Netherlands overhauls Legal Entity Tax Qualification Policy

On March 29, 2021, the Dutch government published a consultation document containing a legislative proposal changing the Dutch legal entity qualification rules for tax purposes. The consultation was announced in late February 2021, when another consultation document, containing a legislative proposal that would see reverse hybrid entities become liable to tax, was published. The latter proposal forms the implementation of the so-called “reverse hybrid taxpayer rule” of the EU Anti-Tax Avoidance Directive II (ATAD II).

However, it was already known as of late 2019 that the Dutch legal entity tax qualification rules would change. During the legislative process implementing ATAD II, the Dutch government indicated that it had heard calls from certain parliamentary groups and practitioners to deal with the root cause of hybrid mismatches and that it would review the possibilities to amend the Dutch legal entity tax qualification policy.

The consultation runs from March 29, 2021, up to April 26, 2021. The new rules, if enacted, will become effective as of January 1, 2022.

Relevance of legal entity tax qualification rules

The Netherlands legal entity tax qualification rules determine which legal entities are treated as a taxpayer for Dutch corporate income tax (CIT) purposes (ie which entities are “opaque”) and which entities are disregarded for Dutch CIT purposes (ie which entities are “transparent”). This distinction is also relevant for the Dutch dividend withholding tax (DWT) and conditional withholding tax (CWT) as well as for the Dutch personal incomes tax (PIT).

Current framework

The Netherlands has historically compared foreign legal forms with Dutch legal forms to qualify such foreign legal forms for Dutch tax purposes.

Under the existing similarity approach, legal entities are either:

• per se opaque if comparable to a Dutch company;
• opaque or transparent if comparable to a Dutch limited partnership; and
• per se transparent if not comparable to a Dutch company and not comparable to a Dutch limited partnership.

The points of similarity tested were:

• whether the entity can have legal ownership (ie whether it has legal personality);
• whether all participants are limited in liability with respect to obligations incurred by the entity;
• whether the entity has a capital divided into shares or a capital that can be considered to be divided into shares; and
• whether, except in the case of legacy or bequest, accession or replacement of participants can occur without prior consent from all participants.

If three out of four questions are answered affirmatively, or where the liability of all participants is limited to their contribution (or obligation to contribute), the business is owned by the entity and the business is not otherwise run at the risk and expense of the participants, an entity is considered opaque for Dutch tax purposes.

An entity is considered to be comparable to a Dutch limited partnership (a CV) if the entity conducts its business enterprise in its own name, has at least one general partner and one limited partner, the general partner has unlimited liability or is liable for equal parts in relation to third parties, the limited partner is only liable up to its contribution, the limited partner does not perform any management activities and the entity does not have a capital divided into shares. The transparency of an entity comparable to a Dutch limited partnership is determined in the same way the transparency of the Dutch limited partnership is determined: the limited partnership is only considered transparent if all partners (both general and limited partners) have to grant prior written consent for the accession, replacement or removal of limited partners.

Proposed framework

Under the proposed framework, the comparison rules, whereby the foreign legal entity is compared to Dutch legal entities, continue to apply. However, the abovementioned fourth question / criterion that gives rise to most hybrid mismatches, ie whether the accession or replacement of partners can take place without the prior written consent of all partners, will no longer be applicable. Due to this change, there is no longer a distinction between the closed limited partnership (transparent for Dutch tax purposes) and the open limited partnership (opaque for Dutch tax purposes). For this reason, the open limited partnership will no longer be treated as a corporate taxpayer.

Change in qualification rules: General remarks

As previously mentioned, under the new Dutch qualification rules, the general rule remains comparing foreign legal forms to Dutch legal forms (ie an approach based on the similarity of foreign legal entities with Dutch legal forms). There will, however, be two exceptions to this similarity approach:

• If no Dutch legal form can be found that is similar to the foreign legal entity under the similarity approach, a fixed approach will apply in case such foreign legal entity is a resident for tax purposes of the Netherlands. That is to say, such foreign legal entity will always be treated as a taxpayer (in other words: as opaque for Dutch tax purposes).
• If no Dutch legal form can be found that is similar to the foreign legal entity under the similarity approach, a symmetrical approach will apply to entities that are not a resident for tax purposes of the Netherlands. That is to say, such foreign legal entities will be treated the same as in their state of residence (in other words: if the state of residence treats such entities as opaque, the Netherlands treats such entities as opaque and if the state of residence treats such entities as transparent, the Netherlands treats such entities as transparent).

Change in qualification rules: Abolishment of open CV

As the distinction between the open and closed limited partnership (open and closed CV) becomes redundant due to the letting go of the unanimous consent requirement (see above), the open CV will be abolished for Dutch tax purposes. This abolishment has several practical consequences, the main one is that the taxpayer status ends. In this respect, several fictions and transitional measures to mitigate the adverse effects of these fictions will be introduced. We have described these fictions and transitional measures below.

Change in qualification rules: Mutual funds

As part of the unanimous consent requirement no longer being applicable, the definition of what constitutes an open (ie opaque) mutual fund and what constitutes a closed (ie transparent) will also be changed.

Going forward, a mutual fund will be considered opaque (ie a taxpayer) if the participations in such fund are admitted to a regulated financial market or comparable trading platform or if the fund is legally obliged (on the basis of the fund’s conditions) to regularly buy back or refund participations in the fund, except if such participations can only be transferred to other fund participants or to family members of the fund participant.

Effects to existing structures and transitional measure

In addition to the changes of the Dutch entity classification rules as outlined above, the proposal contains a mechanism that would result in:

• the deemed sale of all assets at fair market value by the open CV to its participants on the moment immediately preceding the effective date of the law and a deemed termination of the business enterprise of the open CV (currently: January 1, 2022);
• the deemed sale of the participation and any receivables on the open CV by its participants on the moment immediately preceding the effective date of the law (currently: January 1, 2022).

If the aforementioned receivables have been amortized for Dutch tax purposes (ie have resulted in a lower taxable profit), the amortization will be capitalized and this capitalization will be included in the taxable profits of the participant, except insofar this capitalization has already been included in the participant’s taxable profits by virtue of the application of an anti-abuse rule (Article 13b of the Dutch Corporate Income Tax Act of 1969 (CITA)).

To mitigate the adverse consequences outlined above, there are four proposed transitional measures.

Transitional measure I: Rollover relief

Upon joint request by all participants (by December 31, 2022 or, if this is earlier, the filing deadline for the 2021 Dutch CIT returns of the open CV), rollover relief is available with respect to the deemed sale of all assets at fair market value by the open CV to its participants. This rollover relief has retroactive effect to the moment immediately preceding January 1, 2022. This rollover relief is available if:

• the open CV and all of its limited partners are a resident for tax purposes of the Netherlands or conduct a business enterprise in the Netherlands (ie have a permanent establishment in the Netherlands) or are a resident for tax purposes of an EU/EEA Member State;
• all participants are subject to taxation on profits for entities (ie a corporate income tax);
• the same rules for determining the taxable profits apply to the open CV and the participants (ie the open CV or the partners may not be subject to different tax regimes);
• there are no losses carried forward;
• there is no right to relief from double taxation with respect to foreign income;
• the innovation box does not apply;
• there is no carried forward non-deductible interest under the earnings stripping rule of Article 15b CITA;
• the full exemption for profits attributable to permanent establishments (objectvrijstelling) does not apply;
• the participation credit method (deelnemingsverrekening) does not apply;
• the credit method for low-tax passive investment permanent establishments (verrekening laagbelaste beleggingsondernemingen) does not apply; and
• the tax claim is secured.

The result of claiming this rollover relief is that all participants (on a pro rata basis) will take the place of the open CV for Dutch tax purposes. The most important consequence thereof is that the book values of the assets roll over to the participants.

If not all of the requirements outlined above have been met, certain standard conditions, which also exist for, inter alia, legal mergers and demergers, can be included in a delegated regulation, to be published by the Dutch Ministry of Finance together with the entry into effect of the proposed law. Subject to these conditions, the participants of the open CV will take the place of the open CV for Dutch tax purposes.

Transitional measure II: Share-for-share merger

For Dutch resident taxpayers (individuals), a share-for-share merger facility has been included in the legislative proposal as a transitional measure. Upon written request, the capital gains realized by the transfer of the limited partner interest to a wholly owned company (resident of the Netherlands or an EU/EEA Member State) against newly issued shares is not taken into account for Dutch PIT purposes insofar the book value of the limited partner interest is used as the book value of the new shareholding acquired and the Dutch tax claim is not lost.

The written request has to be filed by December 31, 2022, or, if this is earlier, the deadline for filing the Dutch PIT returns over 2021. The share-for-share merger has retroactive effect to the moment immediately preceding January 1, 2022.

In addition, the limited partner requesting this transitional measure should be a resident for tax purposes of the Netherlands or conduct a business enterprise in the Netherlands (ie have a permanent establishment in the Netherlands) or be a resident for tax purposes of an EU/EEA Member State.

Transitional measure III: Deferral of payment

If the abovementioned transitional measures cannot be applied (because the requirements are not met), it is possible to request deferral of payment of the taxes due because of the deemed transfers of assets (at the open CV level) or participation(s) and receivables (at the limited partner level). The transitional measure provides for the possibility of paying the tax due in ten equal annual instalments.

Transitional measure IV: Business use of assets

If the limited partner (or the limited partner’s husband or wife that are married under a general community of property regime) makes available business assets to the open CV, the termination of the business of the open CV results in a (deemed) termination of the making available of such use of business assets, which could result in taxation. There is a transitional measure that allows a rollover for the book value of these assets by the individual making such assets available to the open CV if the assets remain used in the same way as previously used.

Relation with ATAD II

The proposed changes in legal entity qualification rules for Dutch tax purposes are also intended to remove the root cause of hybrid mismatches caused by the current unanimous consent requirement.

The abolishment of the open CV means that Dutch CVs that previously qualified as open (ie opaque), may qualify as closed (ie transparent) for Dutch tax purposes for an indivisible moment in time, after which such a (formerly open) CV may become a reverse hybrid taxpayer due to the Dutch implementation of ATAD II. This would be the case if the Netherlands qualifies the CV as transparent, whereas the state of residence of the partners qualifies the CV as opaque. The current legislative proposal does not contain any transitional rules to mitigate the concurrence of this legislative proposal and the Dutch implementation of ATAD II.

Key takeaways

Under this draft legislative proposal published for public consultation, open CVs will cease to exist as of January 1, 2022. Any open CV in existence immediately prior to that moment will be deemed to have transferred its assets at fair market value to the partners, where the partners are deemed to have transferred their partnership interests and receivables on the open CV at fair market value.

The foregoing – in effect – results in an “exit tax” for existing open CVs. There are several transitional measures that mitigate the effects of this exit tax:

• For open CVs where all partners are companies (ie legal entities subject to corporate income tax), there will be a rollover relief mechanism, subject to certain conditions.
• For open CVs where the partner is an individual, there will be a share-for-share merger facility.
• If the two abovementioned facilities cannot be applied, it is possible to pay the tax in ten equal annual installments.
• Finally, for individuals that make available assets to such an open CV, there is also a rollover relief mechanism.

Where an open CV has both individuals and companies as partners, the rollover relief for companies can only be applied if all individuals first opt in for the share-for-share merger (thereby ensuring that the open CV only has partners that are companies).

In addition to changes with respect to the open CV, the definition of the open (opaque) mutual fund will also change. Instead of the unanimous consent requirement determining whether or not a mutual is opaque (currently: if not all participants have to agree to accession or replacement of fund participants) or transparent (currently: if all participants have to agree to accession or replacement of fund participants), whether or not a mutual fund is considered opaque (a taxpayer) will be determined on the basis of it being admitted to a regulated market or similar trading platform or the fund having a legal obligation (in the fund conditions) to repurchase participations in the fund. The exception to this rule is the family-owned mutual fund.

For many different legal forms, not much will change, as such legal forms are often comparable to Dutch legal forms such as the BV, NV or cooperative. Where legal forms are not similar to Dutch legal forms, there will either be a fixed approach (always a taxpayer) if such entity is a resident for tax purposes of the Netherlands or a symmetrical approach (same treatment as the state of residence) if such entity is not a resident for tax purposes of the Netherlands.