On 20 June 2016, Ecofin reached political agreement on the Anti Tax Avoidance Directive (“ATAD”). The rules included in the ATAD will have an impact on the corporate income tax position of companies operating in the European Union (“EU”), including the Netherlands. Unlike the earlier drafts of the ATAD, the final draft ATAD dated 17 June 2016 no longer includes the switch-over clause. The switch-over clause could have adversely affected the Dutch participation exemption regime.
The ATAD is aimed at combating tax avoidance practices by setting minimum standards regarding the levy of corporate income tax (“CIT”) from companies operating within the EU. It sets out principle-based rules and leaves the details of their implementation to the EU Member States. In that regard, EU Member States may choose to implement measures that are more stringent than the ones set out in the ATAD. Although 3 out of 5 of the ATAD rules are in line with the OECD’s BEPS Actions, namely the EBITDA interest limitation rule (Action 4), the controlled foreign corporation (“CFC”) rule (Action 3) and the hybrid mismatch rule (Action 2), it is important to note that the other 2 ATAD rules are not addressed under the OECD’s BEPS Actions at all, namely the exit tax rule and the general anti-abuse rule (“GAAR”).
Based on the final draft ATAD dated 17 June 2016, subject to certain exceptions for the EBITDA interest limitation rule and exit tax rules (see below for further details) the ATAD rules should be implemented in the domestic laws of the EU Member States ultimately by 31 December 2018 and they should become effective as from 1 January 2019.
Below, we will first discuss the ATAD rules that could potentially have an impact on Dutch (intermediary) holding structures as from 1 January 2019, namely the CFC rule and the hybrid mismatch rule. For sake of completeness, we will also briefly discuss the EBITDA interest limitation rule, the exit tax rule and the GAAR.
ATAD rules with an impact on Dutch (intermediary) holding structures
CFC rule – General
Under the CFC rule, an entity, or a permanent establishment of which the profits are not subject to tax or are exempt from tax in the EU Member State of the taxpayer, is a CFC if the taxpayer holds either alone or together with associated enterprises a direct or indirect participation of more than 50% of the voting rights, or owns directly or indirectly more than 50% of capital or is entitled to receive more than 50% of the profits, of such entity, but only if the actual corporate tax paid by the entity or the permanent establishment on its profits is less than 50% of the effective tax rate in the country of the Member State of the taxpayer.
Where an entity or permanent establishment is treated as a CFC, the EU Member State of the taxpayer shall include in the tax base certain non-distributed income of the entity or permanent establishment. One of the following 2 options can be applied by the EU Member States to tax this non-distributed income:
Under option 1, the following categories of income of the CFC are included in the tax base of the taxpayer:
(i) interest or any other income generated by financial assets;
(ii) royalties or any other income generated from intellectual property;
(iii) dividends and income from the disposal of shares;
(iv) income from financial leasing;
(v) income from insurance, banking and other financial activities; and
(vi) income from invoicing companies that earn sales and services income from goods and services purchased from and sold to associated enterprises, and add no or little economic value.
The CFC rule shall not apply where the CFC carries on a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances. However, EU Member States are allowed to refrain from applying this exception if the CFC is situated in a third country.
Furthermore, the EU Member State of the taxpayer may opt not to treat an entity or a permanent establishment as a CFC if one third or less of the income accruing to such entity or permanent establishment qualifies as CFC Income.
The CFC rule will not apply to certain financial undertakings, provided that one third or less of the CFC Income derived by them stems from transactions with the taxpayer or its associated enterprises. Financial undertakings include credit institutions, (re)insurance undertakings, alternative investment funds, pension funds, UCITS, etc.
Under option 2, the non-distributed income of the CFC that arises from non-genuine arrangements which have been put in place for the essential purpose of obtaining a tax advantage shall be included in the tax base of the taxpayer. An arrangement or a series thereof shall be regarded as non-genuine to the extent that the CFC would not own the assets or would not have undertaken the risks which generate all, or part of, its income if it were not controlled by a company where the significant people functions, which are relevant to those assets and risks, are carried out and are instrumental in generating the controlled company's income.
EU Member States may exclude from the scope of option 2 an entity or permanent establishment (i) with accounting profits of no more than EUR 750,000, and non-trading income of no more than EUR 75,000 or (ii) of which the accounting profits amount to no more than 10% of its operating costs for the tax period.
The ATAD contains detailed rules on the computation of the CFC income to be included in the tax base of the taxpayer pursuant to option 1 or option 2, including a credit mechanism aimed at avoiding that the CFC income is taxed twice (in the tax year in which it has not yet been distributed and upon receipt by the taxpayer following a distribution).
CFC rule – Impact on certain common Dutch (intermediary) holding structures
The Netherlands already applies a CFC inspired rule pursuant to which (i) shareholdings of 25% or more in low taxed passive portfolio investment companies have to be marked-to-market annually for Dutch CIT purposes and (ii) the increase in the aforementioned value is subject to Dutch CIT. Under the CFC rules, it seems that this rule has to be modified. Moreover, the scope of the effect of such rule will be extended to permanent establishments that are exempt from Dutch corporate income tax. Furthermore, CFC income as defined under the ATAD may include items of income that may not be considered passive income under the current Dutch CFC inspired provisions. Consequently, the Netherlands will have to introduce further CFC rules and such rules may affect Dutch holding structures where the Dutch taxpayer directly or indirectly has an entity or permanent establishment in a low taxed country that generates CFC income as defined under option 1 or option 2.
Hybrid mismatch rules – General
In line with OECD BEPS Action 2, the ATAD contains rules aimed at neutralizing hybrid mismatches between certain associated enterprises or under certain structured arrangements between two parties to the extent these hybrid mismatches are attributable to differences in the legal characterisation of a financial instrument or entity. To neutralize these hybrid mismatches, the hybrid mismatch rule provides that to the extent that a hybrid mismatch results in a:
- double deduction, the deduction shall be given only in the EU Member State where such payment has its source; and
- deduction without inclusion, the EU Member State of the payer shall deny the deduction of such payment.
The scope of the hybrid mismatch rules is limited to hybrid mismatches between EU Member States. However, the EU Commission has been requested by Ecofin to put forward a proposal by October 2016 on hybrid mismatches involving third countries with a view to provide for rules consistent with, and no less effective than, the rules recommended under OECD BEPS Action 2. It is intended that an agreement is reached on this EU Commission proposal by the end of 2016.
Hybrid mismatch rules – Impact on certain common Dutch (intermediary) holding structures
The ATAD introduces an anti-hybrid measure providing that to the extent that a hybrid mismatch results in deduction without inclusion, the EU Member State of the payer shall deny the deduction of such payment. Such rule is not yet included in the Netherlands law. However, under the implementation of the anti-hybrid measure provided for under the EU Parent-Subsidiary Directive in the Netherlands, the participation exemption is already not available for benefits or payments derived from a participation if those benefits or payments are deductible for profit tax purposes at the level of the issuer (see our Tax Alert of 21 January 2016). Given that under the EU Parent-Subsidiary Directive anti-hybrid measure there should in principle always be an inclusion, to a certain extent this denial of the deduction seems to provide for overkill in situations in which the participation exemption applies.
The rule that provides that in case of a double deduction the deduction shall be given only in the EU Member State where such payment has its source would be an additional feature not currently provided for in the Netherlands. This will have to be introduced in the Netherlands through new legislation. The real question will be whether the Netherlands will – in line with the scope of the EU Parent-Subsidiary Directive anti-hybrid measure – choose not to limit it to EU situations, but apply the measure on a worldwide basis instead. In this respect, it is important to note that as mentioned above the EU Commission has been requested to put forward a proposal by October 2016 on hybrid mismatches involving third countries.
Other ATAD rules
EBITDA Interest limitation rule
The interest limitation rule limits the deduction of borrowing costs of a taxpayer if such costs exceed taxable interest revenues or equivalent taxable revenues (hereinafter referred to as “exceeding borrowing costs”). Such exceeding borrowing costs shall be deductible only up to 30% of the tax payer's earnings before interest, tax, depreciation and amortisation (“EBITDA”), subject to certain adjustments. However, EU Member States are allowed to give the taxpayer the right to always deduct the exceeding borrowing costs up to EUR 3 million. Furthermore, exceeding borrowing costs are fully deductible if the taxpayer is a standalone entity (i.e., not part of a(n) (international) group).
If the taxpayer belongs to a consolidated group for IFRS/GAAP purposes, the following exceptions to the 30% EBITDA rule may be applied by the EU Member States.
(i) The interest remains fully deductible if the equity-to-debt ratio of the taxpayer is not more than 2% lower than the equity-to-debt ratio of the IFRS/GAAP consolidated group.
(ii) The interest remains (partly) deductible up to the level of the third party interest/EBITDA ratio of the international group to which the taxpayer belongs.
Unused EBITDA and non-deductible interest may be carried over, grandfathering rules for third-party loans concluded before 17 June 2016 apply and exceptions for non-recourse third party loans used to fund long-term public infrastructure projects are provided for under the EBITDA interest limitation rule (subject to the last exception being in compliance with the EU State Aid rules).
EU Member States can choose to apply the EBITDA rule at the level of a local group as defined under domestic tax law (such as the fiscal unity regime in the Netherlands). Furthermore, it is important to note that EU Member States may exclude financial undertakings from the scope of the EBITDA interest limitation.
Finally, Member States which have national targeted rules for preventing base erosion and profit shifting risks at the date of the entry into force of the ATAD, which are equally effective to the interest limitation rule set out therein, may apply these targeted rules until the end of the first full fiscal year following the date on which a minimum standard is agreed under OECD BEPS Action 4, but at the latest until 1 January 2024. If an EU Member State would like to continue to apply its own rules during this period, it will have to provide the EU Commission with all information necessary for evaluating the effectiveness of these rules against BEPS before 1 July 2017.
Exit taxation rule
Under the exit taxation rule, the transfer of an asset, tax residence or permanent establishment to another country shall be subject to exit taxation (based on fair market valuation). The rules provide for a deferral of the payment of the tax liability triggered upon the aforementioned transfers whereby such tax liability can be discharged during 5 installments in 5 years, provided that the relevant transfer has taken place within the EU/EAA. Furthermore, under the exit taxation rule the “acquiring” EU Member State will have to allow for a step up in the tax base of the relevant transferred assets equal to the fair market value of such assets as determined by the “transferring” EU Member State upon exit from such EU Member State.
The exit tax rules should be implemented in the domestic laws of the EU Member States ultimately by 31 December 2019 and they should become effective as from 1 January 2020.
General anti-abuse rule
Under the GAAR, non-genuine arrangements or a series thereof shall be ignored for CIT purposes such that CIT is levied in accordance with the purport of the relevant EU Member State's CIT rules. The GAAR entails a business purpose or substance-over-form test that is in line with the GAAR provided for under the amended EU Parent-Subsidiary Directive that has been implemented in the EU Member States effective as from 1 January 2016.
Because of the removal of the switch-over clause, the Dutch participation exemption should not be adversely affected as a result of the implementation of the ATAD. Furthermore, although the implementation of the CFC rule will likely result in a further expansion of the scope of the existing Dutch CFC rule inspired provisions, the possible adverse effect on the Dutch participation exemption may be limited. Although it will depend on how the Netherlands will implement the ATAD, the ATAD in its 17 June form seems to allow for enough flexibility to not adversely affect the attractiveness of the favorable Dutch holding regime.
However, the extension of the scope of the hybrid mismatch rule to third countries under the proposal to be put forward by the EU Commission in October 2016 may be likely to affect certain typical (reverse) hybrid structures involving the US and the Netherlands. This should be further considered if and when this proposal is released by the EU Commission.