The State Secretary of Finance, responsible for tax policy and tax enforcement, issued on August 30, 2012, a position paper with respect to the international discussion on tax avoidance through interposition of service companies.
International taxation as global challenge.
The paper starts with a discussion on direct foreign investment (DFI) by Dutch special financial institutions[i] (SFI) in developing countries. A review of 23 double tax agreements (DTAs) with developing countries has revealed that the Dutch treaties in general follow the model convention without specific anti-abuse provisions. The Dutch government is willing, in the interest of the developing countries, to incorporate anti-abuse provisions in the present treaties.
SFIs are used in the tax-planning arena as an essential vehicle for the pass-thru payment of interest and royalties that have been deducted in a treaty partner country and will be passed on to a non-taxed environment. The Netherlands don’t levy a withholding tax on interest and royalties and therefore many treaties concluded by the Netherlands with trading partners have a low or zero rated tax in the source country.
Tax treaties contribute to DFI in the Netherlands but also have the effect of avoiding source taxation in treaty partner countries. This effect is unintentional and the Netherlands will take unilateral measures to reduce it. Given the international condemnation of facilitating treaty abuse, the Netherlands is proposing to increase the substance requirements unilaterally. The current requirement is based solely on risk-taking by the entity. At present it is sufficient for a finance company to have a risk of one per cent of the loan in order to qualify for treaty protection.
Transparency and exchange of information.
The sufficiency of the risk appetite of the entity is often negotiated in a so-called Advanced Pricing Arrangement (APA) and Advanced Tax Ruling (ATR) agreements concluded with the tax authority. The position of the government today is to include the substance requirements in the applicable rules and no longer only in the rulings. The new rule will be that if an entity benefits from a tax treaty it will have to make a statement in its tax return that the entity fulfils the unilateral substance requirements. If it turns out after an investigation that the entity does not fulfil these substance requirements, the Netherlands will exchange this information spontaneously with the treaty partner whose treaty has been applied. It is then for the treaty partner to decide if the benefits of the treaty should have been granted to the entity.
A further element of ‘transparency’ in the conduct of the Dutch tax authority will be that the rulings that have been concluded, will be exchanged spontaneously with the foreign tax authority in those cases where the entity does not exercise other activity than just receiving interest and/or royalties. Such an entity is a Dutch taxable entity, but may not be entitled to treaty benefits in the eyes of the source country.
A third measure that will be taken in order to bring the Dutch tax practice more in line with the international standard is the refusal of granting a ruling to those entities that do not have ‘sufficient’ nexus with the Netherlands. There is sufficient nexus in cases of real presence, or in the case of the intention to create real presence, in the Netherlands. SFIs as such will no longer qualify for APA/ATR rulings, unless there is a relevant nexus with the Netherlands.
The Netherlands do not want to stay on the sideline in the international discussion, so are adopting a forward strategy in the struggle to combat treaty abuse trough the use of the Dutch tax treaty network. The Netherlands also invite the source countries to bring their own tax organisation up to standard and will assist developing countries in creating good tax governance.
[i] Special finance institutions are entities that borrow funds from outside of the Netherlands with a purpose of investing the funds in non-Dutch assets. Capital and funds that are directly invested in the Dutch entities are excluded for the calculation of the balance of payments. SFIs play an important role in the conduit of investments that benefit from the Dutch tax treaty network.
Leo Neve LL.M
Owner & Managing Partner