March 9th, the Dutch tax authorities released internal documents concerning pricing agreements with major multinationals relating intra group financing activities, following the abolition of the preferential regime for the income on intra group financing and acquisition funds (Group Financing Regime in Dutch “CFA”) by the European Commission in 2003. The publication followed a request based on the Government Information Act, which allows access to internal policies to ensure a level playing field. It can be questioned whether the former policy is in line with current post-BEPS views on intra-group financing activities and cash boxes. In the event this would not be the case potentially State Aid (in brief: a selective financial benefit granted by the government to a single or limited group of taxpayers) might be triggered, the benefits of which should be reclaimed by the Dutch government.
According to OECD BEPS Action plan 8-10 cash box/capital rich entities without any other people functions or relevant activities should only be entitled to a risk-free return. Any excess profits should be taxed where the value creation takes place. Furthermore, the benefits of group financing activities and cash pools should be divided amongst the participants.
In 1997, the Netherlands introduced a preferential regime for the income on intra group financing and acquisition funds, which were effectively taxed at a rate of around 7%. The goal of the legislation was to retain and attract treasury departments for the Netherlands. In 2003 this regime was sanctioned by the European Commission as forbidden State Aid. A grandfathering period was allowed for multinationals that enjoyed benefits of the regime. The Netherlands did consider implementing another special regime for interest income (the Interest Box) with approval of the EU as per 2007, but in the end the new rules were not enacted. As the Netherlands did not want those multinationals to transfer their treasury departments to other countries, it started talks with the multinationals in order to keep them in the Netherlands, also to bridge the period between the abolition of the CFA regime and the planned “Interest Box”. As the grandfathering period ended starting 2006, multinationals involved had to reconsider their financing structures. Subsequently concluded rulings on the corporate income tax positions were in most cases valid until end 2014.
Broadly speaking the Dutch policy with respect to the financing activities applied a profit split method. Between 10 and 20 percent of the profit was allocated to the entities that were actually performing the treasury functions (including risk taking decisions) in the Netherlands, where 80/90 percent of the profits was allocated to the entities that were mainly just owning the assets. Sufficient treasury substance in the Netherlands was a requirement for entering into an agreement with the Dutch tax authorities. The individual case related facts and circumstances are however kept confidential in the published documents. The approximately 20 multinationals involved supposedly transferred their financial assets to low tax jurisdictions and kept their treasury departments in the Netherlands.
It seems that this policy is on the opposite side compared the current generally accepted views on transfer pricing. The functions performed are a critical part in the functional analysis and when profits should be taxed where the value is created, this adds even more emphasis on the functions performed. When a treasury department is creating financial benefits, those benefits should to some extent be allocated to the entity performing the treasury activities. At least to a bigger extent than to a mere cash box, as seems the case in the agreements under scope. A mere cash box should under BEPS Action 8-10 not be entitled to more than a risk-free return. Before BEPS an approach based on mainly contractual allocation was argued.
In order to determine whether State Aid can be considered a potential risk, one should perform a detailed functional, risk and assets analysis of the entities involved in agreements with the tax authorities. Also comparable situations without rulings with the tax authorities should be reviewed. Besides it could be the case that one needs to explain and quantify whether one should form a provision for the accountant. In a broader sense this example illustrates that previously acceptable structures may now seem non-compliant with BEPS and that a risk analysis can be a good investment in order to tackle the risk before it materializes. It is questionable whether BEPS should have retroactive effect to previous times during which there was not yet a clearly developed common approach.