Earlier this month, the Netherlands Ministry of Finance published a draft legislative proposal ('the proposal') aiming to eliminate double non-taxation resulting from the application of the arm’s length principle. The proposal is open for consultation until 2 April 2021. A final proposal is expected before summer 2021, and the government intends for the proposal to obtain the status of law no later than 1 January 2022. We have outlined the key points below.
Source of double non-taxation
Conceptually, the application of the arm’s length principle may result in both upward and downward profit adjustments for taxpayers. In certain situations, the application of the arm’s length principle may result in a downward adjustment in the Netherlands, without a corresponding (upward) adjustment elsewhere. In order to prevent such mismatches, the proposal effectively provides for an amendment of the application of the arm’s length principle in the Netherlands, by providing that downward adjustments will be denied to the extent there is no (or a lower) corresponding adjustment in the jurisdiction of the related party. The proposal further contains a specific measure in relation to asset transfers, including for assets transferred before the intended entry into force of the Proposal (ie 1 January 2022).
A straightforward example of a transaction caught by the proposal would involve a Netherlands taxpayer attracting an interest free loan from a related party, whilst an arm’s length rate would be 4 per cent. Currently, the Netherlands taxpayer would be allowed to deduct the arm’s length interest rate of 4 per cent from its corporate income tax (CIT) base, irrespective of the tax treatment thereof at the level of the related party. Under the Proposal, the Netherlands taxpayer may only take into account such deduction if (and to the extent) the (deemed) interest income is included in the taxable profits of the related party providing the loan.
Under the proposal, the same principle applies in the situation in which a downward adjustment results in ‘less taxable income’ in the Netherlands. If the example above is inverted, ie if the Netherlands taxpayer provides the loan to a related company at an interest rate of 8 per cent where the arm’s length rate is 4 per cent, the Netherlands taxpayer would currently only have to include the 4 per cent arm’s length rate in its taxable income. On the basis of the proposal, the Netherlands taxpayer would be obliged to include the full 8 per cent interest in its taxable income if there is no corresponding adjustment in the jurisdiction of the borrower (ie if the borrower does not correspondingly lower its interest deduction from 8 to 4 per cent).
Transfer pricing mismatches can also occur in case assets are transferred between related parties. The proposal provides that assets transferred from a related party to a Netherlands taxpayer for less than an arm’s length value may not be included on the Netherlands taxpayer’s balance sheet at the higher arm’s length value if and to the extent that such excess value is not included in the tax base of the transferor. Without this measure, a Netherlands taxpayer would include the asset transferred on its balance sheet for the arm’s length (market) value, leading to a step-up in the tax base of the relevant asset (which may then be depreciated over time), irrespective of whether the transferor’s jurisdiction levied tax on the difference between the arm’s length value and the purchase price. The proposal effectively limits deductible depreciations at the level of the Netherlands taxpayer in these cases.
The proposal considers another jurisdiction to have made a corresponding adjustment if the upward adjustment or corrected deduction is included in the tax base of the related entity, irrespective of the subsequent tax treatment of such income. In other words, the fact that such adjustment may subsequently be taxed at a rate of 0 per cent, falls within a specific exemption or is set-off against tax losses carried forward is irrelevant. There is, however, no corresponding adjustment if the jurisdiction of the related entity does not levy any tax on profits. Even in case the tax base of the related entity is included in the tax base of (one of) its shareholders under controlled foreign company (CFC) legislation, this is not regarded as being ‘included’ for purposes of the proposal. So, ‘favourable’ arm’s length corrections for Netherlands taxpayers are no longer possible in case the related party is tax resident in a tax haven. Loans attracted or assets acquired (see below) from related parties in tax havens on arm’s length terms are, however, still accepted and not targeted by the proposal.
The proposal provides that if an asset is transferred within five bookyears preceding the bookyear starting on or after 1 January 2022, and such transfer would have been caught by this proposal had it been in force at the time of the transfer, then the tax base of such asset is set at the lower of:
- the book value of the asset as follows from the measure as explained under ’Asset transfers’ above (had the legislation been in force at the time); or
- the book value of the asset at the end of the 2021/22 book year.
As such lower tax base results in lower depreciation, and thus more profits and tax going forward, effectively the proposal has retrospective effect.
Burden of proof on taxpayers
The proposal furthermore provides that if a Netherlands taxpayer intends to apply a downward adjustment or a transfer of an asset at an arm’s length value, the taxpayer needs to demonstrate that there has been a corresponding upward adjustment in the jurisdiction of the related party. The proposal will therefore lead to an increased administrative burden for taxpayers that engage in intercompany transactions.
The proposal clearly contravenes long standing case law of the Netherlands Supreme Court. According to the Ministry of Finance, this can be justified by the aim of preventing double non-taxation.
In any case, the proposal is in line with recent tax developments in which jurisdictions (including the Netherlands) increasingly take the tax treatment of a particular transaction or taxpayer by another jurisdiction into account when exercising its taxing rights (most notably, by way of CFC rules and anti-hybrid measures such as those provided for in the EU’s two anti-tax avoidance directives).
We will closely monitor the outcome of the proposal. Multinational groups with operating entities in the Netherlands should be aware of the intended measures and should, in addition to preparing adequate transfer pricing reports, in the meantime carefully analyse whether (and to what extent) transfer pricing mismatches may occur.