The optimal finance structure

The optimal finance structure for your Dutch business will in first instance depend on the operational needs of your business.

The solvability of your company is an important factor in the market place. The parties with who you are going to do business (banks, suppliers, clients and partners) are likely to prefer a party furnished with high equity.

Once you have decided on the amount of financing from an operational perspective, you may want to look into an optimal tax strategy for the financing of your business.

In general there are three different ways to finance transactions and investments:

1. by using net equity
2. by using loan capital
3. by using hybrid instruments

Each of these three forms of financing has its owns fiscal implications. Companies also have their own particular reasons - either tax driven or not - to prefer one or another form of financing, which may be for example limitation of liability, maximum flexibility or a profit depending remuneration.

What is the best finance structure for your Dutch business?

In general terms, loan financing is from a Dutch tax perspective more beneficial than equity financing. The reason for this is that under normal circumstances:

1. the issuance of a loan and the repayment of a loan has no Dutch tax implications (provided that at arm's length conditions are met);
2. interest payments are tax deductible, whereas dividend payments are not;
3. outbound interest payments are not subject to a withholding tax (will be as of 2021 to low-tax countries), whereas dividends are in principle subject to a 15% withholding tax at source (albeit that in many cases and exemption or 0% rate applies).

It is noted that if the foreign lender is a qualifying substantial shareholder in the Dutch company, or if it is directly or indirectly related to a party with a substantial shareholding in a Dutch company, the interest may become subject to Dutch corporate or personal income tax if this substantial shareholding is considered artificial. We note that in most cases, tax treaties prevent the Netherlands to exercise this right to tax.

If the shareholder of the company is a Dutch resident company, the second and third point become less relevant. Normally a Dutch resident company is subject to tax on interest received against the same rate as the company which pays the interest, and in general the dividend withholding tax rate is 0% if the Dutch parent company can claim the participation exemption.

For foreign shareholders financing with loans is in most cases more favourable than financing with equity. Please note however that the Netherlands has incorporated various anti-abuse rules that relate to the deductibility of interest. Under certain circumstances however, equity financing of a Dutch company can still be a preferred option for foreign shareholders. This could for instance occur in the following situations:

• the Dutch tax rate is lower than the tax rate in the country of the shareholder so that interest expenses are preferably allocated at shareholders level
• the Dutch business is not expected to become profitable in the direct future (interest expense would only increase the loss and not result in a direct tax benefit)
• the shareholder has no efficient structure in place to shelter interest income from taxation 
• the Dutch company can allocate the equity to a foreign branch as the resultof which it is eligible for an exemption from Dutch taxation

What are the Dutch tax limitations for loan financing?

When a Dutch company is funded with loans certain limitations apply. The most important limitations for loan financing are:

1. to the extent loans have the same characteristics as capital according to the Dutch criteria they will be treated as capital for Dutch tax purposes (substance over form and capital resemblance test) 
2. interest paid on loans which fall under the definition of profit sharing loans is not tax deductible and is subject to Dutch dividend withholding tax 
3. interest paid on certain categories of loans (usually resulting from intercompany transactions) can only under stringent conditions be tax deductible 
4. Excessive interest may only be partly deductible if it exceeds € 1,000,000 or 30% of the EBITDA of the company (earningsstrippingrule)
5. interest paid on loans provided by qualifying group companies will only be tax deductible to the extent the conditions of the loan are at arm’s length and certain documentation requirements are met (transfer pricing)

The tax implications of equity financing

Net equity financing requires a legal entity with a capital divided into shares, like a Dutch BV. A branch can also be funded with equity, but this will in legal terms relate to the funding of the foreign head office. For Dutch tax purposes the equity of a Dutch branch is determined through allocation of assets and liabilities.

Capital contributions into a BV, for example in exchange for new shares or as share premium by cash or in kind, or equity allocation to a Dutch branch are not subject to Dutch (capital registration) tax.

The return on equity in the form of dividend may be subject to 15% Dutch dividend withholding tax at source. By virtue of the dividend withholding tax exemption or applicable tax treaties (the Netherlands has concluded treaties with many countries to prevent double taxation) in many cases dividend withholding tax is reduced to nil. For an overview of the Dutch tax treaty rates we refer to the page Withholding taxes on outbound payments. Within the EU the Parent Subsidiary Directive is in force, which is binding for all EU Member States and conditionally forbids the levy of withholding taxes on dividend payments to major corporate shareholders.

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