ATAD2 will become effective as from 1 January 2020, albeit that the rule that targets reverse hybrid mismatches will be effective as from 1 January 2022; see below.
Below we will first briefly outline the scope and general effect of ATAD 2 in the Netherlands and the choices that the Netherlands made in this respect. Subsequently we will discuss the specifics on the Dutch implementation.
ATAD 2 & hybrid mismatches
ATAD 2 aims in principle to neutralize hybrid mismatches resulting in mismatch outcomes between associated enterprises (i.e., in short, situations with a double deduction or a deduction without inclusion). To neutralize these mismatches, as a required primary rule, the deduction of a payment shall not be allowed in the state of the payer (the "Primary Rule"). In addition, an optional second rule may apply under ATAD 2 (if implemented into domestic law and provided that the deduction is not already tackled by the Primary Rule), under which rule the payment will be included in the taxable income of the state of the receiver of such payment (the "Secondary Rule"). The Netherlands intends to implement both the Primary and Secondary Rule.
ATAD 2 only applies to the extent a mismatch results from one of the following hybrid mismatches:
- Hybrid entity mismatch: A hybrid entity is any entity or arrangement that is regarded as a taxable entity under the laws of one jurisdiction and whose income or expenditure is treated as income or expenditure of one or more other persons under the laws of another jurisdiction. ATAD 2 covers a number of hybrid entity mismatches that result either in a deduction without inclusion or in a double deduction.
A hybrid entity mismatch may concern a payment made to a hybrid entity which gives rise to a deduction without inclusion (i.e., if the entity is considered as non-transparent by the jurisdiction in which the persons with a controlling interest in the entity are resident, but is considered transparent in its residence state). Under the Primary Rule, the deduction shall be denied in the Netherlands if the payer is a Dutch resident corporate taxpayer. If the deduction is not denied by the payer jurisdiction (i.e., a non-EU Member State), under the Secondary Rule, the payment will be included in the taxable income in the Netherlands if the payee is a Dutch resident taxpayer. We note that this type of hybrid mismatch may also qualify as a reverse hybrid mismatch if the hybrid entity is incorporated or established in an EU Member State, in which case the specific reverse hybrid mismatch provision should be applied first (see further below where we discuss the reverse-hybrid rule).
A hybrid entity mismatch may also concern a payment made by a hybrid entity which results in a deduction without inclusion (i.e., if the hybrid entity is considered as non-transparent in its residence state and makes a payment to a person that has a controlling interest in the entity and this person is resident in a state that treats the entity as transparent and therefore disregards the payment made by the hybrid entity). Under the Primary Rule, the deductibility of the payment will be denied in the Netherlands at the level of a Dutch resident hybrid entity. If the deduction is not denied in the payer jurisdiction (i.e., a non-EU Member State), under the Secondary Rule the payment will be included in the taxable income in the Netherlands if the payee is a Dutch resident taxpayer.
Finally, a hybrid entity mismatch may concern a payment by a hybrid entity resulting in a double deduction (i.e., if the hybrid entity is considered as non-transparent in its residence state and considered transparent in the state of the person that controls the hybrid entity, payments made by the hybrid entity are deductible in both the state of which the entity and the state of which the investor is a resident). Under the Primary Rule, if the investor is a Dutch resident taxpayer, the Netherlands will deny the deduction if and to the extent the payment is deductible against income that is not dual-inclusion income. If the deduction is not denied in the investor jurisdiction, under the Secondary Rule the deduction will be denied in the Netherlands if the payer is a Dutch resident taxpayer.
- Hybrid financial instrument & hybrid transfer: Hybrid financial instrument mismatches concern situations where the tax treatment of a financial instrument differs between two jurisdictions. Under ATAD 2 the term 'financial instrument' also includes a hybrid transfer (we note that the Bill addresses these two mismatches separately). A hybrid transfer means any arrangement to transfer a financial instrument where the underlying return (e.g. dividend) on the transferred financial instrument is treated for tax purposes as derived simultaneously by more than one of the parties to that arrangement (e.g. structuring loans as a share sale and repos). In the case of a financial instrument mismatch, under the Primary Rule the deduction will be denied in the Netherlands if the payer is a Dutch resident taxpayer. If the payee is a Dutch resident taxpayer and the deduction is not denied by the (non-EU Member State) payer jurisdiction, the payment will be included in the taxable income in the Netherlands under the Secondary Rule. If and to the extent the hybrid financial instrument mismatch is already neutralized under the implementation of the Parent Subsidiary Directive (i.e. a payment that qualifies as interest and is deductible in the hands of the payer, will not be exempt under the Dutch participation exemption in the hands of the Dutch payee if it qualifies as a dividend under Dutch tax law), ATAD 2 would not apply (as the Parent-Subsidiary Directive prevails). Under ATAD 2, EU Member States have the option to exclude financial institutions and certain financial instruments from ATAD 2 until 31 December 2022. The Netherlands intends not to implement exclusions for financial institutions (see also below).
- Hybrid permanent establishment ("PE"): ATAD 2 addresses several PE mismatches and corresponding remedies to neutralize the relevant mismatch. Hybrid PE mismatches concern situations where the business activities in a jurisdiction are treated as being carried on through a PE by the head office jurisdiction whereby such jurisdiction exempts the income derived from the PE while the activities the income derives from are not treated as being carried on through a PE in the PE jurisdiction (resulting in an exemption in the head office jurisdiction with no inclusion of the relevant items of taxable income in the PE jurisdiction). Where a hybrid mismatch for instance involves disregarded PE income which is not subject to tax in the head office jurisdiction or in the PE jurisdiction, under the Primary Rule the Netherlands shall not allow a deduction of the payment if the payer is a Dutch resident taxpayer. If the head office is a Dutch resident and the deductible PE income would be disregarded in both the Netherlands (pursuant to the Dutch object exemption) and the PE jurisdiction, the Netherlands shall under the Secondary Rule include the PE income as taxable income at the level of the head office. In this respect, the current Dutch object exemption for foreign PE's will be slightly amended to reflect the order of priority between the rules.
- Imported hybrid mismatch: Imported hybrid mismatches concern situations where the effect of a hybrid mismatch between parties in third countries is shifted into an EU Member State through the use of a nonhybrid instrument. This includes a deductible payment in an EU Member State under a nonhybrid instrument that is used to fund deductible payments involving a hybrid mismatch (that lead to a double deduction or deduction without inclusion). To neutralize these imported mismatches, under the Primary Rule the Netherlands shall not allow the deduction of a payment under a nonhybrid instrument by a Dutch resident taxpayer if the corresponding income from that payment is setoff, directly or indirectly, against a deduction that arises under a hybrid mismatch arrangement giving rise to a double deduction or a deduction without inclusion between third countries. This rule should not apply to the extent that one of the other jurisdictions involved in the transaction already made a hybrid mismatch adjustment in respect of the imported hybrid mismatch.
- Dual resident mismatch: A dual resident mismatch concerns the situation where a payment by a dual resident taxpayer is deductible in both jurisdictions. According to the Primary Rule, if the dual resident is (also) a Dutch resident the Netherlands shall deny the deduction. If both jurisdictions are EU Member States, both EU Member States shall in principle apply the Primary Rule and not allow the deduction. In that case, only the EU Member State where the taxpayer is not deemed to be a resident according to the double taxation treaty between the two EU Member States concerned, shall deny the deduction.
- Reverse hybrid rule: In addition to the Primary and Secondary rule that neutralize hybrid mismatches as from 1 January 2020, a reverse hybrid rule will become applicable as from 1 January 2022. The reverse hybrid rule will not neutralize the effect of the hybrid mismatch, but rather tackle the hybrid mismatch at the source by making the hybrid entity in its entirety subject to tax. The reverse hybrid mismatch rule will apply in a situation of a hybrid entity mismatch where an entity is incorporated or established in an EU Member State which qualifies the entity as transparent, whereas the jurisdiction of one or more associated non-resident entities that hold (in aggregate) a direct or indirect interest in 50% or more of the voting rights, capital interests or profit rights in such entity, qualify the entity as non-transparent, resulting in a deduction without inclusion. Under the reverse-hybrid rule, such hybrid entity will be regarded as a resident taxpayer. As from 1 January 2020, payments made to hybrid entities that result in a deduction without inclusion (or a double deduction), will in principle already be tackled by the Primary Rule (at the level of the payer) or included in the taxable income under the Secondary Rule (at the level of the receiver). Under the reverse-hybrid rule, the neutralizing rules would in principle no longer be necessary as there would no longer be a mismatch as from 1 January 2022. The State Secretary of Finance indicated that a reverse hybrid will also become subject to Dutch dividend withholding tax (further guidance in this respect will be published ultimately in the course of 2021). Additional legislation in this respect will be proposed in the course of 2021.
The reverse-hybrid rule will affect Dutch transparent CV's that are for instance used in a CV-BV structure, where the CV is considered to be transparent for Dutch tax purposes and associated non-resident entities that hold qualifying interests in the CV are located in a jurisdiction that qualify the CV as non-transparent (e.g. under the US check-the-box regime). Income received at the level of the CV (e.g. deductible royalty income derived from IP rights licensed to a Dutch BV) is currently not subject to tax in the Netherlands as a result of its transparent character. On the other hand, the income may not picked up at the level of the investors due to the qualification mismatch (non-transparent for US purposes). Under the reverse-hybrid rule the CV will become subject to tax (for that part of the income that is not picked up at the level of the US investors) in the Netherlands as from 1 January 2022. It should be noted that if and to the extent (part of) the income is picked up (i.e. taxable at a reasonable levy) at the level of the investors, e.g. under CFC-rules, such income would in principle not be (double) taxed under the reverse-hybrid rule in the Netherlands. We note, however, that according to the explanatory notes to the Bill, taxation under the US GILTI regime may not qualify as such 'inclusion' given the deduction available under the GILTI rules.
Depending on the type and purpose of the structure, there may be viable alternatives for both CV-BV structures and for CVs that are used as mere holding company. Reorganizing such structures in time is however of the essence.
According to ATAD 2, any adjustments that are required to be made thereunder should in principle not affect the allocation of taxing rights between jurisdictions set under a double taxation treaty (e.g., a taxpayer resident in an EU Member State cannot be required to include certain income under ATAD 2 if this EU Member State is required to exempt such income under a double taxation treaty with a third country).
The Bill (Dutch implementation)
As ATAD 2 in principle only stipulates minimum standards for EU Member States and also provides certain choices and optional exceptions, we have included the key specifics regarding the intended Dutch implementation of ATAD 2 below. We further note that the provisions of the Bill are largely in line with the proposal that was published for public consultation on 29 October 2018. The questions raised during the public consultation have, however, resulted in some further clarifications.
The primary and Secondary Rule will become effective as of 1 January 2020 (or financial years commencing as from this date). Only the reverse hybrid rule will become effective as from 1 January 2022 (or financial years commencing as from this date).
ATAD 2 only applies in cases of a hybrid mismatch between "associated enterprises", between head offices and their PEs, between two or more PEs of the same entity and mismatches under a so-called "structured arrangement".
The term "associated" is defined in the Bill and generally covers direct and indirect interests of 25% or more (which seems to be a stricter interpretation than ATAD 2, which allows a 50% requirement for certain types of mismatches). However, only in case of the reverse-hybrid rule this percentage is increased to 50%. In determining whether these thresholds are met, the direct and indirect interests of persons who are acting together have to be aggregated. Furthermore, an associated enterprise also means (i) an entity that is part of the same consolidated group for financial accounting purposes as the taxpayer, (ii) an entity in which the taxpayer has a significant influence in the management, or (iii) an entity that has a significant influence on the management of the taxpayer.
A "structured arrangement" means an arrangement with a non-associated enterprise where the hybrid mismatch is priced into the terms of the arrangement or an arrangement has been designed to produce a hybrid mismatch outcome. However, if the taxpayer or an associated enterprise could not reasonably have been expected to be aware of the hybrid mismatch and did not benefit from the tax benefit resulting from the hybrid mismatch, the anti-hybrid rules will not be applicable.
Reverse-hybrid rule exception for regulated collective investment funds
The Bill provides for an important exception regarding the reverse-hybrid rule for regulated collective investment funds (collectieve beleggingsvehikel / alternatieve beleggingsinstelling). Provided that certain requirements are met (inter alia having a diversified portfolio), such funds should in principle not become subject to Dutch corporate income tax as from 1 January 2022, even though such funds may in principle qualify as a reverse hybrid entity.
The neutralizing measures only apply if a double deduction or a deduction without inclusion outcome results from one of the addressed hybrid mismatches. If such outcome results from e.g. a subjective exemption, the absence of income tax, a special regime (such as the innovation box) or transfer pricing differences, the outcome will in principle not be recognized as a hybrid mismatch and will therefore in principle not be neutralized.
The Bill stipulates that the proposed anti-hybrid rules will not apply in respect of a payment to a hybrid entity (in respect of which there is in principle no inclusion), to the extent the income is nevertheless picked-up at shareholder level (e.g. under CFC-rules) at the regular tax rate. However, such taxation at shareholder level may not be subject to deductions or credited (see in this respect also our comment above regarding the US GILTI regime).
Burden of proof (documentation)
The Bill further introduces a documentation requirement: the taxpayer is required to include in its administration all information that substantiates the applicability or non-applicability of the hybrid mismatch rules. If the taxpayer does not has information on the applicability or non-applicability of the hybrid mismatch rules in its administration, the tax inspector could request the taxpayer to substantiate this, which may result in a shifting of the burden of proof.
No temporary exception for banks in the Netherlands
ATAD 2 provides for a temporary (optional) exception for certain financial institutions. Based on this exception certain (intragroup)instruments of such financial institution may be exempt from ATAD 2 until 31 December 2022. However, based on the Bill and the explanatory notes thereto the Netherlands does not intend to make use of this exception as – according to the State Secretary of Finance – payments made in respect of contingent convertible bonds (coco's) are already non-deductible as from 1 January 2019 and given the temporary character of the exemption, the benefit thereof is only limited.
Given the wide scope of ATAD 2, virtually all structures in which hybrid mismatches arise may be affected. We would recommend to review ATAD 2's impact on existing structures, and in particular on imported hybrid mismatches, CV-BV structures and CV holding structures.