On 15 June 2009, the Dutch Ministry of Finance released a discussion paper with proposals for changes in the taxation of group interest, the deductibility of 'excessive' interest and the participation exemption. The discussion paper contemplates that the proposals will become effective as of 1 January 2010.
The proposed changes, in particular those limiting the deductibility of financing expenses, are particularly relevant for private equity funds that make use of Dutch holding companies for leveraged investments.
Mandatory group interest box
A mandatory group interest box is proposed, taxable at an effective rate of 5%. The group interest box will include the balance of all interest income and expenses of the group as well as certain other types of income or gains related to financing activities of the group. The implementation of this regime is subject to approval by the European Commission.
Restrictions on the deductibility of financing expenses – two alternative approaches
In response to recent turmoil about ‘excessive’ interest deductions, the discussion paper further puts forward two alternatives for the legislator to limit the deductibility of interest. Both alternatives apply to related and unrelated party financing, have in common that they only apply if and to the extent interest expenses exceed EUR 250,000, and are to replace existing thin cap rules.
The first alternative introduces two specific rules:
- limitation of the deductibility of interest paid on (i) loans which are attributable to participations that qualify for the participation exemption, and (ii) group receivables that fall within the scope of the group interest box, and
- limitation of the deductibility of ‘excessive’ interest offset by a Dutch holding company against the profits of subsidiaries that is part of the same consolidated tax group (“fiscal unity”). Interest is considered ‘excessive’ if and to the extent the taxpayer’s debt-to-equity ratio exceeds 3:1.
The second alternative comprises generic earnings-stripping rules which focus on a taxpayer's P&L to determine whether interest expenses are excessive. In this proposal, interest will only be deductible up to 30% of the taxpayer's EBITDA. Exceptions apply if the taxpayer is not part of a group or if the group’s debt-to-equity ratio is higher than the debt-to-equity ratio of the taxpayer.
The discussion paper proposes to relax the requirements for the participation exemption. The current objective criteria, although introduced as recently as 2007, have proven highly impractical. The paper proposes to reinstate the pre-2007 nonportfolio investment test but with some improvements. In short, the participation exemption will apply to any participation of at least 5% that is not held as a passive portfolio investment. The proposed change contains an escape for subsidiaries held as passive portfolio investment if:
- the subsidiary is subject to a 10% or higher corporate income tax rate, or
- the assets of the subsidiary consist for less than 50% of passive investments.