1. The tax treatment of W&I premiums and payouts
On 18 October 2022, the Dutch State Secretary of Finance published a document regarding certain Dutch corporate income tax considerations in respect of premiums and payouts under a Warranties and Indemnities (W&I) insurance. The document was published in response to a request under the Dutch Open Government Act (Wet open overheid).
The published document includes a statement of the Participation Exemption Knowledge Group of the Dutch tax authorities (Kennisgroep Deelnemingsvrijstelling) (the "Knowledge Group") dated 11 December 2019. It states, among other things, that the Knowledge Group takes the following positions on W&I insurances in connection with the Dutch participation exemption regime:
- The insurance premiums are considered non-deductible acquisition or selling costs in respect of the shareholding.
- A balanced approach regarding the insurance premiums on the one hand and the payouts under the W&I insurance on the other hand entails that a potential payout under the W&I insurance is not subject to tax; such payout falls within the scope of the participation exemption regime.
- This balanced approach at the level of the buyer also affects the determination of the amount paid (opgeofferd bedrag) for the respective shareholding.
According to the Knowledge Group's statement, a distinction should be made between buyer insurance policies and seller insurance policies.
Buyer insurance policy
Under a buyer insurance policy, the buyer of the shareholding enters into and takes out W&I insurance with an insurer. Any payouts under the W&I insurance are paid by the insurer to the buyer. In that case the insurance premium would not be tax deductible at the level of the buyer, while a payout by the insurer to the buyer would not be subject to tax at the level of the buyer. The buyer's amount paid (opgeofferd bedrag) for the shareholding in question will be increased by the amount of insurance premiums paid and will be reduced by the amount of payouts received under the W&I insurance.
Seller insurance policy
According to the statement, a seller insurance policy can roughly be divided into the following two categories.
- In the first category, the seller of the shareholding enters into and takes out the W&I insurance with the insurer, whereby the insurer would pay the payout under the W&I insurance directly to the buyer. In that case the insurance premium is not tax deductible at the level of the seller, whereas the payout by the insurer to the buyer would not be subject to tax at the level of the buyer. The buyer's amount paid (opgeofferd bedrag) for the shareholding in question will be reduced by the amount of payout received under the W&I insurance.
- In the second category, the seller enters into and takes out the W&I insurance with the insurer, whereby the insurer would pay the payout under the W&I insurance to the seller after which the seller would subsequently pay this amount to the buyer. In that case the seller would be deemed to act solely as a conduit and hence the receipt of the payout by the seller and the subsequent payment to the buyer would not affect the seller's taxable income. The insurance premium is not tax deductible at the level of the seller, whereas the payout would not be subject to tax at the level of the buyer. The buyer's amount paid (opgeofferd bedrag) for the shareholding in question will be reduced by the amount of payout received under the W&I insurance.
It is explicitly stated in the Knowledge Group’s statement that the Knowledge Group’s positions described above relate only to W&I insurances and not to any other insurance. It therefore cannot be concluded from the Knowledge Group’s statement whether (and to what extent) the consequences described above regarding the application of the participation exemption regime would also apply to insurance premiums and payouts under any other (M&A) related insurance.
2. Supreme Courts asks preliminary questions following CJEU Lexel ruling
On Friday, 2 September 2022, the Dutch Supreme Court presented preliminary questions to the CJEU in a court case regarding interest deduction in the Netherlands in respect of an acquisition debt. The questions are directly related to the interpretation of the CJEU ruling in the Lexel case with regard to the Dutch anti-base erosion rules recorded in Article 10a of the Corporate Income Tax Act (CITA).
The purpose of Article 10a CITA is to prevent an artificial erosion of the Dutch tax base by creating interest charges within a group of affiliated taxpayers. In short, these rules prohibit the deduction of interest on loans to affiliated companies used to finance dividend payments or capital repayments, among other things, or the acquisition of an interest in a company that qualifies as an affiliated company of the taxpayer after acquisition (these transactions are also known as “tainted transactions”).
By way of escape, however, interest paid on intercompany loans used to finance a tainted transaction remains deductible, for instance, if the taxpayer proves that both the transaction and its financing are predominantly based on business motives (also referred to as the “rebuttal rule”). This rebuttal rule provides that it must then be proved that both the transaction and the financing are at arm's length (also referred to as the “double arm's length requirement”). The question is, however, whether this double arm's length requirement is compatible with EU law.
In Lexel, the CJEU held, in short, that affiliated transactions that are carried out “at arm's length” are not purely artificial. On this basis, an obstructive national anti-abuse provision may not be justified based on the fight against tax evasion and tax avoidance. Moreover, according to the CJEU, it follows from EU law that if there is no commercial reason for a particular (legal) structure, the proportionality principle requires that interest is only limited in deduction to the proportion of that interest that it is not considered “at arm's length”. Assuming that in the relevant Dutch case both the interest and the terms of the loan are at arm's length, Article 10a CITA may in that case arguably not limit the deductibility of interest on the basis of the CJEU ruling in the Lexel case.
The Dutch Supreme Court is of the opinion that Article 10a CITA remains within the boundaries set by the CJEU in its case law for a statutory provision restricting one or more of the freedoms set out in Articles 49, 56 and 63 of the TFEU. However, due to the divergent views in Dutch literature regarding the potential impact of the CJEU ruling in the Lexel case on Article 10a CITA, and considering the EFTA judgment in PRA Group Europe AS and the fact that the Swedish restrictive provision in the Lexel case applied only to internal acquisitions (as opposed to Article 10a CITA, which applies to both internal and external acquisitions), the Dutch Supreme Court has nevertheless decided to present preliminary questions to the CJEU.
The Dutch Supreme Court’s preliminary questions are whether the freedom of establishment (Article 49 TFEU), the freedom of services (Article 56 TFEU) and the freedom of capital movements (Article 63 TFEU) (jointly the “EU Freedoms”) and Article 10a CITA can coexist, or whether Article 10a CITA should be limited in application by the EU Freedoms. More specifically, the Dutch Supreme Court asks the CJEU whether it would be in contravention of the EU Freedoms to limit interest deduction in respect of a loan that is part of a wholly artificial construction, regardless of whether that loan, viewed in isolation, was entered into at arm's length. Should the CJEU’s answer to this question be no, the Dutch Supreme Court raises the follow-up question whether it would be in contravention of the EU Freedoms if the entire interest is limited in deduction, also to the extent that the interest, viewed in isolation, does not exceed the amount that would have been agreed on between independent companies.
The Dutch Supreme Court’s final question to the CJEU is whether it makes any difference to the answers to the first two preliminary questions whether the acquisition/expansion in question relates to (i) a company that was already related to the taxpayer before the acquisition/expansion; or (ii) a company that becomes related to the taxpayer only after the acquisition/expansion
It is now up to the CJEU to answer these preliminary questions and to decide whether and to what extent Article 10a CITA is compatible with EU law. This is likely to take around 1.5 to 2 years. We will update you as soon as any relevant next steps or developments take place. If your company is or may be faced with an amount of non-deductible interest under Article 10a CITA, it may be wise to lodge an objection to the corporate tax assessment incorporating the interest deduction limitation in order to preserve any rights. It may be possible to agree with the inspector to “reserve” the ruling on the objection until the CJEU and/or the Dutch Supreme Court rule in these (preliminary) proceedings.
3. Consultation proposals on modernization of partnerships
On 10 October 2022, a new internet consultation opened on the legislative proposal on modernization of partnerships. This new proposal was submitted for consultation partly in response to the reactions to the internet consultation on this topic in 2019 and after consulting various organizations. Compared to previous proposals on this topic, this legislative proposal has now been supplemented with the (i) main accompanying tax measures; (ii) the rules for conversion of partnerships into legal entities and vice versa; and (ii) transitional law. The most relevant consequence under the legislative proposal would be that certain Dutch partnerships (maatschap, vennootschap onder firma en commanditaire vennootschap) will acquire legal personality.
In view of the proposed amendments to the Dutch Civil Code, various amendments to Dutch tax law have also been proposed. The guiding principle here is that these amendments should, where possible, be policy-neutral and support the proposed civil law amendments. The current proposal regulates that, on the one hand, for the partnership, the transparency for purposes of personal income tax, corporate income tax, dividend withholding tax, inheritance tax and gift tax will be maintained, regardless of whether the partnership has legal personality or not, and on the other hand, for purposes of real estate transfer tax, the legal personality of the partnership will have consequences. For real estate transfer tax purposes, in principle, the interpretation of the tax consequences is based on civil law.
The consultation documents do not take into account any other intended changes that potentially interface with the measures contained in this legislative proposal, such as the legislative proposal regarding the Dutch classification rules for certain domestic and foreign legal entities, which is expected to be submitted to the Dutch Lower House in the spring of 2023. We refer to our blog of 2 July 2021 and 7 June 2022 for a summary of this legislative proposal. The consultation documents on the legislative proposal regarding the modernization of partnerships state that the possible concurrence with the measures included in the legislative proposal regarding the Dutch classification rules for certain domestic and foreign legal entities will be safeguarded. They also state that the starting point for both legislative proposals is the same: partnerships (with or without legal personality) are transparent for purposes of personal income tax, corporate income tax, dividend withholding tax, gift tax and inheritance tax.
Under current Dutch civil law, a partnership lacks legal personality and is classified as transparent for the purposes of Dutch personal income and corporate income tax, among others. However, this does not apply to an “open limited partnership” (open commanditaire vennootschap), which is classified as opaque for corporate income tax purposes. As a result of the tax transparency, the assets and liabilities and the results of the partnership are attributed to the participants of the partnership. In other words, for personal income tax and corporate income tax purposes, not the partnership but each participant is taxable with respect to its participation in that partnership. For dividend withholding tax purposes, the consequences of the tax transparency of the partnership are twofold. First, it is not the partnership that is considered the beneficiary (taxpayer) of the proceeds of its shareholdings. Instead, the partners of that partnership are considered the beneficiary (taxpayer) of the proceeds. Second, a partnership is not considered a withholding agent for dividend withholding tax purposes.
As stated above, partnerships do not have legal personality under current Dutch civil law. Because, in principle, the real estate transfer tax follows the approach of civil law, partnerships are regarded on that basis as transparent for real estate transfer tax purposes. This means that if a partnership acquires immovable property in the Netherlands, the participants of the partnership, rather than the partnership itself, are subject to real estate transfer tax in respect of their interest in the immovable property.
The granting of legal personality to the “public (openbare) partnerships” (maatschap, vennootschap onder firma en commanditaire vennootschap) constitutes a significant change. A partnership is considered a public partnership if a partnership is, in short, clearly recognizable to third parties.
Despite the fact that under the legislative proposal for the modernization of partnerships the partnership would acquire legal personality, the government has decided that for several reasons the partnership will remain transparent for personal income tax, corporate income tax, dividend withholding tax, inheritance tax and gift tax purposes.
With regard to conditional withholding tax on interest and royalties, however, the government does not consider it desirable – with a view to discoursing payment from the Netherlands to low-tax jurisdictions – to maintain tax transparency for partnerships with legal personality. However, for purposes of the conditional withholding tax on dividends, which enters into effect on 1 January 2024, the partnerships will nevertheless not become withholding agents. This is because the concept of withholding agent in the Withholding Tax Act 2021 is aligned (where possible) with the concept of withholding agent in the Dividend Withholding Tax Act. As stated above, the partnership is not a withholding agent for dividend withholding tax purposes.
For real estate transfer tax purposes, public partnerships that are registered in the commercial register will become subject to real estate transfer tax, instead of the participants of the partnership, when acquiring immovable property. In addition, disposals of qualifying participation in a qualifying partnership, or the qualifying entry or qualifying exit of a qualifying participant, will no longer automatically trigger the levy of real estate transfer tax.