Only losses which accrue after the effective date can be taken into account.
Exchange results on loans connected with the acquisition of foreign participations will fall under the participations exemption (therefore, currency profits on these loans will be exempt; on the other hand, currency losses will no longer be deductible). At present these exchange results are taxable while the results on the participation itself qualify for the exemption. Upon request, the participation exemption can also apply to hedging instruments designed to cover the exchange results on participations.
B. ANTI-ABUSE PROVISIONS
1. Protection Of The Dutch Tax Base
General
These provisions are primarily meant to prevent the deduction of interestif the borrowing relates to certain transactions. If the provisions areapplicable, an interest deduction is not allowed irrespective of whether ornot the lender is a Dutch resident or foreign resident.
The following transactions are specifically mentioned:
1. A dividend or repayment of capital declared but not paid by a Dutch taxpayer, which results in a loan between the Dutch taxpayer and its shareholder;
2. A Dutch taxpayer borrows from an affiliated entity or an affiliated individual to finance a profit distribution or a repayment of paid-in capital to an affiliated entity or an affiliated individual;
3. A Dutch taxpayer borrows from an affiliated entity or an affiliated individual to finance the acquisition of a Dutch resident affiliated entity (the Ministry of Finance is of the opinion that this provision also applies if a fiscal unity is formed with the acquired entity);
4. A Dutch taxpayer contributes capital to an entity and borrows this back.
Under the latter three transactions the interest can be deducted if the Dutch taxpayer can show, that there are predominantly commercial reasons for the transaction. For example, the affiliated entity that provides the loan to the Dutch taxpayer may show that it, in turn, has borrowed the funds from a third party.
The interest can also be deducted if the lender is subject to - by Dutch standards - a reasonable level of taxation. In this respect, however, a tax level is not deemed to be reasonable if effectively no tax is payable by the lender due to loss compensation or a credit for prepaid taxes (either local, or foreign). What constitutes a reasonable level of taxation is not further defined in the Bill.
Interest which is not deductible under one of the four circumstances will, pursuant to a transition period, not be taxable to a Dutch lender until the year 2001. After 2001, any interest received will be taxable to the lender.
Fiscal Unity
Interest which is not subject to one of the above-mentioned deduction limitations, may be subject to limited deductibility within a fiscal unity. Interest which is due to an affiliated entity (this can be a Dutch entity as well as a foreign entity) in connection with the acquisition of the shares of an entity which will be part of a fiscal unity, is, in principle, only deductible to the extent the debtor has sufficient taxable profit of its own (the method which has to be followed in this respect will be further explained in a public ruling). The interest which is not deductible in one year is carried forward to subsequent years.
The denial of this interest deduction cannot be avoided by the Dutch taxpayer, even if he shows that there is a commercial reason for the transaction, or that the level of taxation on the lender is reasonable.
The above rule is not subject to a transition period. A similar deduction limitation will apply if the entities would legally merge.
This deduction limitation does not apply to the extent the acquiring group has borrowed money from non-affiliated entities.
2. Participation Exemption, Foreign Group Finance Companies
The participation exemption will only be available to a Dutch parent with respect to its foreign finance company if the foreign finance company is "actively" engaged in group financing.
In the explanation to the Bill, six cumulative conditions are listed which all must be met to avoid the application of the provision.
1. The foreign finance entity must be involved, other than incidentally, with the arrangement and execution of financial transactions on behalf of group companies;
2. The foreign finance entity is at least 20% financed with loans from third parties;
3. The foreign finance entity may not have a cash box function (in the explanation certain ratios are mentioned);
4. The foreign finance entity must employ sufficient qualified personnel;
5. The foreign finance entity must have an office supplied with facilities which are common in the finance sector;
6. The foreign finance entity must arrange relevant transactions through its own bank accounts.
According to the explanation of the Bill, the aim is to also include these conditions in the Unilateral decree for the relief of Double Taxation 1989. This may in particular be relevant for foreign finance branches of Dutch entities.
C. FURTHER REGULATIONS ANNOUNCED IN THE COMPLIANCE AREA
Apart from the very detailed draft legislation included in the Bill, the explanation to the Bill announces a number of regulations in the compliance area. In practice, the most important regulation deals with the question of interest connected with foreign participations which qualify for the participation exemption. Under current law, this interest is not deductible. The Bill explains the use of a specific calculation method to determine the amount of the connected interest expense.
Further information can be obtained from Mr te Spenke, KPMG Meijburg & Co, Amsterdam (Netherlands); fax 31 (20) 656 1247; or enter a text search 'KPMG' and 'Business Monitor'.
Keywords: Netherlands / Dutch / Europe / EC / EU / European Union /KPMG Meijburg & Co / business climate / risk-resource / functional currency / liberalization / anti-abuse provisions / foreign group / companies / regulations / area
Note: The content of this contribution is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
