For financial services companies, minimum substance requirements have been around for at least 10 years now, based on Dutch tax practice and guidance specifically for entities that wish to enter into an Advance Pricing Agreement. Recent changes have now turned these substance requirements into law, inspired by international developments in mutual assistance, but also in the context of BEPS.
The Netherlands is known for its extensive treaty network and numerous tax and non-tax related benefits, which have attracted substantial investments by US Multinationals. This resulted in many Netherlands-based active operations, regional headquarters, but also holding companies and financial services companies (i.e., performing licensing- and /or financing activities for the group).
While the group as a whole may very well have active operations in the Netherlands, typically holding and financial services companies have limited operational substance due to the nature of the activities. Although as a general rule a company incorporated under Dutch law is always considered a Dutch tax resident, in the international treaty context in particular the issue of beneficial ownership is key in order to invoke treaty benefits. The beneficial ownership issue is in principle a source country issue. However, as discussed below, the spontaneous information exchange that will be triggered where the Dutch substance requirements are not met, may have an impact on the source country's assessment of beneficial ownership.
Legislation on substance requirements for Financial Services Companies
On 1 January 2014, new legislation was implemented in Dutch law (article 3a Uitvoeringsbeschikking Wet op de Internationale Bijstandverlening), which created the legislative basis for substance requirements for financial services companies ("FSCs").
a. When does a company qualify as an FSC?
The requirement for companies actively to provide information on their level of substance (potentially resulting in exchange of information) specifically applies to Dutch companies which qualify as an FSC. Dutch law defines an FSC as a company whose activities in a fiscal year consist of 70 percent or more of directly or indirectly receiving and paying interest, royalties, rent or lease installments, to or from non-resident affiliated companies. In determining whether a company is an FSC, the relevant factors taken into account are: (i) the activities performed by the company and time spent by its employees; (ii) the assets used; (iii) the company's turnover; as well as (iv) the profit generated by the company on each of its activities. The decree is unclear on how each of these factors needs to be weighed. Holding activities should be excluded when applying the 70 percent test.
b. What are the substance requirements applicable to an FSC?
At least 50 percent of the FSCs statutory board members that are authorised to represent the company must be Dutch residents and have sufficient professional expertise to properly fulfil their duties. These duties include decisions on entering into transactions and the follow-up on those transactions.
The FSC must have qualified personnel to execute and administer its transactions.
The following must all be taken/held in the Netherlands: board decisions, main bank accounts, bookkeeping, and business address.
The FSC must not, to its best knowledge, be considered a tax resident in another country. It must incur real risks in relation to its financing, licensing, rental or leasing activities; and maintain sufficient equity in relation to the real risks it incurs.
c. What are the consequences of not meeting the substance requirements?
The legislation requires FSCs to actively inform the Dutch tax authorities about whether they meet the full list of Dutch substance requirements, throughout the fiscal year by checking a box in the Dutch corporate income tax return for the relevant year. FSCs that do not meet (all of) the substance requirements will be required to provide detailed information explaining reasons for not doing so, data on the nature of income and whether treaty benefits have been invoked. With this information, the Dutch tax authorities will verify the substance level and if they decide that the FSC does not meet the desired substance level, they can decide to exchange information on the FSC with the relevant jurisdictions. The exchange of information will only be done if treaty benefits or benefits on the basis of the EU Interest & Royalty Directive have been (or could have been) invoked. Such information may inspire the tax authorities in these countries to deny tax treaty benefits or the application of the EU Interest and Royalty Directive.
Impact on Advance Pricing Agreement ("APA") and Advance Tax Rulings ("ATR") environment
In addition to the legislative changes effective 1 January 2014, a number of related Decrees were updated on 12 June 2014. These Decrees essentially provide guidance around the ruling procedures relevant to Dutch companies that wish to enter into an APA (for FSCs) and/or an ATR with the Dutch tax authorities. With the update no change in the existing APA/ATR practice is envisaged. The relevant aspects that did change are addressed below.
a. What is the impact on FSCs that wish to obtain an APA after 12 June 2014?
An FSC that wishes to obtain an APA for its activities must meet the minimum substance requirements as explained above, with a particular focus on the real risk requirement mentioned above. There is detailed guidance on when an FSC is regarded as running a real economic risk. The decree also includes updated examples, as well as information on potential spontaneous exchange of information (i.e., the APA) on the basis of mutual assistance legislation. Most importantly, for APAs issued after 12 June 2014, if an FSC only meets the minimum substance requirements and the Dutch group to which it belongs does not have any other activities in the Netherlands (nor any plans to expand in the Netherlands), the content of the APA may be spontaneously exchanged with the relevant foreign tax authorities.
b. What is the impact on (holding) companies that wish to obtain an ATR?
While FSCs typically apply for an APA on the transfer pricing aspects, an ATR applies more broadly and provides advance certainty with respect to general corporate income tax matters such as the application of the Netherlands participation exemption regime, permanent establishment findings, dividend withholding tax exemptions etcetera., The updated ATR decree dated 12 June 2014 now specifically confirms that Dutch holding companies are eligible for an ATR if they meet all the substance requirements mentioned above other than equity maintenance can obtain an ATR. Furthermore, the decree now also states that when a (holding) company does not yet meet the required substance requirements on a stand-alone basis, it can still apply for an ATR if the group to which it belongs has operational activities in the Netherlands or has concrete plans to engage in operational activities in the future.
Considering this new development and in particular the impact this has on information exchange, multinationals are well-advised to review their existing substance levels in the Netherlands.