USE OF THE DUTCH PARTICIPATION EXEMPTION

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1 USE OF THE DUTCH PARTICIPATION EXEMPTION The Dutch participation exemption exempts all benefits, dividends and capital gains derived from a qualifying participation, from Dutch corporate income tax liability. The exemption applies to both Dutch and foreign subsidiaries. A participation in a foreign subsidiary will only qualify if the subsidiary is subject to a profit-base income tax in its country of residence. There is no minimum tax rate requirement, thus a rate of, for example, 2% would suffice to qualify for the exemption. Furthermore, the law does not require a look through to sub-subsidiaries. The Dutch participation exemption may be used by shareholders residing in a country that has entered into a double taxation treaty with the Netherlands and wishing to operate a business in a low or zerorated tax jurisdiction. Basic conditions for the participation exemption There is no specific holding period, although the participation exemption will not apply if the shares are acquired as inventory (trading stock). A sale shortly after acquisition will in practice lead to the assumption that the shares were acquired with a view to resale. Conditions applicable to all shareholdings (including shareholdings in Dutch companies): 1 The participation (shareholding) consists of at least 5% of the nominal paid-up capital of the company (on application, a lower percentage may be acceptable). 2. The investor is a Dutch resident company or a Dutch branch. 3. The shares in the company are not held as stock (inventory), i.e. primarily intended for the purpose of resale. Conditions applicable only to shareholdings in non EU foreign companies: 4. The shares in the foreign company must not be held as a portfolio investment. 5. The foreign company is subject to a corporate income tax on its profits. Condition 1, concerning the 5% minimum shareholding, will usually be relaxed if the shareholding represents a strategic investment, relevant to the group's main activities. Condition 4, is usually considered as being fulfilled if both companies qualify as active business companies and their activities within the group are considered to be linked. Condition 4 is also deemed to be met if the Dutch holding company owns at least 25% of the nominal paid-up share capital of a company covered by the EU Parent/Subsidiary Directive, that is incorporated under Dutch law. In that event, the portfolio requirement does not need to be met. The Dutch corporate income tax act provides anti abuse law, preventing EU companies being used as intermediary between non-qualifying non-eu companies. Condition 5

2 The tax must be levied by the sovereign state of which the company is a resident. Although Hong Kong, Gibraltar, Taiwan and the United Arab Emirates are not sovereign states, they are deemed to be such 1. However it is to be noted that not all companies formed in these jurisdictions qualify. Consequence of the participation exemption applying 100% of the dividends received are exempt from company tax. Capital gains on the sale of shares are exempt from company tax. Capital losses are not deductible with the exception of, under certain conditions, liquidation losses. Deductibility of interest Under the participation exemption regime all costs, including management costs and interest expenses, incurred by the Dutch parent relating to a participation in a foreign company, are taxdeductible due to a change of law following a decision by the European Court of Justice, the so-called Bosal case. The most important item here is usually interest on loans taken out to acquire shares in a foreign subsidiary. There is legislation in place dealing with excessive debt financing. One of the safe harbours in place in this respect is a debt-equity ratio of 1:3. Example A Dutch B.V. with stockholders incorporates a Jersey active business company. According to Jerseylaw this company is taxable for its Jersey-sources at a rate of 20% up to 30%. However, the non- Jersey sources are taxable only at a rate of 2% to 3%. If a Dutch B.V. keeps its subsidiaries through a Jersey ABC-company it will be able to call upon the participation exemption. Note: the interposition of the Jersey company is only necessary if the ultimate participation is located in a zero tax country, including countries that have tax systems that are not based on a company s income or profits. Stockholders Switzerland NL B.V. Netherlands ABC-Company Jersey Participations in low or zero tax countries 1 MvF nr. IFZ94/224 d.d. 01/03/1994

3 2. USE OF A DUTCH PARTNERSHIP OR BRANCH AND THE PARTICIPATION EXEMPTION TO AVOID DIVIDEND WITHHOLDING TAXES As set out in paragraph 1, the Dutch participation exemption exempts from corporate income tax any benefit (dividends or capital gains) derived from a qualifying participation. The Dividend Withholding Tax Act (DWTA) allows the subsidiary to omit the withholding of tax on a distribution of dividend to a parent company if the shareholding of the parent qualifies under the participation exemption. The same rules apply to non-resident parent companies, provided the participation may be attributed to a permanent business establishment in the Netherlands. Instead of creating a Holding company in the Netherlands, consequently leading to the creation of several other Holding companies as well as taxation on dividend, it is also possible to use a permanent establishment in the Netherlands. The State Secretary published Policy Rules on this subject in a Statement dated 13 June The statement deals with the question whether, and under what conditions, shares owned can be allocated to a Dutch permanent establishment of the foreign shareholder. If the shares are allocated to the Dutch permanent establishment, the participation exemption applies to the dividends paid by the various companies to the permanent establishment. In this manner, the dividends ensuing from those various companies can be paid out without withholding dividend tax, even if there is no Double Taxation Treaty with the foreign country. The Statement of Practice covers, inter alia, the following structure. Ultimate shareholder Holding Company Foreign country Permanent establishment The Netherlands Subsidiary 1 Subsidiary 2 Subsidiary 3 Europe Statement On the basis of the aforementioned statement it is possible to obtain an advance ruling on the allocation of the shares in the companies to a Dutch permanent establishment. However, it will not be possible to obtain an advance ruling if the aim of the Group structure is to undo the possibility of levying Dutch dividend tax on existing profit reserves. This restriction does not seem to take future profits into account.

4 Conditions The Tax Authorities will assess each request on its own merits. In the preamble the authority to contract and the power of decision between the main office, the permanent establishment and the Holding company are important. Although the statement was based on a query concerning an international group having its European headquarters in the Netherlands, this does not seem to be a criterion of the statement. Moreover, the following conditions have to be met: The foreign company carries on an active trade or business in the Netherlands through the permanent establishment. There is direct link between the activities of the shareholding company, its subsidiary companies and the permanent establishment. The permanent establishment makes independent decisions concerning its own activities as well as activities relating to the purchase, sale and maintenance of the subsidiary companies. The activities of the permanent establishment are performed by qualified personnel. The assets and liabilities concerning the activities of the Dutch permanent establishment are attributed to the permanent establishment, including the liabilities concerning the purchase of subsidiary companies. The shareholding company is independent with respect to the purchase and sale of subsidiary companies and has qualified personnel to perform as required. On the basis of aforementioned criteria, it is clear that the substance of the permanent establishment in the Netherlands is very important. Preparatory measures will therefore be necessary. Application This Statement of Practice is applicable in situations where there is a Double Taxation Treaty between the Netherlands and the dividend receiving country, as well as in situations where there is no Treaty. In both situations the Dutch dividend tax might be reduced to zero. Dutch BV General partner partnership Holding Co BVI Tax haven Netherlands Example Note: the use of a partnership is not essential, but aids in setting up a permanent establishment. Should the Holding Co be able to create a Dutch permanent establishment without the use of a Dutch partnership, and allocate the shares in the Dutch corporation to that partnership, the exemption would also apply. Dutch corporation Caveat: Dutch internal revenue is likely to carefully scrutinise these situations. The structure should be planned and carried out very carefully. Jimmie van der Zwaan

5 Van Mens & Wisselink Amsterdam, Netherlands