New law clarifies that where the participation exemption applies or stops applying because of a change in law (rather than a change of fact or circumstance), then dividends or gains from the non-qualifying period must be pooled or compartmentalised. The new law could have retrospective effect to 1 January 2007, or even further back.
Under Article 13 of the Dutch Corporate Income Tax Act, dividends and capital gains derived by a Dutch resident company from a participation in a subsidiary company are exempt from Dutch corporate income tax, if the Dutch resident company holds at least 5 percent of the nominal paid up capital of a subsidiary with a capital divided into shares and the subsidiary in short does not qualify as a low-taxed passive portfolio investment. If the Dutch parent company holds a participation in a subsidiary that initially did not qualify for the participation exemption, but started to qualify as from a certain date (or vice versa), then the compartmentalisation doctrine comes into play. This doctrine was developed by the Dutch Supreme Court for situations where, as a result of a change of facts, the participation exemption became applicable or no longer applied. The doctrine applied to capital gains and liquidation distributions. It was never explicitly confirmed that it also applied to dividends. Capital gains or liquidation distributions derived from a participation must be compartmentalised and allocated to the non-qualifying period and the qualifying period from which they stem.
Legislative amendment 2007
As of 2007, the participation exemption regime was substantively amended. For example, the subject to tax test was abolished for active subsidiaries. The legislature indicated that the compartmentalisation doctrine should also apply in situations where a legislative amendment results in a change of the application of the participation exemption. Additionally, the legislature indicated that the doctrine should also apply to dividends. Both notions of the legislature were however not formalised in the law itself.
Dutch Supreme Court case
On 14 June 2013, the Dutch Supreme Court ruled differently and judged that the compartmentalisation doctrine does not apply where the participation exemption becomes applicable due to a legislative amendment (rather than due to a change of facts). In that case, a foreign subsidiary had paid a dividend to its Dutch parent company in a year in which the participation exemption applied. However, this dividend originated from a period where the participation exemption did not apply. The participation exemption had become applicable as a result of the 2007 amendment of the participation exemption regime. The Supreme Court ruled that, absent an explicit legislative provision, the doctrine does not apply in situations where the change of the qualification under the participation exemption is the result of a legislative amendment.
The State Secretary of Finance immediately issued a press release, in which amending legislation was announced with retroactive effect to 14 June 2013. This legislation was adopted on 14 April 2015 and implements the compartmentalisation doctrine in article 28c and article 34c of the Dutch Corporate Income Tax Act for all situations in which the application of the participation exemption changes. Furthermore, the new legislation explicitly covers both dividends and capital gains. Under the new rules, a Dutch parent company must revalue its participation to fair market value at the moment of transition from non-qualifying to qualifying and vice versa. The difference between the fair market value and the tax book value is added to a so-called "compartmentalisation reserve".
a. Taxable compartmentalisation reserve
If the participation exemption did first not apply, but becomes applicable, then a taxable reserve is formed. Dividends and capital gains derived from the participation must be allocated to the non-qualifying period and the qualifying period. For dividends, in principle a LIFO system applies, unless the dividend resolution explicitly allocates the dividend to profits realised by the participation in another period. Upon realisation of dividends or capital gains allocable to a non-qualifying period, (i) the tax book value of the participation is reduced by the amount of the dividend received or realised gain, (ii) followed by a reduction of the taxable reserve, which reduction is then added to the taxable profit of the Dutch parent company.
b. Exempt compartmentalisation reserve
If the participation exemption did first apply, but no longer applies thereafter, then an exempt reserve is formed. The mechanics regarding the exempt reserve are in essence similar to the mechanics pertaining to the taxable reserve.
c. Retroactive effect
The new legislation has retroactive effect and will apply as from 14 June 2013. However, materially the retroactive effect may under circumstances stretch back even before this date. A distinction must be made here: transitions resulting from changes in facts were already captured by the doctrine developed by the Supreme Court, so the new legislation should materially not change much in that respect. However, transitions resulting from legislative amendments that occurred before 14 June 2013 are also captured by this new legislation. The material retroactive effect may stretch back to 2007. In such situation, the compartmentalisation reserve must formed at the moment immediately prior to the realisation of income from the participation.