Fraus Legis
Decision
Future Tax Planning
Every capital contribution to a Dutch company, whether in cash or in kind, is subject to a 0.55% capital duty on the basis of the fair market value of the contribution. However, certain exemptions are available for share mergers, internal reorganizations or demergers. Under the business merger exemption the contribution of capital is exempt if an EU entity with capital divided into shares acquires the following:
- a whole enterprise;
- an independent part of an enterprise; or
- the entire equity from a similar EU entity, against the issuance of own shares.
On the basis of case law this exemption also applies if the contributor is not a resident of an EU member state, but is a resident of a state with which the Netherlands has concluded a tax treaty that contains a non-discrimination clause similar to the clause included in the Organization for Economic Cooperation and Development Model Convention. The treaty between the United States and the Netherlands includes such a clause, while the treaty between Canada and the Netherlands does not.
The tax authorities may decide to ignore certain transactions entered into by the taxpayer unless they can prove that such transactions were primarily concluded in order to avoid or reduce direct taxes. Under the fraus legis (abuse of law) doctrine the intent and purpose of the tax law should prevail over the transactions entered into by the taxpayer. When invoking the abuse of law doctrine the tax authorities apply the relevant tax provisions as if the (series of) transactions had not occurred (or occurred in a different order or manner).
On July 12 2001 the lower court of The Hague ruled on the question of whether fraus legis could be applied to a transaction that involved the capitalization of an intermediate holding company. The case concerned a US company (USCO) that incorporated a Dutch company (DutchCo) with a minimum share capital of Fls40,000. Subsequently, USCO incorporated an US intermediate holding (USHC) with a share capital of Fls20 million. USHC then acquired the shares in DutchCo from USCO and contributed its entire equity to DutchCo (with the exception of the shares in DutchCo) in exchange for shares in DutchCo. The funds were used by DutchCo to acquire 49.5% of the shares in a Chinese manufacturing company.
In the Dutch capital duty return DutchCo took the position that the capital contribution was exempt from capital duty by virtue of the business merger exemption (ie, the contribution of entire equity). This exemption requires an EU contributor, but on the basis of the United States-Netherlands treaty, DutchCo could also invoke the exemption for USHC as the contributor. The tax inspector challenged the exemption on the ground that the sole purpose of capitalizing DutchCo in this manner was to save capital duty.
The lower court held that DutchCo and USHC had deviated from the most obvious order to capitalize DutchCo: first incorporate USHC and then have USHC capitalize DutchCo with Fls20 million. The two-step acquisition of capital (first the minimum capital of Fls40,000 and then the capitalization by contributing the entire equity of USHC) served no other purpose than to avoid the levy of Dutch capital duty. The purpose and meaning of the capital duty tax is that a capital contribution to a Dutch company is subject once to capital duty. The court argued that in this case capital duty was only levied on a fraction of the capital contribution, which was contrary to the purpose and meaning of the capital duty tax.
Consequently, the Dutch company could not claim the capital duty exemption and capital duty was levied on the contribution of Fls20 million.
The Dutch company's argument that the application of the fraus legis doctrine was not possible under the non-discrimination article of the double tax treaty between the United States and the Netherlands did not succeed. The court held that the article does not prevent the application of fraus legis to this series of transactions.
The taxpayer has filed an appeal against the lower court's decision with the Supreme Court. It is not inconceivable that the Supreme Court will reverse the lower court's decision. The case clearly demonstrates that capital duty planning should be carefully structured and preferably be linked to a commercial transaction.
For further information on this topic please contact Wouter A Paardekooper at Baker & McKenzie, Amsterdam by telephone (+31 20 5517555) or by fax (+31 20 626 79 49) or by email ( [email protected]).