The Netherlands will participate in international initiatives to analyze international tax structuring, but will not jeopardize its competitive position by seeking unilateral solutions.
The Netherlands cannot solve the issue of international tax avoidance by itself. That is one of the conclusions of the letter by the Dutch State Secretary of Finance to Dutch Parliament published last Thursday (the “Letter”). In a climate of populist reporting on international tax structures, the State Secretary answered Parliamentary questions regarding international tax saving structures via the Netherlands. The Letter is a beacon of rationality, albeit sometimes a laboring the obvious, in a sea of ill-informed sound bites.
The letter describes why the Netherlands is an attractive jurisdiction for internationally active enterprises. It explains how sensible tax regulations can have certain types of international tax avoidance opportunities as an undesired side-effect. It goes on by explaining which types of tax avoidance actually occur and by describing the policy dilemmas raised.
The State Secretary once again expressed his priority to further develop the favorable (tax) climate of the Netherlands, for example by way of concluding tax treaties with jurisdictions of new arising markets in Africa, Asia and South America.
2. Favorable (tax) climate of the Netherlands
The Netherlands fosters its competitive and favorable climate for international enterprises. Its traditional focus on international trade and expansion has been one of the drivers for its effort to prevent international double taxation. This has been one way to safeguard a level playing field for Dutch enterprises operating internationally. The Dutch participation exemption, often considered one of the pillars of the Dutch corporate income tax system, is intended to avoid economic double taxation by exempting income and gains from a Dutch or foreign subsidiary. The notion is that those profits should be taxed at the level of the subsidiary and not (again) at the level of the shareholder.
A second pillar is the broad Dutch tax treaty network, intended to prevent international double taxation. In doing so, many tax treaties reduce or exempt withholding tax rates on dividends, interest payments and royalties. Under Dutch domestic tax law there is no withholding tax on outbound ordinary interest or royalty payments.
A third pillar is the open communication with the tax authorities and the general possibility to seek advance tax rulings from the Dutch tax authorities binding on the tax authorities. This professionalism is also reflected in our tax courts. By maintaining a system with specialized tax judges and without a jury, the tax courts’ verdicts are by and large predictable.
Many non-tax features have also contributed to the international success of the Dutch economy. The Letter mentions the infrastructure, the development of the national work force, the administrative efficiency and the general environment. The consequence is that, according to the State Secretary, foreign enterprises provide 17% of employment and 31% of the total Dutch turnover.
While these tax pillars are essential features for a small trading nation with an open economy like the Netherlands, they may also attract companies that only reside in the Netherlands for tax reasons. Dutch tax law, including the tax treaty network, simply applies to these companies too. If necessary, action may be taken against undesired situations through specific anti-abuse measures and the exchange of information.
According to the State Secretary there are two main topics in respect of the discussion on tax avoidance that should be distinguished from one another. First, the general discussion on the acceptability of tax planning by international companies. Second, as part of such tax planning, the use of Dutch intermediate companies.
3. Different forms of International tax planning
The Letter distinguishes three trends in international tax planning:
- Profit allocation to low tax jurisdictions;
- Arbitrage between different tax systems; and
- The use of conduit companies.
3.1. Profit allocation
Multinationals continue to expand their business to different countries. Therefore, they are able to allocate their profits to the jurisdiction with the lowest effective tax rate. According to the State Secretary, this is done in three different ways:
- Transfer or start up business activities to jurisdictions with an low tax rate.
The State Secretary notes this is legitimate.
- Relocate easily movable assets that generate income – such as receivables and licenses - to jurisdictions with a low effective tax rate.
The State Secretary notes companies are free to decide where they want to carry out their business. However, most countries feel they should protect the taxable basis, especially where equity is removed and replaced by intercompany debt from low tax jurisdictions. The Netherlands has introduced various ways to curb such base erosion and the State Secretary considers the Netherlands to have found a good balance in this respect.
- Allocate group profits to jurisdiction with lowest effective tax rate.
Artificial profit attribution is challenged by the (Dutch) tax authorities. International and domestic transfer pricing aim to prevent such allocation when no real business activities are carried out in the jurisdiction concerned. Because transfer pricing is not an exact science it leaves taxpayers some room for interpretation (and tax optimization). This cannot be prevented and the State Secretary of Finance does not perceive it as a problem.
3.2. Arbitrage between different tax systems
Multinationals can plan based on the lack of harmonization between the tax systems. The effect of such lack of harmonization can, for example, be found in the different qualification of taxable entities (transparent versus non-transparent), agreements (equity versus debt; dividend versus interest) and taxable events. This type of mismatch may lead one income stream to be qualified as deductible expenses in one jurisdiction and exempt income in another. It may also lead to double dips (where the same expenses are deductible in two jurisdictions) or stateless income (where taxation of income is postponed or such income is not taxed at all).
The State Secretary comments that as long as taxpayers properly apply the laws of the jurisdictions involved it is evident that this cannot be successfully challenged under those laws. The mismatch is caused by the laws themselves.
3.3. Use of (Dutch) intermediate companies
Withholding taxes on dividends, interest and royalties are often seen as an important impediment to international enterprises. The withholding taxes can be high and may even lead to double taxation. Dutch tax treaty policy aims to lower withholding tax rates and so does the European Union’s policy (cf. the Parent-Subsidiary Directive and Interest- and Royalty Directive). Such withholding taxes are often mitigated by the use of conduit or intermediate companies in jurisdictions with the best tax treaty network. The Netherlands has one of the most wide spread tax treaty networks and is therefore often seen as a favorable jurisdiction for an intermediate company.
Other reasons may also play an important role to incorporate a Dutch intermediate company in an international structure, e.g. cash pooling, use of the broad network of Bilateral Investment Treaties (BITs), the high quality legal services, the stable political environment and the possibility to obtain advance tax rulings. Obviously substance rules will always have to be taken into account in respect of intermediate companies. Provided these companies have sufficient substance in the Netherlands, the Dutch tax treaty network is available as well as certain Dutch corporate tax facilities.
The issues of profit allocation to low-tax jurisdictions and international arbitrage between tax systems are not specific Dutch topics. Therefore, the Netherlands cannot solve these issues by itself. The State Secretary will not consider solving these issues unilaterally because that would not work and could harm the competitive position of the Netherlands and its corporate residents.
The Netherlands will participate actively in the forums of both the OECD and the EU that will analyze the issues. According to the State Secretary, two aspects are important for the Netherlands in finding appropriate international measures to fight tax avoidance. It is crucial that the solutions are laid down in 'hard law', binding to countries and that they are not just recommendations ('soft law'). It is also important that the different nature of the economies of the countries is taken into account. For the Netherlands this means that the proposed solutions would take into account the open nature of the Dutch economy providing sufficient room for the Netherlands to maintain an effective tax system that supports investments in the relevant sectors of Dutch economy, but also leave room for a Dutch tax system that supports companies established in the Netherlands to spread their wings internationally.