Stibbe Tax Webinar on Dutch classification rules – update on Dutch FGR’s

On 1 July 2021, the Dutch state secretary of Finance issued a letter in which he indicated that – because of the significant impact on the investment portfolio of mainly pension funds and insurance companies – the proposed amendments to the Dutch fund for joint account (fonds voor gemene rekening or “FGR”), as explained below, will no longer be part of the legislative proposal on the Dutch tax classification rules. Instead, any amendments to the Dutch FGR will depend on the results and be part of a currently pending evaluation of the exempt investment fund regime (vrijgestelde beleggingsinstelling) and the fiscal investment fund regime (fiscale beleggingsinstelling).

This was also one of the topics of our tax webinar on Tuesday 29 June 2021, in which we discussed certain tax developments with relevance for real estate funds. We zoomed in on the draft bill to amend the Dutch classification rules for certain domestic and foreign legal entities and more specifically the potential impact on real estate funds. The draft bill proposes the following three amendments to the Dutch classification rules for domestic and foreign legal entities that could potentially have implications for existing domestic or cross-border real estate funds:

1. existing open Dutch limited partnerships (commanditaire vennootschap or “CV”) will become transparent for Dutch tax purposes;
2. amendment of the definition of a FGR that is considered as taxable entity (open FGR); and
3. introduction of two supplementary methods to classify foreign legal entities without an equivalent Dutch legal form.

Re 1. Existing open Dutch CVs will no longer be subject to Dutch taxation

Under current Dutch tax law a CV qualifies as transparent (closed CV) for Dutch tax purposes and the partners are taxed on the income derived from their interest in the CV, if the unanimous consent of all partners is required for the admission or substitution of a limited partner. In the Consultation Document the Dutch government proposes to abolish this ‘consent requirement’ for the classification of a CV and to classify each CV as transparent for Dutch tax purposes. This means that if the Dutch parliament adopts this proposal, all existing open CVs will become transparent for Dutch corporate income tax purposes. We discussed during the webinar that – although the proposal to abolish the open CV may be understandable – the draft bill requires more attention with respect to e.g. (i) other taxes (real estate transfer tax consequences are not mentioned) and (ii) the outcome of the transitional rules in case CV switches from non-transparent to transparent as a result of this bill.

Re 2. Amendment of open FGR definition

Regarding the FGR we discussed that it is a commonly used vehicle in the Netherlands for structuring real estate funds, mainly as a closed FGR (transparent) based on the condition that its participations can solely be transferred to the FGR itself (inkoopvariant). The Consultation Document introduces a new definition for an open FGR. Based on this new definition an open FGR is an FGR whereby either:

• the participations are traded on a regulated stock exchange within the meaning of article 1:1 of the Financial Supervision Act (Wet op het financieel toezicht) or a comparable trading platform; or
• based on its fund terms and conditions (fondsvoorwaarden), the FGR has the ongoing legal obligation to repurchase or repay its own participations from the assets of the FGR at the request of its participants and habitually makes such repurchases or repayments.

As discussed during the webinar, the suggested amendments to the definition of an open FGR may have an enormous impact on real estate funds. Currently transparent funds relying on the possibility to solely transfer its participation to the FGR itself, could potentially switch from closed FGR to open FGR. As indicated above, in view of the impact, the Dutch state secretary of Finance decided to postpone the amendments to the FGR and deal with this separate from the legislative proposal on the Dutch tax classification rules.

Re 3. Introduction of two supplementary methods for classifying foreign legal entities

Based on current Dutch policy, the classification of foreign legal entities as transparent or non-transparent for Dutch tax purposes is based on a comparison of certain civil law characteristics of the foreign legal entity and existing Dutch legal entities (legal entity comparison method). Based on this approach, for Dutch tax purposes a foreign legal entity is in principle treated the same way as the Dutch legal entity that is comparable to it.

In addition, if a foreign legal entity is comparable to a Dutch CV (e.g. a limited partnership) it will be classified as a taxable entity if the admission or transfer does not require the consent of all partners of that entity.

In the draft bill it is proposed that the legal entity comparison method of the Entity Classification Decree will continue to apply to foreign legal entities which can be compared to Dutch legal entities. As a result of the abolishment of the open CV it can therefore be expected that - after enactment of the proposed amendments - most foreign limited partnerships will qualify as transparent for Dutch tax purposes.

However, according to the Consultation Document in situations where no Dutch equivalent to a foreign legal entity exists, the legal entity comparison method is not helpful to classify a foreign legal entity for Dutch tax purposes and this may potentially result in a hybrid entity mismatch. In the Consultation Document, the Dutch government introduces two supplementary classification methods for situations where there is no Dutch legal entity equivalent to a legal entity established/incorporated under foreign law:

• Symmetrical or follow method: this method can be used for legal entities incorporated under foreign law that are resident outside of the Netherlands. Pursuant to this method, the Netherlands will for Dutch corporate income tax purposes follow the classification of that foreign legal entity for profit tax purposes in the jurisdiction in which that foreign legal entity is incorporated/established.
• Fixed method: this method can be used for legal entities incorporated/established under foreign law that are resident in the Netherlands. Pursuant to this method, those foreign legal entities are considered a taxable entity for Dutch corporate income tax purposes.

In the webinar we discussed that, although many hybrid mismatch situations under ATAD2 will be solved by the proposal, not all differences in qualifications of entities will be resolved and new ones may even occur. It is not clear why the Dutch government did not propose to use the symmetrical method in all cases. This should take away all hybrid entity mismatches (the main goal of the proposal) and the definitions of the FGR and CV is no longer relevant for the qualification of foreign entities. If the government still wishes to address the issues around the national aspect of the CV and FGR, it can take more time to do so and do it completely separate from the qualification of foreign entities.

Other than as initially stated in the draft bill, the consultation document will not lead to a final bill which will be presented to the Dutch Parliament as part of the 2022 Budget plan. In view of the significant number of responses received as part of the consultation, it has been decided to take more time to assess the impact of the proposed amendments. A draft bill is now announced for the winter ‘21/’22, meaning most likely Q1 of 2022. If adopted by the Dutch Parliament, the (revised) proposed amendments are then expected to become effective 1 January 2023, if not later.

For more details on the consultation document, we refer to our Tax Alert of 1 April 2021: click here

If you have any questions about the webinar or you would like to watch the webinar (again), please send an e-mail to maurits.vandijk@stibbe.com.