It took 53 years, but last week the Netherlands and German governments have signed a new double taxation treaty (the "New Treaty"). The old treaty from 1959, although amended several times over the years, was quite outdated (it even predates the oldest version of the OECD Model Tax Treaty). The New Treaty can be said to be more or less similar to the OECD standard. Below please find a birds-eye view of the New Treaty giving you the most notable details.
Resident for purposes of the New Treaty
The Protocol to the New Treaty provides that entities that are resident in the Netherlands for the purposes of the Dutch corporate income tax act, will be deemed to be subject to Dutch tax for purposes of the New Treaty (except where the income is treated as income of its beneficiaries, members or participants). This means that Dutch resident exempt entities, such as pension funds, recognized charities, but also fiscal investment institutions (fbi) and exempt investment institutions (vbi) may qualify as residents of the Netherlands for purposes of the New Treaty.
The tie-breaker, resolving situations of entities resident in both states, largely follows the OECD standard. One notable deviation is the arrangement for cross-border premises. This concept, which also appears in the old treaty, caters typically for situations of neighbouring countries. In fact, like the old one, the New Treaty contains an annex with detailed arrangements for cross-border premises. A second deviation relates to shipping companies effectively managed on board of a ship. In such case, the shipping company is resident in the state in which the operator is resident.
Dividends, interests and royalties
The withholding rates for cross-border interests and royalties are 0% under the New Treaty. For dividends there are three rates:
- 5%: if the beneficial owner is an entity (not being a cooperation) that holds at least 10% of the capital of the distributing entity. Please note that in many such situations the (implementation of) the EU Parent-Subsidiary Directive should provide for an exemption from withholding taxes on dividends.
- 10%: if the beneficial owner is a Dutch resident pension fund. However, in order for a Dutch pension fund to benefit from this reduced rate under the New Treaty (besides meeting the requirements to qualify as a pension fund), at least 75% of the participants of the Dutch pension fund have to be individuals resident in the Netherlands or Germany and be entitled to the benefits from the pension fund in relation to services rendered to an employer resident in the Netherlands.
- 15%: in all other situations. Note that this is also the Dutch statutory dividend withholding tax rate.
The dividend article reserves the right of the source state to tax dividends distributed to an individual shareholder who has migrated out of the source state within 10 years before the income is derived. This serves as a reservation by the Netherlands for its substantial interest levy and a similar reservation can be found in the capital gains article.
The definition of dividends for purposes of this article is quite broad and for instance includes any proceeds from a (partial) liquidation of an entity or from the repurchase of shares.
Real estate investment companies
The capital gains article of the New Treaty contains special rules dealing with non-listed real estate investment companies. These rules apply in the case where the shares in a company derive more than 75 per cent of their value directly or indirectly from real estate. However, real estate that is used by the company or its shareholders as their business premises, is not taken into account in determining whether the 75% threshold is met. In the event that these special rules apply, the gains from the alienation of such shares are taxable in the state where the underlying real estate is located. There are two important carve outs to these rules (in which case the state where the selling shareholders are resident, may tax the gains derived upon alienation):
a) the selling shareholder owned less than 50 per cent of the shares in the real estate investment company prior to the first alienation; or
b) the alienation takes place in the course of a corporate reorganisation, amalgamation, division or similar transaction.
The New Treaty stipulates that an item of income, profit or gain derived through an entity that is fiscally transparent in either or both states, will be treated as derived by a resident of a state to the extent that it is treated for the purpose of the taxation laws of that state as an item of income, profit or gain of its resident. This provision is gaining impetus as a global standard and is amongst others similar to the one that can be found in the current income tax treaty concluded between the Netherlands and the United States. Below are examples of certain situations that might frequently occur. You will see that the provision gives a solution for several situations, but not for all and you should take into account that many other, more complicated situations may occur. For situations not solved by provision, the states may endeavour to seek mutual agreement and can publish such agreements if reached.
R is a German resident. Hybrid is a German based entity treated as tax transparent for German tax purposes, but as a company for Dutch tax purposes. BV NL, a Dutch resident company, distributes a dividend to Hybrid. For Dutch tax purposes, the dividend is deemed received by Hybrid, while for German tax purposes R receives the dividend directly. Under the New Treaty, because the income is derived for German tax purposes by R, its resident, the Netherlands will have to treat the dividend as derived by R too.
Same facts, only now Hybrid is an entity treated as taxable for German tax purposes, but as transparent for Dutch tax purposes. In addition, assume Hybrid is a resident of Germany for German tax purposes. For Dutch tax purposes, the dividend is deemed received by R directly, while for German tax purposes Hybrid receives the dividend. Under the New Treaty, because the income is derived for German tax purposes by a German resident, now being Hybrid, the Netherlands will have to treat the dividend as derived by Hybrid too.
Same facts as example 1, only now Hybrid is a resident of the Netherlands. Now both states would have the view that a resident (R for Germany, Hybrid for the Netherlands) derives the dividend and the provision does not appear to solve the qualification difference. This may not be an issue in this particular situation as Dutch domestic law would generally provide a shelter from double taxation, but an issue could arise when Hybrid would subsequently make a distribution to R, in which case again neither state would view the item of income as derived by one of its residents.
Same facts as example 2, only now Hybrid is established in the Netherlands. Now Germany views the item of income as derived by a non-resident (Hybrid) and so does the Netherlands (who views it as derived by R). The provision does not appear to provide a solution for the qualifications difference.
Administrative efficiency for transparent entities
If an entity is treated under the New Treaty as a tax transparent entity it can obviously not benefit from its provisions, but its participants might be entitled to treaty benefits. In order to facilitate an efficient application of the New Treaty, the managers of tax transparent investment arrangements, cooperations or closed funds for joint account may claim treaty entitlement on behalf of their participants.
Article 23 of the New Treaty provides that it should not be interpreted as impeding the states in applying their domestic rules for the prevention of avoidance of taxation. At first glance this seems like an open invitation for the contracting states to override the treaty they have just signed. It may be a bit more nuanced than that. The second paragraph of this article opens the way to a mutual agreement procedure if the domestic rules lead to double taxation or are otherwise not in agreement with the New Treaty. Also, the protocol to the New Treaty provides some more guidance on which prevention rules are meant, although the summary of the domestic anti-abuse rules in the protocol appears to be non-exhaustive. Finally, it clarifies that Germany is entitled to apply its national legislation to a Dutch exempt investment institution.
A binding arbitration clause is included in the New Treaty and a convention for the procedural matters governing the arbitration is already signed (it accompanies the New Treaty). The matters that can be the subject of arbitration appear to be quite broad as they range from different interpretations of the New Treaty, to transfer pricing, exchange of information, application of domestic anti-abuse rules and qualification of hybrid entities. Although this is certainly not the first binding arbitration clause in a double tax treaty, the trend to adopt provisions like this is quite recent and the fact that this is a treaty between neighbouring, developed countries, with an huge amount of commercial cross-border activity may justify the expectation that this arbitration procedure will not remain unused.
Entry into force
The New Treaty will generally apply to tax periods starting on or after January 1 of the calendar year following the calendar year it enters into force. The entry into force will be the first day of the second month after the exchange by the states of the instruments of ratification. To be generally applicable for January 1, 2013, the ratification instruments would therefore have to be exchanged ultimately on October 31 of this year. That timing, as recent history shows, is challenging, so an application as of 2014 might be more realistic.