Currently new legislation is pending in Dutch Parliament with regard to the Dutch participation exemption regime.  The new rules will presumably enter in force per 1 January 2004.  In this memorandum we will elaborate on this new legislation and the impact that may have for your Dutch business ventures.

What is it about?

Under the current rules of the Dutch participation exemption, expenses allocable to foreign subsidiaries are non-deductible.  However, based on a recent EU court case (the so-called Bosal-case), this limitation has been abolished for costs relating to EU subsidiaries. 

The new legislation aims to change the law accordingly, in the sense the limitation of the non-deductibility of these expenses is abolished, not only for EU but also for non-EU subsidiaries.  Simultaneously, thin capitalisation rules (a debt-equity ratio of 75:25) and limitations for loss compensation for holding companies is introduced. 

It is apparent that the Bosal case is very beneficial for Dutch intermediary holding companies.  A full costs deduction at the level of the Dutch holding, whereas virtually all the income is exempt, offers the possibility to generate taxable profits from other activities without effectively paying tax.  The Dutch legislator has accepted this consequence, but tries to limit the damage through a conditional limitation of interest deduction (thin capitalization rules) in combination with a limitation of the loss carry back - carry forward possibilities for holding companies.

Deductibility of costs

Under the new Dutch participation exemption rules, a Dutch (intermediate) holding company is allowed to deduct all costs and expenses (not only general and administrative expenses but also interest expenses related to acquisition financing) incurred in connection with its foreign subsidiaries.  No distinction is made between costs related to taxable profits within or outside the European Union (EU), i.e. Dutch or foreign subsidiaries.  Please note that still the general rules apply that expenses are only deductible to the extent they are at arm’s length and that they belong at the level of that particular company.  

Thin capitalization rules

In connection with the abolishment of the limitation on the non-deductibility of costs and expenses, thin capitalization rules are introduced only applicable within a group of companies.  The rules do apply to all companies regardless their activities. 

For Dutch holdings the essence of these thin capitalisation rules is that interest deduction on acquisition loans granted by group companies is not allowed to the extent the percentage of loan funding exceeds a certain ratio. This ratio is 75:25 i.e. the loan funding may not exceed three times the equity funding, or in other words, the loan funding may not exceed 75% of total funding.  By applying this ratio both intra-group loans and bank loans must be considered, but only the net amount of loans (debt less receivables) counts for the 75% threshold.  To the extent the loan funding exceeds the 75% threshold, the tax deduction of interest paid on group loans will be denied, unless one of the following escapes apply:  

1                    For practical reasons, only when the loan financing exceeds the equity financing with at least € 500,000 (franchise), the 75:25 debt-equity ratio applies.  

2                    If the Dutch (intermediate) holding company is able to demonstrate that its debt-equity ratio is in line with the debt-equity ratio of the group of which it is part of, the interest will be deductible after all (provided of course no other limitations apply; see also below at “The relevance for your Dutch holding company”).           

The new rules are supposed to enter into force on 1 January 2004.  There is no grandfather provision for existing loans. 

Loss utilization

Under current law, tax losses can under certain conditions be carried back to be offset against the taxable profits of the previous three years and can be carried forward for an indefinite period of time.  Under the new rules, losses incurred by a pure holding company or group finance company can only be offset against holding and finance income in preceding and following years if, in short, the nature and size of the activities of the company in that particular year is comparable to the nature and size of the activities in the year from which the tax losses originate.  In essence this rule prohibits that a pure holding company starts up new activities as a result of which it looses its status of pure holding for the reason of compensating its losses from holding activities with profits generated with other activities.  Losses incurred however after the holding company did loose its status as pure holding company are nevertheless to be compensated with future profits.    

A holding company is defined as a company whose activities during the year or nearly the whole year mainly consist of holding participations and financing affiliated companies.  A company with at least 25 full time employees who are not involved in holding or group financing activities does not fall within the scope of this new legislation (it can be anticipated that the number includes employees working for companies that are part of a Dutch fiscal unity).    

The relevance for your Dutch holding companies

Due to the Bosal case, deduction of costs and expenses in relation to EU subsidiaries can be taken into account this year and furthermore in all the tax years that are still open.  From 1 January 2004 and onwards, costs in expenses in relation to all foreign subsidiaries can be claimed. 

General and administrative expenses

Considering the above, it is recommended to deduct all the general and administrative expenses that have been incurred of all the still outstanding years as well as in the 2003 tax return and the tax returns for the following years.  Provided there is profit capacity to absorb these expenses, there is now an incentive for a proper allocation of group expenses to the Dutch holding.   

We recommend that all costs en expenses relating to the activities of Dutch (intermediate) holding companies be actually invoiced to the companies.  For the year 2003 you may consider to recharge these expenses to the extent the underlying services related a particular Dutch (intermediate) holding company. 

For deductibility of expenses the normal rules apply. In particular for intra-group charges the following is relevant:  

1                    the expenses must be at arm’s length (i.e. if charged by a related party the amount charged must be market rate);

2                    the tax payer must be able to justify the deduction at the Dutch level;

3                    transfer pricing documentation is required.              

Costs relating to the purchase and sale of subsidiaries

In essence the costs relating to the purchase and sale of subsidiaries is also with the normal boundaries tax deductible.  It is noted however that the Dutch legislator announced new legislation, which will limit the deduction of purchase costs. 

Interest expenses

In line with the new legislation interest expenses in relation to (acquisition) loans granted by affiliated companies can be taken into account, provided that the debt-equity ratio is met and furthermore that other provisions in the tax law do not limit the deduction of these expenses.  

Apart for the normal limitations that apply for the tax deduction of expenses in general (see above), specific limitations can apply for tax deduction of interest.  

For loans granted by affiliated parties for example, Dutch tax law prescribes that in order to be allowed to interest deduction, the loan should have been granted for sound business reasons or the related party that receives the interest is subject to tax at a rate that according to Dutch standards is reasonable.  If this condition is not met, the interest is not tax deductible.  To the extent the loans are truly third party loans, the deduction can however be claimed. 

Please note however that the thin capitalization rules apply to all your Dutch business ventures using a Dutch (intermediate) holding company.   The 75:25 ratio can be used as a safe haven for intra-group financing.

We note that when a holding company claims interest deduction, close scrutiny from the Dutch tax authorities can be expected.  Extensive information will have to be provided about the origin and nature of the loans, the parties involved with the loans financing and the acquisition of the subsidiaries. 

It is recommended to determine to what extent the current loans qualify for interest deduction.  To the extent this is not the case, a restructuring of the debt may be required to achieve interest deduction.    

Loss utilization

Under the new loss utilization rules an activity test is to be introduced, which should prevent the possibility to offset the losses from holding activities against profits from other activities in a certain year.  In essence, losses incurred in relation to holding activities can only be offset against profits generated in years the company qualifies as a pure holding company.  Another condition is that in order to be allowed to compensate a loss incurred with holding activities in a certain year the balance of the book values of the affiliated debts and receivables do not differ from the balance in the year the loss was incurred.       

What to do in order to utilise your 2003 and previous tax losses?  As the new loss utilization rules apply to the compensation of losses with profits generated in book years starting at or after 1 January 2004 (and includes carry forward of losses from previous years) it may be considered to transfer new profit generating activities to the Dutch holding, but before 31 December 2003 or at the latest before the end of your current book year. 

Summary

The above can be summarized as follows:

·        Under the new participation exemption rules in force per 1 January 2004, all general and administrative costs and other expenses in relation to (foreign) participations are tax deductible.

·        Thin capitalization rules are introduced allowing interest deductions on loans used for the acquisition of participations, to the extent a debt-equity ratio of 75:25 is met.

·        If this debt-equity ratio is not met, interest on loan financing may still be deductible provided that it can be substantiated that the debt-equity ratio used is common in the group the Dutch (intermediate) holding company is part of.

·        Loans granted by related parties should have been granted for sound business reasons.

·        Loss utilization restrictions are to be introduced preventing the compensation of losses from holding activities against profits from other activities.