The Fiscal Investment Climate
On June 11 2001 the report of the Corporate Income Tax in International Perspective study group was published. The study group was established by the Ministry of Finance with a mandate to prepare an advisory report on the desirability and possibility of amending certain business taxes, in particular the Corporate Tax Act. The report should be seen in the context of the emerging trend in the European Union to reduce effective tax corporate rates, recent tax reforms implemented or announced by various EU member states, and the discussion regarding harmful tax competition and the code of conduct.
The study group was particularly requested to pay attention to the following issues:
- the effective tax rate in the Netherlands and surrounding countries;
- the preparation of an analysis of the costs connected with reducing the corporate tax rate and how such reduction could be financed (eg, by broadening the taxable base);
- identifying 'bottlenecks' in the existing tax regime and providing suggestions on how to deal with these; and
- the possibilities of reducing the administrative burden.
The lengthy report (approximately 200 pages, including annexes) consists of three parts. The first part deals with the fiscal investment climate and discusses certain economic and fiscal trends in the European Union, in particular the competitive position of the Netherlands in light of the trend of reducing effective corporate tax rates. The second part addresses other topics, such as the participation exemption and hybrid loans. The third part of the report discusses European aspects of eliminating fiscal obstacles to operating in different EU member states.
The first part of the report concludes that countries that substantially reduce the burden of taxation will be more successful in attracting new investments. As a result, the Netherlands' tax base may be eroded. If the Netherlands does not bring the local tax burden in line with international trends then this will create additional costs in the form of higher tax rates, lower employment rates and reduced wages for employees.
The study group further believes that it is necessary to reconsider the corporate tax rate for two reasons. First, the Netherlands economy is a relatively small and internationally oriented economy and cannot afford to fall behind in EU corporate taxation developments. Second, is the rapid internationalization of the capital markets.
The study group recommends cutting the corporate tax rate by 5%. As a result, the corporate tax rate would be 25% for profits up to Fls50,000 and 30% for profits exceeding this amount.
The study group also recommends that capital duty be abolished (immediately or by way of a phase-out).
The participation exemption regime has been criticized because of the liberal application of the regime, the exemption of taxed foreign profits and the deductibility of liquidation losses. The study group emphasized that this exemption regime should be made available to businesses that conduct real economic activities in foreign countries. Therefore, the study group recommends that the difference between active and passive income be further accentuated. Income with a 'passive' character should be excluded from the participation exemption, where this is not already the case under current legislation. Also, the group recommends that the foreign subsidiaries should have a certain level of substance in order to qualify for the participation exemption.
In respect of the use of EU subsidiaries as a shelter for companies that do not qualify for the participation exemption (ie, a Dutch company owns the first- tier qualifying EU subsidiary that in turn owns the second-tier non-qualifying non-EU subsidiary), the group is of the opinion that this is abusive. Therefore it proposes to introduce an anti-abuse provision for non-EU portfolio investment subsidiaries that are held indirectly through an EU subsidiary. It is not clear whether this would also affect first-tier qualifying EU subsidiaries with branch activities in a non-EU country.
The group proposes no changes to the current loss liquidation rules.
Under the current participation exemption regime, costs relating to a foreign subsidiary are not tax deductible (because all profits are exempt). This provision has been challenged before the European Court of Justice and pending the outcome of this procedure the study group proposes no changes to the existing rules. The study group does recommend developing alternatives in case the Netherlands revenue loses the case. One proposal is that the actual costs can be deducted but that only 95% instead of 100% of the benefits from the participation are exempt (similar to the Belgian regime). Alternatively, although less likely, the restriction in respect of the deductibility of costs could also be extended to domestic participations.
The group has proposed measures to prevent dividend stripping. The Ministry of Finance has already taken up these proposed measures and it was announced on April 27 2001 that a draft bill would be published shortly. Under the proposed measures, a credit or refund of dividend tax will not be granted if the person requesting the credit or refund is not the ultimate beneficiary. The recipient of the dividend is not considered the ultimate beneficiary if the dividend proceeds are, through some form of consideration and directly or indirectly, for the benefit of another person.
'Hybrid loans' are defined as loans with mixed characteristics of both equity and debt. Hybrid loans can be attractive if the interest is tax deductible and the loan is considered equity for commercial purposes. The study group proposes that hybrid loans be requalified as equity if any of the following conditions are met:
- The interest rate is entirely dependent on the result (the profit) or the profit distributed by the company and the term of the loan exceeds seven to 10 years;
- The interest rate consists of a fixed component or a variable component where the fixed component is less than, for example, half of the market rate, the variable rate depends on the profit and the term of the loan exceeds seven to 10 years; or
- The interest rate is fixed but the payment is subject to the result or dividend of the borrowing party, where the loan is subordinated and the term of the loan is very long (eg, 30 - 50 years).
The result of this proposal would be that if a hybrid loan is requalified as equity, the interest is not tax deductible and, potentially, dividend tax would apply to the payments on the loan.
Hybrid financing structures are also used to create a tax deduction in one country and to receive exempt income under the participation exemption in the Netherlands. The study group recommends preventing this abuse by applying the participation exemption only if the company providing the hybrid financing already owns a qualifying interest in the foreign company. In addition, the remuneration on the hybrid financing should not be treated as interest (ie, should not be tax deductible) in the country where the recipient of the hybrid financing is located.
The mandate granted to the study group also included a review of the rules governing tax provisions. As a result of Supreme Court case law (the Baksteen Case 1998), it has become less difficult to form a tax provision for future expenses as it is no longer necessary that these expenses relate to an existing legal relationship. This case caused uncertainty as it is less clear under what conditions a tax provision can be formed.
The study group analyzed two alternatives for the current regime of fiscal provisions. The first alternative was to link the tax provisions to International Accounting Standards. Alternatively the tax provision would only be accepted if a similar provision in the commercial accounts was formed.
The study group came to the conclusion that it was not advisable to adopt either of the two alternatives. Consequently, the study group does not propose a change to the current regime of tax provisions.
Depreciation of real estate
The study group proposes to treat real estate held as an investment for tax purposes similarly to other investments. This means that such real estate cannot be depreciated. Instead, the value of the real estate for tax purposes is determined on the basis of the original cost price or the lower market value. Any decrease in value of the real estate below the original cost price would be tax deductible and, accordingly, a subsequent increase (but only up to the amount of the original cost price) is taxable. It appears that this measure is primarily motivated on the basis of its estimated budgetary effect.
Depreciation of acquired goodwill
The Netherlands allows depreciation of immaterial assets such as acquired goodwill. In general, the acquired goodwill (representing the present value of future profits) depreciates over five years.
The study group recommends extending the depreciation period of the acquired goodwill from five to 10 years. This would bring the depreciation period for acquired goodwill in line with what is usual in the EU countries.
The study group noted that companies operating in the European Union are faced with 15 different tax jurisdictions and 15 different corporate tax systems. This results not only in an additional administrative burden but also in additional costs such as double taxation and the evaporation of losses that cannot be offset. These obstacles should be removed and the study group discussed a common base taxation as a possible solution. The idea behind the system of common base taxation is that European group results can be consolidated provided that a common base is agreed upon by the EU member states.
The report of the study group does not include legislative proposals. It is a summary of recommendations to amend certain provisions, mostly the international implications of the Corporate Tax Act. It is not certain whether the Ministry of Finance will embrace the proposed recommendations. The report provides a helpful insight into the tax issues that are currently on the agenda of the Ministry of Finance for discussion, and the possible course of direction this discussion will take.
For further information on this topic please contact Wouter A Paardekooper at Baker & McKenzie, Amsterdam by telephone (+31 20 551 75 55 or +31 20 5517 848) or by fax (+31 20 626 79 49) or by e-mail (Wouter.A. [email protected]).
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