On 29 March 2021 the Dutch government has released a consultation document (the “Consultation Document”) containing a draft bill of law and explanatory memorandum to amend the Dutch classification rules for certain domestic and foreign legal entities.
This amendment aims to avoid hybrid entity mismatches (i.e. a situation whereby the Netherlands consider a legal entity as taxable/non-transparent for Dutch tax purposes, whereas another jurisdiction classifies the entity as transparent) that are caused by the fact that the current Dutch classification of certain domestic and foreign legal entities deviates from the classification of those entities in other jurisdictions.
As noted in our earlier Tax Alerts (see our Tax Alerts of March 2017 and July 2019), the EU Anti-Tax Avoidance Directive 2 (“ATAD 2”) provides for minimum standards to neutralize the consequences of hybrid entity mismatches (i.e. double deduction or deduction without inclusion) and came into effect in the Netherlands as of 1 January 2020. These minimum standards do, however, not eliminate the actual cause for hybrid entity mismatches. The amendments to the Dutch classification rules for domestic and foreign legal entities proposed in the Consultation Document aim to reduce the number of potential hybrid entity mismatches.
We note that currently there is also a separate consultation ongoing regarding a legislative proposal targeting so called ‘reverse-hybrids’ and the Dutch tax treatment thereof which is part of the implementation of ATAD 2 and - if adopted - will become effective 1 January 2022. We refer to our Tax Alert of March 2021. It is not yet clear how that proposal would relate to the current proposal regarding the classification rules for domestic and foreign legal entities.
Interested parties can submit their comments until 26 April 2021. The released Consultation Document only contains a draft bill of law which may be modified before it will be presented to the Dutch Parliament. However, based on experience with other consultations we do not expect that the consultation shall lead to substantial changes of the draft bill. If adopted by the Dutch parliament, the proposed amendments are expected to become effective 1 January 2022.
Amendments proposed in the Consultation Document
The Consultation Document proposes the following three amendments to the Dutch classification rules for domestic and foreign legal entities that could potentially have implications for existing domestic or cross-border structures effective as of 1 January 2022 and may require further restructuring:
- existing open Dutch limited partnerships (commanditaire vennootschap or “CV”) will become transparent for Dutch tax purposes;
- amendment of the definition of a fund for joint account (fonds voor gemene rekening or “FGR”) that is considered as taxable entity (open FGR); and
- introduction of two supplementary methods to classify foreign legal entities without an equivalent Dutch legal form.
Re 1. Existing open Dutch CVs will no longer be subject to Dutch taxation
Under current Dutch tax law a CV qualifies as taxable entity (open CV) if, among others, the admission or substitution of a limited partner (commanditaire vennoot) and each change in the relative interest between partners does not require the unanimous consent of all partners (both general/managing partners and limited partners). If the unanimous consent of all partners is required, a CV qualifies as transparent (closed CV) for Dutch tax purposes and the partners are taxed on the income derived from their interest in the CV.
In the Consultation Document the Dutch government proposes to abolish this ‘consent requirement’ for the classification of a CV and to classify each CV as transparent for Dutch tax purposes. This means that if the Dutch parliament adopts this proposal, all existing open CVs will become transparent for Dutch corporate income tax purposes effective 1 January 2022. In addition, existing open CVs will no longer have an obligation to withhold and pay Dutch dividend withholding tax and the recently enacted Dutch conditional withholding tax on interest and royalties. Furthermore, as per 1 January 2022, the assets and liabilities of the (tax transparent) CV are directly allocated to the limited partners in proportion to their entitlement in the CV.
The classification of a CV as transparent should as such not affect the tax position of the general/managing partner of the CV as such partner is, and will continue to be, subject to tax in proportion to its interest in the CV.
The Consultation Document provides for transitional rules on the Dutch tax implications resulting from the change in the tax classification of existing open CVs. These transitional rules stipulate (by fiction) that immediately prior to the moment existing open CVs become transparent for Dutch tax purposes:
- an open CV will be deemed to have (i) transferred its assets and liabilities at fair market value to its participants (both general/managing partners and limited partners) and (ii) ceases to derive taxable profits in the Netherlands, as a result of which an open CV may be subject to Dutch corporate income tax on any hidden reserves, tax reserves and goodwill (if any) if and to the extent allocable to its limited partners.
- the limited partners of an open CV will be deemed to have transferred their participations in that CV at fair market value, as a result of which they may be subject to Dutch tax on any (deemed) capital gains.
In order to avoid immediate taxation as much as possible the transitional rules also provide for roll-over relief for taxpayers that meet certain conditions and the possibility to pay the tax in ten equal annual installments.
The Consultation Document does not elaborate on the implications of the proposed amendments included in the pending civil law legislative proposal to modernize Dutch partnerships, pursuant to which a CV may obtain legal personality. If another jurisdiction would classify a CV with legal personality as a taxable entity, and assuming that it will continue to be classified as partnership for Dutch tax purposes, this may still result in a hybrid entity mismatch the consequences of which are neutralized by the minimum standards under ATAD 2 as implemented in Dutch tax law.
Re 2. Amendment of open FGR definition
An FGR is a commonly used vehicle in the Netherlands for structuring investment funds. An FGR is a contractual agreement between a fund manager (beheerder), depositary (bewaarder) and the participants/investors. Depending on the requirements for the admission and substitution of participations, an FGR may qualify as a tax transparent (closed FGR) or as a taxable entity (open FGR) for Dutch corporate income tax and dividend withholding tax purposes.
An FGR is considered a taxable entity (open FGR) if its participations can be transferred to new or existing participants without the consent of all participants. If its participations can (i) only be transferred among new or existing participants with the consent of all participants or (ii) solely be transferred to the FGR itself or to blood relatives and relatives by marriage of the participants in the direct line (bloed- en aanverwanten in de rechte lijn), an FGR is considered tax transparent (closed FGR).
To avoid hybrid entity mismatches in respect of an FGR, the Consultation Document proposes, in line with the proposal for CVs (see above), to abolish the consent requirement for classifying an FGR as taxable entity (open FGR) or transparent (closed FGR). Instead, the Consultation Document introduces a new definition for an open FGR. Based on this new definition an open FGR is an FGR that raises capital for collective investment and whereby either:
- the participations are traded on a regulated stock exchange within the meaning of article 1:1 of the Financial Supervision Act (Wet op het financieel toezicht) or a comparable trading platform; or
- based on its fund terms and conditions (fondsvoorwaarden), the FGR has the ongoing legal obligation to repurchase or repay its own participations from the assets of the FGR at the request of its participants and habitually makes such repurchases or repayments.
Based on this new definition, an FGR - with the exception of “family funds” (see below) - can choose for the desired civil law structuring, whereby the FGR is either a taxable entity (open FGR) or transparent (closed FGR) for Dutch tax purposes. According to the Consultation Document, the Dutch government expects that this freedom of choice in setting-up the fund terms and conditions of an FGR results in simplicity and clarity for both taxpayers and the Dutch tax authorities.
The new definition of an open FGR however makes an exception for “family funds” which cannot be considered as taxable entity (open FGR) and will always be transparent (closed FGR) for Dutch tax purposes. An FGR is considered a “family fund” if the participations in the FGR legally or in fact, directly or indirectly, exclusively or almost exclusively can be transferred to a participant in the FGR, a partner of a participant, one or more blood relatives and relatives by marriage in the direct line or up to and including the fourth degree (bloed- en aanverwanten in de rechte lijn of tot en met de vierde graad van de zijlijn) of the participant or its partner1. The background for this exception is that in recent years family funds have organized themselves as open (taxable) FGRs to avoid taxation of the individual participants in Box 3 (income from savings and investments) or to anonymize the funds’ assets in order to protect the privacy of the individuals.
Re 3. Introduction of two supplementary methods for classifying foreign legal entities
Current Dutch policy
Based on current Dutch policy (Decree from the Dutch Under Minister for Finance dated 11 December 2009 (nr. CPP2009/519M), the “Entity Classification Decree”), the classification of foreign legal entities as transparent or non-transparent for Dutch tax purposes is based on a comparison of certain civil law characteristics of the foreign legal entity and existing Dutch legal entities (legal entity comparison method), such as a public limited company (naamloze vennootschap), private company with limited liability (besloten vennootschap) or limited partnership (commanditaire vennootschap). Based on this approach, for Dutch tax purposes a foreign legal entity is in principle treated the same way as the Dutch legal entity that is comparable to it.
In short, if three of the following four questions are answered with “yes” the foreign legal entity is qualified as taxable entity (non-transparent) for Dutch tax purposes. If not, the foreign legal entity in principle qualifies as tax-transparent.
- Can the foreign legal entity hold the legal ownership of assets?
- Is the liability of the participants limited?
- Does the foreign legal entity have a capital divided into shares?
- Can the admission or substitution of participants take place without the consent of all participants?
In addition, if a foreign legal entity is comparable to a Dutch CV (e.g. a limited partnership) it will be classified as a taxable entity if the admission or transfer, outside of a bequest or inheritance, does not require the consent of all partners of that entity.
The Dutch tax authorities regularly publish an indicative (non-binding) list (in Dutch) of the classification of certain commonly used foreign legal entities for Dutch tax purposes.
The legal entity comparison method of the Entity Classification Decree will continue to apply to foreign legal entities which can be compared to Dutch legal entities. As a result of the abolishment of the open CV it can therefore be expected that - after enactment of the proposed amendments - most foreign limited partnerships will qualify as transparent for Dutch tax purposes.
However, according to the Consultation Document in situations where no Dutch equivalent to a foreign legal entity exists, the legal entity comparison method is not helpful to classify a foreign legal entity for Dutch tax purposes and this may potentially result in a hybrid entity mismatch. This concerns, inter alia, the limited liability partnership (LLP) established under UK law, the Unlimited Company (ULC) established under Irish law and the Kommanditgesellschaft auf Aktien (KGaA) established under German law (although the ULC and KGaA are classified as non-transparent in the non-binding indicative list to the Entity Classification Decree).
In the Consultation Document, the Dutch government introduces two supplementary classification methods for situations where there is no Dutch legal entity equivalent to a legal entity established/incorporated under foreign law:
- Symmetrical or follow method (symmetrische of volg methode): this method can be used in situations where either (i) the legal entity is incorporated under foreign law, resident outside of the Netherlands and holds an interest in a Dutch corporate income taxpayer (Dutch inbound structure) or (ii) a Dutch corporate income taxpayer holds an interest in a legal entity established/incorporated under foreign law (Dutch outbound structure). Pursuant to this method, the Netherlands will for Dutch corporate income tax purposes follow the classification of that foreign legal entity for profit tax purposes in the jurisdiction in which that foreign legal entity is incorporated/established. Hence, in case this method is applicable and the foreign legal entity is considered non-transparent in the jurisdiction in which that foreign legal entity is incorporated/established, the foreign legal entity will also be classified as non-transparent for Dutch tax purposes. By the same token, if the foreign legal entity is considered transparent in the jurisdiction in which that foreign legal entity is incorporated/established, the foreign legal entity will also be classified as transparent for Dutch tax purposes.
- Fixed method (vaste methode): this method can be used for legal entities incorporated/established under foreign law that are resident in the Netherlands. Pursuant to this method, those foreign legal entities are considered a taxable entity for Dutch corporate income tax purposes.
According to the Consultation Document these supplementary classification methods will be incorporated in the provisions of our tax code defining which Dutch resident legal entities (fixed method) and foreign legal entities (symmetrical method) are subject to Dutch corporate income tax and for which foreign legal entities the Dutch participation exemption may be applied (symmetrical method). Although the Consultation Document is silent in this respect, we would expect that these supplementary classification methods would also be reflected in the Entity Classification Decree and accompanying list.
We would like to stress that these supplementary classification methods only apply to foreign legal entities that have no Dutch equivalent. For other foreign legal entities the existing classification rules will continue to apply.
The legislative proposals up for consultation are the latest measures taken by the Netherlands to target hybrid entity mismatches. The legislative proposals include several amendments to the Dutch classification rules for domestic and foreign legal entities in order to eliminate the actual cause for hybrid mismatches. In addition to the implementation of ATAD 2 (which was implemented in the Netherlands as per 1 January 2020) hybrid entity mismatches will therefore be tackled in various ways.
If the proposed bill of law is adopted, existing Dutch open CVs will no longer be subject to Dutch corporate income tax and will no longer have to withhold tax on outbound payments of dividends, interest and royalties. Provided certain conditions are met, taxation of gains on deemed transfers of assets may be postponed (roll-over relief or payment in installments).
The proposed amendments are furthermore relevant for the Dutch tax classification of foreign legal entities, both with (e.g. limited partnerships) and without a Dutch equivalent.
Although the proposed amendment to the definition of an open FGR is mostly technical, it may affect the classification of FGRs for Dutch corporate income tax and dividend withholding tax purposes.
Since the proposed amendments may have an impact on existing corporate structures it should be carefully checked on a case-by-case basis whether the proposal would lead to adverse tax consequences and may require further restructuring prior to 1 January 2022.
The internet consultation closes on 26 April 2021. We will keep you informed of further developments.
1] This includes, among grandparents, parents, children, grandchildren, brothers, sisters, uncles and aunts, first cousins and nieces of the participant or its partner.