On 1 January 2019, a new interest deduction limitation entered into force in the Netherlands, the earnings stripping rule. Earnings stripping legislation applies to all Dutch taxpayers subject to Dutch corporate income tax. The earnings stripping rule is part of the Dutch implementation of the EU Anti-Tax Avoidance Directive (ATAD1).
This measure will affect the real estate sector seriously as real estate investments are generally heavily financed and the measure also applies to bank loans. For real estate developers furthermore applies that their tax EBITDA (based on which interest deduction is determined for the earnings stripping rule) is relatively low or amounts to zero during the development phase.
The earnings stripping rule limits the deduction of net borrowing costs (i.e. the amount by which the interest expenses exceed the interest income) to the highest of:
- 30% of the tax EBITDA; or
- EUR 1,000,000.
The tax EBITDA is the taxable amount plus net borrowing costs, depreciation on assets and impairments on assets. Net borrowing costs include all costs / receivables originating from loans and similar agreements, among which currency results, financing costs (e.g. handling fees, advisory fees and penalty interest) and costs and results on hedging instruments (such as interest rate swaps or currency swaps). Loans used to fund certain public infrastructure projects are in principle not taken into account when determining the net borrowing costs and are therefore not limited in interest deduction by virtue of the earnings stripping rule.
The earnings stripping rule applies per taxpayer, which means that if an entity has opted for a ‘fiscal unity’ for corporate income tax purposes (a consolidation regime) the tax EBITDA should be determined on a consolidated basis and the EUR 1,000,000 threshold also solely applies once. As interest deduction may be limited as a result of a lower tax EBITDA, the earnings stripping rule could have an impact on the preferred timing of incurring certain costs.
Interest that is non-deductible by virtue of the earnings stripping rule can be carried forward unlimited. If in a subsequent year there is any room left to deduct carried forward interest based on the abovementioned rule, this carried forward interest may be deducted. However, the legislator has announced that it intends to introduce a measure based on which carry forward interest shall be forfeited if the ownership in the taxpayer has changed substantially (i.e. 30% or more) to prevent the trade in ‘interest entities’ (similar to the rule based on which losses are forfeited after a substantial change of ownership in a taxpayer to prevent the trade in ‘loss entities’). As opposed to the rule that prevents the trade of loss entities, no step up will be granted to the fair market value of the assets to which non-deductible interest can be offset.
As a result of the entering into force of the earnings stripping legislation, new considerations have been introduced to take into account in relation to the structuring of a real estate investment. This applies to how a real estate investment should be structured from the start (e.g. whether the entity that will hold the real estate will be part of a fiscal unity), during an investment (e.g. whether costs should be incurred in a certain year) and in relation to the exit of an investment (i.e. a share deal or an asset deal).
We suggest to review whether this measure has any impact on your company and, if so, to discuss with your tax advisor whether the current way real estate investments are structured should be reconsidered.