This Tax Alert provides an update on three relevant tax developments: i) the scope of the attorney-client privilege in relation to tax cases; ii) the government's response to the introduction of a dividend withholding tax exit levy (initiative law presented by the opposition); and iii) recent Supreme Court rulings regarding interest deductibility.
i) No amendments to the scope of attorney-client privilege in tax matters
On 19 July 2022, the Dutch government launched a public internet consultation (internetconsultatie) of the draft Taxation (Miscellaneous Provisions) Act 2024 (Fiscale verzamelwet 2024) started. The internet consultation will be open until 22 August 2022. The annual Taxation (Miscellaneous Provisions) Act introduces changes (substantive amendments as well as technical updates) to various tax laws. The draft Taxation (Miscellaneous Provisions) Act 2024 includes inter alia amendments to provisions relating to the scope of the attorney-client privilege (legal privilege) in tax matters.
The scope of legal privilege in tax matters has been subject to discussion in recent years, as the government argued that there may be some tension between such privilege and (full) tax transparency. Also in view of international developments (e.g. the OECD asked countries to focus on the scope of professional privilege in the field of tax), the State Secretary for Finance published a proposal for a statutory measure that was submitted for internet consultation in the second half of 2020. The proposal defined (and limited) the activities of lawyers and civil-law notaries that would fall under legal privilege and, in certain cases, made it possible for the tax inspector to approach the lawyer or civil-law notary with the request to submit information initially requested from the taxpayer. The proposal (a far-reaching erosion of legal privilege) was heavily criticized in the consultation.
In the Explanatory Memorandum (Memorie van Toelichting) to the draft Taxation (Miscellaneous Provisions) Act 2024, the government expresses that it acknowledges the criticism to the 2020 consulted proposed measure and states that it therefore does not want to take the measure any further in its consulted form. Instead, the government now proposes amendments to the legal privilege provisions in tax law which includes (a) codifying the guiding case law of the Dutch Supreme Court on the interpretation of the legal privilege, which clarifies that information covered by the legal privilege must be information that is exchanged with the person entitled to legal privilege in "his capacity" as professional entitled to legal privilege (i.e. a lawyer or civil-notary), and (b) clarifying when the taxpayer cannot invoke his right of refusal (i.e. the right to refuse to share certain information, which right stems from the legal privilege of a lawyer or civil-notary). Specifically, it is proposed to make explicit that the involvement of someone with legal privilege does not relieve the taxpayer from fulfilling the information obligations which he would have towards the inspector even without the involvement of such person (as also confirmed by the Supreme Court). The amendments are only aimed to clarify, and not to limit or change, the scope of legal privilege. The proposed clarifications are much welcomed in light of the on-going discussions regarding the scope of legal privilege in tax cases.
ii) Dividend withholding tax exit levy
On July 10, 2020, a member of one of the Dutch opposition parties GreenLeft (GroenLinks) submitted to the Dutch House of Representatives a legislative proposal for a so-called Dividend Withholding Tax Exit Levy Emergency Act (Spoedwet conditionele eindafrekening dividendbelasting) (“exit levy proposal”). The exit levy proposal provides for a dividend withholding tax exit levy for some types of crossborder activities, including reorganizations, relocations, mergers, demergers, and stock mergers. The most recent legislative proposal submitted would have retroactive effect as from 15 November 2021. In short, it is proposed that entities that leave the Netherlands by way of a transfer of seat, merger etc. would be subject to an exit levy in respect of any profits created in the Netherlands that would otherwise be subject to Dutch dividend withholding tax upon distribution. There is an exception proposed if the ‘new’ jurisdiction has a similar dividend withholding tax and does not provide for a step-up. The proposal has been scrutinized and criticized, and multiple amendments have been proposed. In the last amendment of December 8, 2021, the scope of the initial proposal has been narrowed by including that (i) the exit levy proposal will only be invoked if a company departs from the Netherlands to a country that is not a member state of the EU or the EEA that does not levy dividend withholding tax itself or does not provide a "step-up" upon entry and (ii) the exit levy will only be levied on investors who are residents of a country that is not a member state of the EU or the EEA and with which the Netherlands has not concluded a tax treaty. For a more detailed description, we refer to our Tax Notes International article of 3 January 2022.
Today, two years after the first proposal was submitted, it is still unclear whether a dividend withholding tax exit levy will be enacted into Dutch tax law. However, on July 15, 2022, the Dutch government sent a letter expressing its appreciation of the exit levy proposal: the Dutch government advises the House of Representatives not to adopt the bill. In doing so, the Dutch government follows the negative advice given by the Advisory Division of the Council of State with regard to the exit levy proposal. The Dutch government's objections to the initiative bill consist of the following nine points:
- The effectiveness and efficiency of the exit levy proposal are questionable;
- The amendments proposed in the exit levy proposal represent a radical system change to the Dividend withholding tax Act, while the levy is limited to a very small group of shareholders;
- The exercise of a company's right of recourse against the shareholders is too complicated;
- There is a real chance that a court will consider the exit levy proposal to be contrary to Dutch tax treaties and the good faith that the Netherlands must observe in interpreting and applying them;
- The exit levy proposal would be a breach of the free movement of capital;
- The proposed franchise of € 50 million may, now that it does not appear to be objectively justifiable, lead to a selective advantage and therefore to a risk of state aid for companies that fall below that threshold;
- The exit levy proposal is very difficult to implement;
- The retroactive effect of the measures included in the exit levy proposal does not seem justified and the many changes to the date of entry into force lead to (legal) uncertainty for entities and their (potential) shareholders;
- The exit levy proposal has a negative impact on investments in the Netherlands.
Although it is still unclear whether the exit levy proposal will be enacted into Dutch tax law and to what extent this advice of the Dutch government will be followed by the House of Representatives, this advice will hopefully mark the first step toward the end of the exit levy proposal and thus an end to the uncertainty hanging over the market.
iii) Supreme Court rulings interest deductibility
Also on July 15, 2022, the Dutch Supreme Court ruled in two cases on the deductibility of interest on loans used to finance an external acquisition by private equity funds. These judgements provided clarity on, inter alia, an outstanding question regarding the Dutch anti-base erosion rules laid down in art. 10a Corporate Income Tax Act 1969 (“CITA”), which in principle only apply in intra-group situations. As discussed in more detail below, the Supreme Court followed a less material interpretation of “group” for deciding whether there is an “intragroup non-business motivated diversion” than the lower courts and the court of appeal had done. Although the Supreme Court provided a helpful clarification in these judgements, the impact of these judgements on the deductibility of interest in the current landscape still remains to be seen. Firstly because – other than during the period the two judgements relate to – the “cooperating group” concept has been introduced in Article 10a CITA as a result of which shareholders are more easily regarded as related entities. In addition, the Supreme Court ruled that fraus legis (the general anti-abuse concept developed in Dutch case law) could still limit the interest deduction on loans that are used to finance external acquisitions.
The first case (ECLI:NL:HR:2022:1085) concerned various subfunds of a private equity fund that participated in a Dutch acquisition company through a Luxembourg parent company. In view of the acquisition of a Dutch target group, the Luxembourg parent company provided a loan in 2011 to the Dutch acquisition company and raised these funds by the issuance of preferred equity certificates (PECs) to its shareholders. None of the PEC holders did have an interest of at least one third in the Luxembourg parent and did therefore not qualify as related entities according to the then prevailing application of art. 10a(4) CITA, which did not yet include a cooperating group concept. In dispute was whether art. 10a CITA would prevent the deductibility of the interest on this shareholder loan. More specifically, the question was whether there had been an intra-group non-business motivated diversion of the capital of the subfunds via the Luxembourg parent company to the Dutch acquisition company.
The Court of Appeal of The Hague ruled, insofar as relevant, that the PEC holders did qualify as group companies and therefore that there was a non-business intra-group diversion of the capital. The Court of Appeal noted that it was hereby not decisive that the PEC holders did not qualify as related entities following art. 10a(4) CITA, because other involved companies (than related entities according to art. 10a(4) CITA) may also qualify as group companies. The Supreme Court did however not follow this approach. According to the Supreme Court, art. 10a(4) CITA was decisive for the definition as group company. As such, the Supreme Court noted that the PEC holders did not qualify as group companies of the Luxembourg parent company and therefore there was no intra-group diversion of the funds. The Supreme Court has referred the case to the Amsterdam Court of Appeal for further consideration and decision with regard to the outstanding points of the case with observance of this judgement.
Same as in the first case, the second case (ECLI:NL:HR:2022:1086) concerned a shareholder loan by a Luxemburg parent company to a Dutch acquisition company that was funded by the issuance of PECs to PEC holders who did not qualify as related entities according to the then prevailing art. 10a(4) CITA. In the second case, the Dutch acquisition company used only part of the loan for the acquisition of the Dutch target group and part to refinance current debts of the target group. In dispute was whether the interest on the shareholder loan was deductible. In line with the first case, the supreme court ruled contrary to the Court of Appeal of Amsterdam, that the PEC holders did not qualify as group companies since they did not qualify as related entities for purposes of the then prevailing art. 10a(4) CITA, and therefore that there was no intra-group diversion of the funds by the PEC holders via the Luxembourg parent company to the Dutch acquisition company. As a result, the Supreme Court ruled that the invocation by the taxpayer of the escape clause of art. 10a(3) was successful (i.e. art. 10a CITA was not applicable as it could be substantiated that both the transaction and the debt were entered into for business reasons). Since the Court of Appeal ignored the appeal of the Dutch tax authorities on fraus legis, the Supreme Court referred the case to the Court of Appeal of The Hague for a further decision on whether fraus legis would limit the interest deduction.
Especially the second decision is worth monitoring, as the question is still outstanding whether fraus legis can be applied in a case where an appeal to the rebuttal rule of art. 10a(3) CITA has succeeded like in the one at hand.