On 6 June 2018, the Dutch Ministry of Finance published a legislative proposal amending the Dutch fiscal unity regime. The proposal is in response to a judgment by the European Court of Justice (ECJ) on 22 February 2018 (Case C-398/16) in which the ECJ ruled that the Dutch anti-abuse rule for related party financing in combination with the fiscal unity regime violates the EU freedom of establishment. This legislative proposal (hereafter referred to as Remedial Legislation) aims to neutralize the impact of that judgment by eliminating certain benefits connected with the fiscal unity regime. This legislative proposal therefore significantly affects many taxpayers that are part of a fiscal unity. As the Remedial Legislation has retroactive effect until 25 October 2017, taxpayers should consider the implications of this legislative proposal as from that moment. For prior tax periods, however, we believe the aforementioned ECJ judgment could create opportunities for taxpayers.
2. Existing fiscal unity benefits affected by the Remedial Legislation
On the basis of the Remedial Legislation, the following provisions in the Dutch Corporate Income Tax Act (CITA) and Dividend Withholding Tax Act (DWTA) will be applied as if the Dutch fiscal unity regime does not exist (which is generally disadvantageous):
- specific anti-abuse rule for related party financing (10a CITA)
- mathematical interest limitation rule in relation to the financing of participations (13l CITA)
- participation exemption regime (13, paragraph 9-15, 17 CITA)
- loss limitation rule for changes of ultimate ownership (20a CITA)
- dividend withholding tax: facility for redistributions (11, paragraph 4 DWTA)
Below, we discuss in further detail the implications of the Remedial Legislation in relation to these provisions.
a. Specific anti-abuse rule for related party financing (article 10a CITA
On the basis of article 10a CITA, interest expenses on loans from affiliated entities (or individuals) may be disallowed for corporate income tax purposes to the extent the loan is related to a dividend distribution, capital contribution and/or acquisition (Tainted Transactions), unless certain counter evidencing rules apply.
Currently, Tainted Transactions and/or loans between fiscal unity members are not visible due to the tax consolidation of the fiscal unity members. Since the Remedial Legislation requires the application of article 10a CITA as if the Dutch fiscal unity does not exist, Tainted Transactions and loans between fiscal unity members will become visible and will (in principle) fall within the scope of article 10a CITA. This may result in a disallowance of interest deductibility.
Interest expenses are generally not disallowed if the taxpayer is able to reasonably argue that both the debt and the Tainted Transaction are predominantly business-driven (Business Purpose Test) or the interest payments are sufficiently taxed in the hands of the creditor in accordance with Dutch tax standards, unless used to offset tax losses or creditable withholding tax (Compensating Levy Test).
In practice, demonstrating the (historical) business reasons of the loan and Tainted Transaction may be challenging, since not all taxpayers will be equipped to demonstrate this for all (particularly older) loans and/or Tainted Transactions. Furthermore, if the creditor is included in a fiscal unity and had pre-fiscal unity losses, this could result in a disallowance of interest deductibility. Although not entirely clear, this also seems to be the case if the fiscal unity as a whole incurred or incurs losses.
The Remedial Legislation only provides limited guidance on the application of the Business Purpose Test and/or the Compensating Levy Test. Unless further clarification is provided, these aspects are likely to result in significant discussions between taxpayers and the Dutch tax authorities. For example, it is currently unclear why an intra-fiscal unity loan or Tainted Transaction (which was originally invisible for Dutch tax purposes) would not automatically satisfy the Business Purpose Test, since such loans or Tainted Transactions are unlikely to be entered into for tax reasons, given that the fiscal unity would have neutralized any tax effect through the consolidation.
Where possible, taxpayers are recommended to consider removing the loan within their fiscal unity (e.g., by repaying, capitalizing or waiving the loan or by merging the entities involved). If it is not feasible to remove the loan from the structure, it remains unclear whether the application of article 10a CITA can be prevented by 'untainting' the transaction that the loan financed (e.g., by merging the company that was acquired or to which a capital contribution was made).
b. Mathematical interest limitation rule in relation to the financing of participations (article 13l CITA)
Article 13l CITA limits the deductibility of excessive interest expenses and costs in excess of EUR 750,000 related to debts that are used for the acquisition of shares in, or a capital contribution to, subsidiaries that qualify for the Dutch participation exemption ("Participations"). Article 13l CITA contains a mathematical test and, as a starting point, the interest deduction limitation only applies to the extent the annual average cost price of the Participations exceeds the annual average fiscal equity.
Currently, the cost price of Participations that are part of the same fiscal unity is disregarded for the purposes of this calculation, due to the consolidation of the fiscal unity entities. On the basis of the Remedial Legislation, however, the cost price of the Participations that are part of the same fiscal unity will need to be taken into account; as a result, this interest deduction limitation will apply sooner than before. The EUR 750,000 threshold will apply per fiscal unity entity. Under article 13l CITA, the amount of non-deductible (or excessive) interest expenses can be limited by the application of the business expansion and/or the historical acquisition price allowance. In practice, demonstrating the (historical) business reasons of the acquisition and/or the capital contribution to a Participation may be challenging, as not all taxpayers will be equipped to demonstrate this for all (particularly older) transactions.
c. Participation exemption (article 13 CITA)
For Dutch corporate income tax purposes, income (e.g., dividends and/or capital gains) received from a Participation is subject to tax unless the participation exemption of article 13 CITA applies.
Currently, Dutch subsidiaries that are part of the same fiscal unity are not considered Participations within the meaning of article 13 CITA and any income derived from such entities is exempt on the basis of the fiscal unity regime. Based on the Remedial Legislation, however, subsidiaries that are part of the same fiscal unity will become visible and treated as Participations. For such Participations, one should review whether the Participation exemption applies. As Dutch Participations that are part of the fiscal unity are subject to Dutch corporate income tax, it is expected that the Dutch participation exemption will — in most cases — apply to such Participations. Consequently, with a few exceptions, the impact of this change is expected to be limited.
If a Participation does not qualify for the Participation exemption, one should assess whether the mandatory revaluation rule of article 13a CITA applies (which, to a large extent, has the effect of a CFC rule). Unlike all of the other rules that are part of the Remedial Legislation, the amendments to article 13a CITA are only applicable from 1 January 2019.
It is worth noting that article 13, paragraph 17 CITA is specifically mentioned in the Remedial Legislation. This is the Dutch anti-hybrid instrument rule implementing the modification of the EU Parent Subsidiary Directive effective 1 January 2016. This seems to suggest that the Dutch Ministry of Finance is not convinced that this anti-hybrid rule can be justified under EU law. After all, the ECJ's judgment of 22 February 2018 would not affect this anti-hybrid rule if the distinction that it creates can be justified.
d. Loss limitation rules for changes of ownership (article 20a CITA)
On the basis of article 20a CITA, in principle, tax losses can no longer be carried forward if the ultimate interest in the taxpayer has changed substantially (i.e., by 30% or more). However, this loss limitation rule does not apply if (among others scenarios) the activities of the taxpayers have not been reduced to less than 30% of the total activities as compared to the activities at the beginning of the oldest year from which losses were carried forward. Currently, the activities of all fiscal unity members can be taken into account when determining whether the activities of the taxpayer have been reduced. On the basis of the Remedial Legislation, only the activities of the relevant fiscal unity entity can be taken into account. This means that, in domestic situations, taxpayers may be confronted with a limitation of losses carried forward more quickly. This aspect should particularly be considered in the context of M&A transactions.
e. Dividend withholding tax: deductibility of redistributed dividends (article 11 DWTA)
Based on article 11 DWTA, the Dutch dividend withholding tax due on a redistribution of a dividend may be reduced if a withholding tax of at least 5% has been previously withheld in (for example) a tax treaty jurisdiction. Under paragraph 4 of this provision, foreign withholding tax is attributed to the parent company of the fiscal unity for the purposes of this redistribution facility. Under the Remedial Legislation, foreign withholding tax will no longer be attributable to the parent company of the fiscal unity.
3. Retroactive effect of the Remedial Legislation
The legislative proposal will have retroactive effect from 25 October 2017, 11 am CET. This also applies for the purposes of the specific anti-abuse rule for related party financing (article 10a CITA) and the mathematical interest limitation rule in relation to the financing of participations (article 13l CITA). However, with regard to these provisions, loans or transactions that already existed (or took place) before 25 October 2017, 11 am CET will, in principle, be treated the same as loans or transactions that occur thereafter. In that sense, the Remedial Legislation has an indefinite retroactive effect. However, the (part of) interest payments that relate to the period prior to 25 October 2017, 11 am CET shall not be affected by the Remedial Legislation.
With regard to the specific anti-abuse rule for related party financing (article 10a CITA), the Remedial Legislation includes a grandfathering clause up to and including 31 December 2018. Based on this grandfathering clause, interest related to Tainted Transactions that took place before 25 October 2017 will not be disallowed for Dutch corporate income tax purposes if such interest does not exceed EUR 100,000 in a 12-month period.
Taxpayers that are confronted with adverse consequences resulting from the retroactive effect of the Remedial Legislation may wish to consider litigating against such retroactive application under the principle of legal certainty, as laid down in the case law of the Dutch Supreme Court, the European Court of Justice or the European Court of Human Rights. Although the retroactive application was already announced on 25 October 2017, it may be argued that not all parts of the Remedial Legislation were sufficiently clear prior to 6 June 2018. Furthermore, for certain aspects of the Remedial Legislation, the proportionality of retroactive application may be called into question. For example, this could be the case for intra-fiscal unity loans that are confronted with the specific anti-abuse rule for related party financing (article 10a CITA), since one could argue that there was no clear need to cover such situations under the Remedial Legislation, which may make such changes disproportionate.
4. Feasibility of the legislative proposal
The Remedial Legislation was accompanied with the official feedback by the Dutch tax authorities on the expected practical application of this legislative proposal. Most parts of the Remedial Legislation are qualified as "impactful" and one specific aspect (modification of the mathematical interest limitation rule in relation to the financing of participations (article 13l CITA)) was even qualified as "not feasible." This is the first time that the Dutch tax authorities have officially (in part) declared a legislative proposal that they will have to apply in practice as "not feasible." For most of the remaining parts of the Remedial Legislation, the Dutch tax authorities indicated that the practical application will be problematic in 2017 and 2018. Nevertheless, the Ministry of Finance decided to proceed with the legislative proposal.
5. Opportunities for the past and provisions not covered by the legislative proposal
As far as the period up to 25 October 2017 (11 am CET) is concerned, the ECJ judgment of 22 February 2018 (Case C-398/16) creates certain benefits in cross-border situations with respect to the provisions covered by the Remedial Legislation. In particular, this applies with regard to the deductibility of interest and (in some cases) the carry forward of losses and redistribution of dividends.
It is worth noting that several provisions that also seem to be (potentially) affected by the ECJ judgment of 22 February 2018 are not covered by the Remedial Legislation:
- applicability of liquidation loss rules (article 13d CITA)
- applicability of loss ring-fencing rules (article 20(4) CITA)
- deferred (gradual) taxation of assets transferred to EU companies (article 15 CITA)
- applicability of certain restrictions in the innovation box regime (article 12b CITA)
With respect to these provisions (i through iv), the ECJ judgment of 22 February 2018 continues to create opportunities in cross-border situations even after the Remedial Legislation.
6. Many questions remain
The precise application of the Remedial Legislation is expected to be highly complex and administratively burdensome in many situations. The legislative proposal and the explanatory memorandum thereto so far only contain very general guidance on the application. Therefore, unless further clarification is provided in the coming months, it will be challenging to provide a comfortable level of certainty on the application and impact of the Remedial Legislation.
7. Future developments
The Remedial Legislation only aims to address the most pressing short-term issues following the ECJ's judgment of 22 February 2018 in an attempt to manage the budgetary impact of the ECJ decision. At the same time, the Ministry of Finance announced that, in the longer term, the existing Dutch fiscal unity regime will be replaced by a new group regime. In contrast to the existing regime, there are indications that the new fiscal unity regime would not result in the same level of consolidation of group members (and elimination of intercompany transactions).
Furthermore, it seems that, in their feasibility test of the Remedial Legislation, the Dutch tax authorities are assuming that article 13l CITA (Mathematical interest limitation rule in relation to the financing of participations) will be abolished as per 1 January 2019, at the same time as the earnings-stripping rule (as introduced in the EU Anti-Tax Avoidance Directive) is being introduced.
Although not specifically mentioned in the Remedial Legislation, it is safe to assume that the earnings-stripping rule contained in the EU Anti-Tax Avoidance Directive will also be applied as if the Dutch fiscal unity regime does not exist. We assume this will be addressed in a separate legislative proposal specific to the implementation of the EU Anti-Tax Avoidance Directive (expected before the Dutch Government's summer recess).