Dutch Spring Memorandum, EU’s DEBRA Proposal and the 2021 Annual Report Advance Tax Rulings

In addition, we would like to refer you to our contributions to the latest edition of the Chambers Corporate Tax 2022 Global Practice Guide and the Chambers Tax Controversy 2022 Global Practice Guide.

1. Spring Memorandum

In this year’s Spring Memorandum, the amendments to Dutch tax laws are quite significant compared to other years, mainly due to a ruling of the Supreme Court at the end of last year in which it found that the manner in which wealth is taxed in the Netherlands – based on a notional yield – violates the European Convention on Human Rights (according to the ruling, only actual returns should be taxed). As a result, the Dutch government had to look for at least EUR 3.6 billion to compensate complainants for the wrongly paid Box 3 asset tax. The government intends to raise billions of euros by shifting tax rates and discounts that mainly affect people with a high amount of wealth and a high income. For international business, mainly the following amendments are relevant:

• The current proposal includes a decrease of the lower bracket of the corporate income tax rate. As a result of this decrease, the first EUR 200,000 (currently EUR 395,000) of taxable profits is taxed at 15% and the remainder is taxed at 25.8%.
• It is also proposed to limit the scope of the “30 percent ruling”, a tax benefit for expats. On the basis of this regime, people recruited from abroad to work in the Netherlands who qualify for the benefit do not have to pay tax on 30 percent of their wages. According to the Spring Memorandum, this will apply only to an income limit of up to EUR 216,000 per year. That limit, known as the Balkenende Norm, is equivalent to 130 percent of a minister’s earnings.
• The general real estate transfer tax rate will be increased from 9 percent to 10.1 percent. The general rate does not apply to the acquisition of main dwellings. This rate increase applies in particular to acquisitions of non-residential buildings and to acquisitions of houses by legal entities and natural persons who do not themselves (other than temporarily) use the houses as their main residence. This measure comes on top of the increase in the coalition agreement from 8 percent to 9 percent.

The other proposed measures – some of which are likely to have a significant impact – focus more on the taxation of individuals.

2. EU Commission publishes proposal to implement debt-equity bias reduction allowance (‘DEBRA’)

The DEBRA Proposal lays down rules (i) to provide, under certain conditions, for the tax deductibility of notional interest on increases in equity, and (ii) to limit the tax deductibility of exceeding borrowing costs.

The DEBRA Proposal would have to be implemented and applied by Member States from 1 January 2024 and is expected to have a significant impact on EU corporate taxpayers. The measures included in the DEBRA Proposal would apply in addition to the interest deduction limitation rules based on the EBIDTA as introduced under ATAD1.

The DEBRA Proposal is a follow-up to the EU Communication on Business Taxation for the 21st Century of May 2021, which sets out a long-term vision to provide a fair and sustainable business environment and EU tax system, as well as targeted measures to promote productive investment and entrepreneurship and ensure effective taxation.

Scope

The DEBRA Proposal applies to all taxpayers subject to corporate income tax in one or more Member States and includes, as mentioned, two separate measures that apply independently: (i) an equity allowance and (ii) a limit on interest deduction.

It does not apply to financial undertakings, such as credit institutions, investment firms, AIFs, AIFMs, UCITS, UCITS management companies, insurance and reinsurance undertakings, pension institutions, securitisation vehicles (covered by Regulation (EU) No 2017/2402) and crypto-asset service providers.

• Equity allowance

On the basis of the proposal, companies would be allowed to deduct an allowance on equity from their taxable base for ten consecutive periods, where a taxpayer increases their equity from one tax period to the next. The allowance on equity is computed by multiplying the allowance base by the relevant notional interest rate.

           Allowance on equity = Allowance Base X Notional Interest Rate (NIR)

The allowance base is equal to the difference between equity at the end of the tax year and equity at the end of the previous tax year (the year-on-year increase in equity). The proposal defines equity as the sum of paid-up capital, share premium account, revaluation reserve and reserves and profits or losses carried forward. Net equity is then defined as the difference between a taxpayer’s equity and the sum of the tax value of its participation in the capital of associated enterprises and of its own shares. The Commission notes that this definition is meant to prevent cascading the allowance through participations.

The applicable interest rate is a currency specific risk free rate for 10-year debt. This rate is combined with a risk premium rate of 1%. A higher risk premium interest rate (1.5%) is proposed for SMEs.

           Notional Interest Rate (NIR) = Risk Free Rate + Risk Premium

           Risk Premium = 1% (or 1.5% for SMEs)

The allowance is limited to 30% of EBITDA. If the allowance exceeds the taxpayer’s net taxable income, the part of the allowance on equity that would not be deducted in a tax year due to insufficient taxable profit may be carried forward indefinitely to future periods. Any unused allowance capacity (where the allowance exceeds 30% of EBITDA) can also be carried forward and used for a maximum of five years to reinforce parity with the EBITDA rule of ATAD1.

A reduction in the equity after the taxpayer obtained the allowance on equity, based on this proposal, results in the taxation of a proportionate amount over ten consecutive tax periods and up to the total increase of net equity for which such allowance has been obtained, unless the taxpayer can demonstrate that the decrease of equity is a consequence of accounting losses incurred in the period, or is due to a legal obligation to reduce capital.

The proposal also includes anti-abuse measures as a result of which equity increases will be excluded from the allowance base if they are related to certain (intra-group) transactions.

• Limitation of interest deduction

On the debt side, the allowance for notional interest on equity is accompanied by a limitation of the tax deductibility of debt-related interest payments. In particular, a proportional restriction will limit the deductibility of interest to 85% of exceeding borrowing costs (i.e. interest paid minus interest received). According to the Commission, such an approach makes it possible to address the debt-equity bias simultaneously from both the equity and the debt side, which is most efficient and preserves the sustainability of Member States’ public finances.

Given that interest limitation rules already apply in the EU under Article 4 of the ATAD, the taxpayer will apply the rule of Article 6 of this proposal as a first step and then calculate the limitation applicable in accordance with Article 4 of ATAD. If the result of applying the ATAD rule is a lower deductible amount, the taxpayer may carry forward or back the difference in accordance with Article 4 of ATAD.

The following example is included in the DEBRA proposal:

If company A has exceeding borrowing costs of 100, it should:

1. first, apply Article 6 of the DEBRA proposal that limits the deductibility to 85% of 100 = 85 and thus renders a non-deductible amount of 15; and
2. second, compute the amount that would be deductible under Article 4 of the ATAD. If the deductible amount is lower, e.g. 80 (and subsequently the non-deductible is higher, i.e. 20), the difference in the deductibility, i.e. the additional non-deductible amount (i.e. 85-80 = 5), would be carried forward or back in accordance with the conditions of Article 4 of ATAD, as transposed in national law.

The outcome for company A is that 15 (100 - 85) of interest borrowing costs are non-deductible and a further 5 (85 – 80) of interest borrowing costs are carried forward or back.

Next steps

If the Member States unanimously agree on the DEBRA Proposal, the rules would apply from 1 January 2024 (except for Belgium, Cyprus, Italy, Malta, Poland and Portugal, six Member States with similar rules that would be granted a 10-year grandfathering period). This means that corporate taxpayers have a relatively short time to assess the impact on their position, especially if the other initiatives that the EU Commission has recently issued or intends to issue are also taken into account (e.g. the Unshell Proposal and the Pillar II Proposal (see our Tax Alert of December 2021 for details)).

3. Annual report on Advance Tax Rulings

The 2021 Annual Report on Advance Tax Rulings covers all rulings of an international nature and includes both rulings with large companies and rulings with small and medium-sized enterprises. In 2021 there were no significant changes in the ruling practice. According to the report, there has been continued familiarisation with the new practice that has applied since July 2019.

There are no substantial changes in the number of requests received and disposed of compared to 2020. The number of requests received is 594 (2020: 642). The total number of completed requests is 650 (2020: 600). The number of requests granted has increased slightly to 446 (2020: 387). There appears to be some stabilization in the numbers of requests received following the stricter conditions for tax rulings since 1 July 2019.

The report mainly focuses on the numbers of ruling requests submitted and tax rulings granted, but also provides some (limited) insights on positions taken by the Dutch ruling team. These include the following:

• No economic nexus is required with respect to a Dutch passive limited partnership that does not conduct a business by Dutch tax standards, in line with the already known position that such economic nexus is not required for an advance tax ruling with respect to the absence of a permanent establishment. In such cases, there will obviously be a critical examination of whether the fund’s activities are not of such a nature that they exceed the investment criterion.
• As in 2019 and 2020, in 2021 requests for preliminary consultations were processed that relate to financing activities and that provide a further clarification of the answer to the question of when there is sufficient economic nexus in cases of intra-group financing activities. In this respect it is important to compare the functions performed in the Netherlands with the other relevant functions in the group that relate to the financing activities.
• With regard to a dual resident NV that was part of a group of companies with substantial operational activities in the Netherlands, the tax ruling request could be processed in view of the substantial economic nexus of the group as a whole in the Netherlands and because it was evident that taxation has not played a role in the choice for the dual resident.
• The situation whereby a company established in the Netherlands holds shares in an entity incorporated under the laws of and established in a country outside the EU that conducts an active business, through its permanent establishment, in a jurisdiction included in the low-tax jurisdictions and non-cooperative jurisdictions for tax purposes, does not preclude a tax ruling if – as in the relevant case – the participation also holds interests in other operating entities.
• It has furthermore been confirmed that certainty in advance can be obtained in view of the introduced conditional withholding tax on dividends. The law in question will enter into force as of 1 January 2024.