Private Equity in the Netherlands: a Tax Update

NL Law

In today’s rapidly changing tax environment, it is important to keep an overview of all relevant tax developments. In the past months, several new tax rules have been implemented or announced, cases have been decided by the Dutch tax courts and knowledge groups of the Dutch tax authorities have published statements which are relevant for private equity transactions with a Dutch component. We will discuss these developments below.  

1. Dutch tax classification rules

The Dutch tax classification of foreign entities (including partnerships) as either transparent or non-transparent for Dutch direct tax purposes is currently based on a comparison of certain civil law characteristics of the respective foreign entity and existing Dutch entities (the similarity approach). In essence, this approach involves examining the Dutch equivalent that bears the closest resemblance to the foreign vehicle in order to determine its Dutch tax status. However, the similarity approach does not always provide a satisfactory solution as not all foreign entities have a Dutch equivalent. Furthermore, as the current Dutch tax classification rules are rather unique and deviate from international standards, the Dutch tax classification rules often result in hybrid mismatches. This is mainly caused by the very specific criterion used to qualify a Dutch partnership (commanditaire vennootschap, or “CV”) as tax transparent or opaque: whether accession or substitution of a limited partner requires unanimous consent of all (general and limited) partners. Only if such unanimous consent is required and in practice obtained (consent requirement), a CV is considered transparent for Dutch direct tax purposes. As a result, comparable foreign limited partnerships, generally transparent in the jurisdiction where they are established, are currently often non-transparent from a Dutch tax perspective.

In 2023, the Dutch government adopted new tax rules entering, in principle, into force in 2025. These rules include new classification rules for Dutch CVs, funds for joint account (vennootschap onder firma or FGR) and comparable foreign entities. The rules entail the abolition of all Dutch non-transparent partnerships (with effect from 1 January 2025) by revoking the “unanimous consent requirement”. 

Consequently, Dutch CVs will by default be transparent for Dutch tax purposes as of 1 January 2025. For existing non-transparent CVs, this shift will result in a deemed transfer of all assets and liabilities to the limited partners at fair market value on 31 December 2024, potentially, subject to tax at the partnership and individual partner level (temporary facilities may apply during 2024 to mitigate taxation).

In addition, the tax classification rules for Dutch FGRs will also change. From 1 January 2025, an FGR may only maintain its non-transparent status if it is regulated following the Dutch Financial Supervision Act and if the participations in the FGR are tradeable. These new rules are accompanied by transitional measures that allow for tax-friendly restructurings in 2024 to avoid a tax triggering deemed transfer on 1 January 2025. 

As a result of the amendments to the CV/ FGR, the Netherlands will also classify foreign partnerships which are similar to Dutch partnerships as transparent for tax purposes from 2025 onwards. In addition, the new legislation includes two new rules for when the similarity approach does not provide a solution (i.e., no evident Dutch equivalent for the entity). For non-Dutch resident entities the classification of the “home” jurisdiction would generally be followed. For foreign entities based in the Netherlands, the “fixed approach” will apply, meaning that this entity will always be classified as non-transparent for Dutch tax purposes.

The Dutch Ministry of Finance launched a public consultation on a draft decree with a framework on how to compare foreign entities. The draft decree also includes a list of foreign entities that have already been classified by the Dutch Ministry of Finance. For US private equity funds it is relevant to note that the Delaware and Ohia LLC are included in this draft decree and considered equivalent to a Dutch opaque entity and - assuming no further changes are made - will (continue to) be classified as non-transparent. As the US tax classification can differ from the Dutch qualification, LLCs may remain subject to the various Dutch anti-hybrid rules.

2. Dutch corporate income tax

a) Interest deduction / anti-base erosion rule

The Netherlands has several interest deduction limitation rules. The Dutch anti-base erosion rule is one of those and aims to prevent an artificial erosion of the Dutch tax base by creating interest deduction within a group of affiliated taxpayers. It tries to prevent the deduction of interest on loans to affiliated companies used to finance certain “tainted transactions” (such as dividend payments, capital contributions or the acquisition of an interest in a company that qualifies as an affiliated company of the taxpayer after acquisition). Exceptions may apply if the taxpayer proves that both the transaction and its financing are predominantly based on business motives. 

Over the last years, acquisition financing structures of several private equity funds have been targeted by the Dutch tax authorities arguing that their financing structure resulted in Dutch tax base erosion. In several instances, the Dutch tax authorities also tried to apply the general abuse of law doctrine (fraus legis), which is developed in case law and not codified in tax law, as a weapon to counter the deduction of interest. Despite sustained criticism by respected authors on this route, this approach has been accepted by the Dutch Supreme court in recent case law. Fraus legis can be applied if the deduction of interest is against the objective and purpose of the law, e.g. if unnecessary legal acts are used with the predominant motive to realize a tax benefit. The respective case law covers old tax years and the legislation has been amended several times since then (amongst others in 2017 by introducing the cooperating group concept). Nevertheless, the recent cases are  important as it shows a trend that the Supreme Court is no longer reluctant in restricting companies in their freedom of financing businesses activities and fraus legis is in certain cases being successfully used by the Dutch tax authorities. Also a recent, still pending, case covers this topic. The Dutch Advocate-General Wattel in his advisory opinion has argued that based on legislative history, even if there are no affiliated parties, in exceptional cases where interest deduction is not covered by the literal text of the anti-base erosion rules but where the boundaries of permissible tax savings has clearly been exceeded, interest deduction can still be denied on the grounds of fraus legis. The Dutch Supreme Court still needs to rule on this case.

There is currently also an important case pending with the European Court of Justice. The Dutch Supreme Court asked the European Court of Justice whether related-party loans that are at arm’s length fall outside the scope of domestic anti-abuse provisions. Basically, this would allow for an escape for at arm’s length related-party loans for the purpose of anti-abuse provisions. The outcome of this case could have a significant impact for Dutch taxpayers. For further background please refer to our Tax Alert on this case.

Furthermore, on 22 March of this year, the Dutch Supreme Court ruled on a private equity structure whereby a Dutch Bidco incorporated by private equity funds acquired a Dutch target. The Dutch BidCo claimed interest deduction on the loan that was obtained for the acquisition. The Supreme Court ruled, among other things, that the interest deduction in this private equity structure was not limited by application of the anti-base erosion rule (the lenders were not affiliated under the anti-base erosion rule). The Dutch Supreme Court also looked at fraus legis and ruled that the relevant parties already set up the main part of the structure before the Dutch acquisition and incorporated only briefly before the acquisition a new Dutch vehicle to benefit from interest deduction in the Netherlands. According to the Supreme Court, the deduction of the interest paid to the lenders was thus partly restricted by application of fraus legis.

Pursuant to these recent cases it is clear that the exact boundaries of the anti-base erosion rules and the interaction with fraus legis are not fully crystallized yet. For example, when funding a Dutch BidCo to acquire a Dutch target entity it is important to analyse the potential application of the anti-base erosion rules at the level of such Dutch BidCo.   

b) Foreign exchange results

The Dutch participation exemption (generally applicable when a shareholder holds an interest of at least 5% of the nominal paid-up and outstanding capital of a company, subject to certain anti-abuse rules) is an important rule as all dividend and capital gains are in principle exempt under the participation exemption from corporate income tax at the level of the Dutch recipient entity. Generally, costs regarding the acquisition or sale of a qualifying participation also fall under the scope of the participation exemption and are thus not deductible for Dutch tax purposes. This generally includes profits or losses as a result of hedging instruments for the currency exchange risks in respect of such participation. In this respect, there have been certain developments clarifying the scope of the exemption on foreign exchange results.

i. Foreign exchange results on contributions

The knowledge group of the Dutch tax authorities published a statement (kennisgroepstandpunt) that profits or losses from hedging instruments regarding capital contributions in a different currency could also fall under the scope of the Dutch participation exemption. However, it is noted that prior written approval from the Dutch tax authorities is required in this respect to prevent that taxpayers will decide last minute whether it would be beneficial (when there is a currency exchange profit rather than a loss) to request such approval. It is further clarified that there is no “all-or-nothing” approach for the several tranches of capital contributions, meaning that if for a certain tranche prior approval is forgotten this will, in principle, not affect the other contributions, assuming prior approval is obtained for these contributions. Based on the foregoing it is important that prior approval is timely obtained for each contribution. 

ii. Acquisition of a subsidiary in a foreign currency

The knowledge group of the Dutch tax authorities has also published a statement regarding the situation whereby a Dutch entity holds a participation in a subsidiary that applies a different currency from the currency applied by the Dutch taxpayer. If the Dutch entity wants to acquire additional shares in such participation and the  SPA for such additional shares includes several contingent conditions that are beyond the control of the relevant taxpayer, the Dutch tax authorities hold the view that given the uncertainty on whether the contingent conditions would be met, it is not relevant to the participation and therefore the foreign exchange results should not be covered by  the Dutch participation exemption (i.e. a profit is taxable and a loss is deductible).

iii. Dividend distributions in a foreign currency

On 3 November 2023, a Dutch Supreme Court decision was published regarding an international group consisting of a US parent entity and a wholly owned Dutch subsidiary that holds all shares in a Swiss entity. There was a timing difference between the declaration of the dividend (1 July 2011) and the payment of dividend (4 August 2011). The exchange rate of the Swiss franc against the euro increased in such period. The Dutch entity took the position that the dividend should be accounted for in euros on the 4th of August and that the foreign currency profit should fall under the Dutch participation exemption. The Dutch Supreme Court ruled that the dividend receivable on the Swiss subsidiary was created on the 1st of July 2011 (i.e. the dividend declaration date) and that therefore on that date the income out of the participation was received. Any currency exchange results after that date should not be deemed related to the participation and as a result the Dutch participation exemption could not be applicable on the foreign currency gain. This decision of the Dutch Supreme Court may especially be relevant for cases in which a minority interest or listed share are held, which may result in the shareholder having less or no control on the timing of the dividend (i.e. declaration and payment thereof potentially resulting in taxable foreign exchange results). For further background information please refer to our Tax Alert.

c) Transaction costs and transaction bonuses

In general, transaction costs and bonuses regarding the acquisition or sale of a qualifying participation are not deductible pursuant to the Dutch participation exemption. Based on a 2017 Dutch Supreme Court ruling it is important to determine whether there is a direct causal connection with the sale or acquisition of a subsidiary. The following examples have been considered directly related: costs for managing the transaction, costs for due diligence investigations, costs for a virtual data room, legal fees, costs for drafting the transaction documentation, a success fee, and notary costs. 

The Dutch tax authorities published a knowledge document on this topic on 1 February 2024 . This document discusses amongst other things the aspect of allocation of costs and the ‘benefit-test’. Also the motive to make certain costs plays an important role and a third party comparison may have to be made. 

The knowledge document further mentions that, the (non-)deductibility of costs focuses on internal and external costs that are made during the course of a transaction and not only focuses on costs that are made pursuant to the legal transfer of shares by a civil law notary. 

The document mentions 19 examples of transactions and provides their initial view on whether this should be covered by the participation exemption. A few relevant examples are costs related to the preliminary investigation of a potential target/potential disposal, an information memorandum, sales preparation, W&I insurance, drafting a (buyers) long list and short list, and competition authority approval.

When there are so-called mixed costs, parties could come to an agreement with the Dutch tax authorities regarding a certain distribution key. 

The Dutch Supreme Court recently ruled further on farewell bonuses granted to the entire staff after the sale of a subsidiary and clarified that the required direct causal connection to the transaction includes the condition that such costs are incurred because they are, objectively speaking, useful or necessary to achieve and/or complete the transaction. The Dutch Supreme Court ruled that, based on the specific circumstances and mainly because the farewell bonuses were paid after the transaction, that these costs should not be qualified as non-deductible transaction costs. 

d) W&I insurance 

As already mentioned above in respect of the knowledge document, W&I insurance costs are non-deductible for Dutch corporate income tax purposes pursuant to the Dutch participation exemption. 

The knowledge group of the Dutch tax authorities also published a statement regarding the tax treatment of legal costs in respect of claiming under a W&I insurance policy. The knowledge group is of the opinion that such expenses are not in scope of the Dutch participation exemption (i.e. such legal expenses are deductible) as there is no direct causal connection to the transaction (the costs were not necessary to complete the transaction). Even though this point of view does not come as a surprise, it is beneficial to taxpayers to have certainty in this respect. 

e) Pillar Two

Pillar Two, as implemented in Dutch domestic law as of 1 January 2024 following an EU Directive on Pillar Two, aims to target both international and domestic groups whose consolidated group revenues exceeds EUR 750 million in at least two of four consecutive years, and introduces a minimum effective tax rate (“ETR”) of 15%.  Under either (i) the so-called “Qualified Domestic Minimum Top-up Tax, (ii) the so-called “Income Inclusion Rule” or (iii) the “Undertaxed Payments Rule” (the latter applicable as of 1 January 2025), EU member states will collect a ‘top-up’ tax if the group which is in scope of the Pillar Two rules is subject to an ETR that does not meet the minimum standard in a country where the group carries out activities. For further background on the mechanics. please refer to our previous Tax Alert on this topic. As Pillar Two has just been implemented, it remains to be seen how these rules will play out in practice, but Pillar Two may have a significant impact on private equity structures and M&A transactions in terms of, amongst others, commercial considerations. 

Acquiring a target could have an impact on the acquiring group’s ETR and administrative obligations under Pillar Two and may result in the acquiring group meeting the minimum revenue level for Pillar Two purposes. It may, however, also be an advantage if the target group has a high ETR as this could increase the acquirer’s group overalls ETR. 

A different question is whether a private equity fund itself could be in scope of the Pillar Two rules. In this respect it should be noted that private equity funds generally do not consolidate portfolio companies at fund level, which could be relevant in light of the EUR 750 million revenue threshold. 

Furthermore, the overall process of a private equity transaction will also be impacted as certain protection should be included in the transaction documents (e.g. in the form of warranties and indemnities, conduct of administrative obligations under Pillar Two, etc.). It also requires more specific Pillar Two due diligence when structuring and documenting the transaction.

3. Dutch withholding tax

a) Conditional withholding tax

As of 1 January 2021, a conditional withholding tax is effective with respect to (deemed) intragroup interest and/or royalty payments to related entities in low tax jurisdictions and in certain cases of abuse. The low-tax jurisdictions are listed in ministerial decree jurisdictions:

  • jurisdictions with a profit tax applying a statutory rate of less than 9% (updated annually based on an assessment as per 1 October of the year prior to the tax year); or
  • jurisdictions included on the EU list of non-cooperative jurisdictions.

The applicable tax rate is equal to the standard corporate income tax rate (currently 25.8%). In this context, companies are considered related if the recipient company has a qualifying interest in the paying company or vice versa or if a third company has a qualifying interest in both the paying and recipient company. An interest is considered “qualifying” if it represents enough influence in the decision-making process of an entity that the activities can be determined. 

As from 1 January 2024, this conditional withholding tax will also be applicable on dividend distributions. This withholding tax will be levied in addition to the “regular” dividend withholding tax of 15%. There is an anti-cumulation rule so that in case “regular” dividend withholding tax has been paid, this can be set of against the conditional withholding tax.

b) Anti-dividend stripping

With respect to the regular Dutch dividend withholding tax, based on the EU Parent-Subsidiary Directive, a full exemption should be applicable for shareholders (entities) with a shareholding of at least 5%, subject to certain requirements. An exemption is only available if the structure or transaction is not abusive and is entered into for valid commercial business reasons. The Dutch dividend withholding tax exemption is further denied in so-called dividend-stripping cases (i.e., in cases where it appears that the person receiving the dividend is not considered the beneficial owner of the dividend). Dividend stripping may, for example, occur in cases where a shareholder transfers its shares to a third party which is entitled to a more beneficial withholding tax treatment, thereby holding its interest in the shares. As – according to the Dutch legislator – the current Dutch measures to avoid dividend-stripping did not always prove to be effective in practice, new legislation became effective as of the start of this year that contains several measures to counter dividend -stripping more adequately: e.g. a shift in the burden of proof from the tax inspector to the individual seeking tax benefits, and the codification of the dividend record date for publicly traded shares in Dutch tax law. 

4. 30% ruling

The 30%-ruling is a tax facility for foreign employees with specific expertise working in the Netherlands. As part of this regime, employers can apply an exemption of up to 30% as a reimbursement of extraterritorial expenses on a notional basis. The 30%-ruling has a maximum duration of five years. As from 1 January 2024, the tax free allowance will be phased down as follows:

  1. 30% tax free during the first 20 months of the employment;
  2. 20% tax free during the second 20 month of the employment;
  3. 10% tax free during the final 20 months of employment

Furthermore, the tax base (salary) as from 2024 is capped at the so-called Balkenende norm (currently set at EUR 223,000). Transitional rules apply for existing 30%-rulings.