On 26 September 2008, the Netherlands and the United Kingdom signed a new tax treaty ("New Treaty") which should replace the existing tax treaty of 1980 as amended by protocols of 1983 and 1989 ("Existing Treaty").
The Dutch Ministry of Finance issued a short press release together with the proposed wording of the New Treaty in Dutch, but no explanatory notes were published (yet). UK HMRC have now also issued a press release stating that the New Treaty will shortly be presented to Parliament for approval and will be published at that time. The New Treaty will only enter into force if and when it has successfully followed the parliamentary approvals procedures in both countries.
The New Treaty is aimed at, on the one hand, the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains and on the other hand the exchange of tax information and the assistance and support in tax collection.
This tax alert will summarize the most relevant provisions of the New Treaty and differences with the Existing Treaty.
- Highlights of the New Treaty
- Entry into force
- Concluding remarks
- Highlights of the New Treaty
According to the New Treaty, dividend distributions by a taxpayer to its ultimate beneficial owner residing in the other state should be exempt from dividend withholding tax, provided that among others such owner is a pension fund, charitable institution or corporate entity controlling at least 10% of the voting power of the distributing entity. Although in most cases the Parent – Subsidiary Directive will already provide for a 0% rate, this is an improvement compared to the Existing Treaty which contains a reduced rate of 5% for ultimate beneficial owners controlling at least 25% of the votes of the distributing entity. This is in particular an improvement for UK parties investing into the Netherlands as the Dutch domestic dividend withholding tax rate is 15%, while the United Kingdom – apart from REITs (see below) – does not levy dividend withholding taxes under its domestic laws.
Furthermore, the New Treaty provides that the rate for portfolio dividends (i.e. distributions to individuals and to corporate entities controlling less than 10% of the votes of the distributing entity) will be reduced from 15% to 10%.
Also the New Treaty provides that dividend distributions by certain so-called "real estate investment vehicles" which distribute a substantial part of their profits annually will be subject to a 15% dividend withholding tax rate, which is also the Dutch domestic withholding tax rate. This latter provision is most likely included in the New Treaty at the request of the United Kingdom as distributions by UK REITs are generally subject to a 20% withholding tax rate under UK domestic tax law (so that the new rate of 10% would have meant further loss of UK tax). However, this 15% rate seems to apply also to Dutch fiscal investment institutions investing in real estate, while these institutions are generally considered not eligible for the Parent – Subsidiary Directive as they are subject to Dutch corporate income tax at the rate of 0%.
In line with the more recent Dutch tax treaty policy, the protocol to the New Treaty provides that income in relation to the (full or partial) liquidation of an entity or the repurchase of shares by an entity is - for Dutch tax purposes - covered by the dividend article rather than the capital gains article.
To prevent abuse of the dividend article, the New Treaty provides that the reduced rates are not available if the main purpose of the relevant parties is to rely on the benefits of this provision rather than bona fide commercial reasons.
In conformity with the Existing Treaty, the New Treaty provides that interest and royalty payments by an entity of one of the states to an entity in the other state should generally be exempt from withholding taxes (an exception applies to certain payments made in triangular cases). This absence of withholding taxes is in accordance with the Dutch tax treaty policy, as also under Dutch domestic law there are no withholding taxes on royalty and interest payments (apart from certain situations developed in case law where debt is requalified into equity for Dutch tax purposes). From a UK perspective, this continued reduction of the rates is important, as the domestic withholding tax rate for interest and royalty payments is 20% (although it is nil where the EU Interest and Royalty Directive is applicable). Furthermore, anti-abuse provisions apply similar to the one mentioned-above for dividends.
In deviation from the Dutch tax treaty policy, the capital gains article in the New Treaty provides that under certain circumstances the source country rather than the home country of the shareholder has the right to levy taxes on gains realised in connection with the sale of non-listed real estate shares. This is in particular a concern from a Dutch perspective as under the Dutch substantial interest rules the Netherlands can effectively tax capital gains realised by a foreign shareholder on the sale of shares of a Dutch entity if the shares are not allocable to a business enterprise conducted by the shareholder. Hopefully, it will be clarified by the Dutch authorities why this provision is included, as the UK does not generally levy capital gains tax on non-residents.
The residency provision in the New Treaty does not contain – in deviation from the Existing Treaty - a so-called "tie breaker rule" according to which an entity residing in both states is deemed to be a resident of the state in which its place of effective management is situated. In stead, the New Treaty provides that in case an entity resides in both states the competent authorities will have to agree on residency by mutual agreement. If no mutual agreement will be reached, the taxpayer can not rely on the benefits of the treaty, apart from the double taxation, non-discrimination and mutual agreement arrangements as provided for in the treaty. However, an entity that participates in a so-called "dual listed company arrangement" will be deemed to be a resident of its state of incorporation only, provided that it has its main listing in that state. This is a new approach which we have not seen before in the Dutch tax treaty policy.
Furthermore, the New Treaty provides for certain rules which are generally aimed at avoiding both double taxation and non-taxation in case tax transparent entities are involved.
Also the New Treaty contains an arbitrage provision and provisions regarding the exchange of information and the assistance and support in tax collection, which are generally in line with the relevant OECD model provisions.
- Entry into force
The New Treaty will enter into force if and when it has successfully followed the parliamentary approvals procedures in both the Netherlands and the United Kingdom. With respect to the Netherlands the New Treaty will then become effectively applicable as of 1 January of the year following in which the parliamentary approvals have been obtained. In the United Kingdom the New Treaty will become effectively applicable for corporate income tax and income tax purposes as of 1 and 6 April, respectively, of the year following in which the parliamentary approvals have been obtained. The Existing Treaty will generally no longer be applicable as of the moment that the New Treaty becomes applicable in conformity with the above-mentioned rules.
- Concluding remarks
The New Treaty contains a few provisions, such as for example the 0% dividend withholding tax rate, which can be considered an improvement compared to the Existing Treaty. However, the New Treaty also provides for some measures, in particular for Dutch real estate investment institutions – to wit the 15% Dutch dividend withholding tax and the potential Dutch substantial interest taxation for capital gains realised by foreign shareholders as referred to above– which may affect cross border transactions and therefore impair one of the purposes of the treaty to further enhance the economic relationship between the United Kingdom and the Netherlands. Furthermore, the New Treaty contains a few provisions – like the residency and tax transparency clauses – the purpose and scope of which is not yet entirely clear. Hopefully, this will be further clarified once the explanatory notes to the New Treaty become available.