Further to the OECD antitax avoidance Base Erosion and Profit Shifting (BEPS) initiatives, respective EU Directives and general anti-abuse narrative, the Netherlands has consistently introduced various legislative measures against flow through holding and financing companies over recent years.
In particular, substance requirements have received increased attention from the EU and the OECD, leading to restrictions on Dutch tax legislation.
For instance, since July 2019 even preliminary consultations for granting an advance tax ruling with an international dimension cannot be initiated unless a taxpayer filing the ruling request has sufficient relevant economic nexus with the Netherlands. In short, economic nexus means operational business activities. Certain additional requirements should also be met.
The substance and information disclosure requirements applied to so-called service companies – where the entity’s activities predominantly consist of receiving and paying interest, royalties, rent or lease instalments from and to non-Dutch group entities – started to tighten this year. The following items were added to the existing list of substance requirements:
• The service company carries a minimum amount of €100,000 of wage expenses
• The service company has an office space at its disposal for a period of at least 24 months.
Thus, service companies should meet these additional new (and earlier introduced) minimum substance requirements to prevent spontaneous exchange of information by the Dutch tax authorities (DTA) with the foreign tax authorities of the source states. In turn respective tax authorities may take this information into account in determining whether the relevant company can apply the benefits of the relevant tax treaty or EU Directive.
It is also important to note that the Dutch Ministry of Finance conducted a study on whether the application of the Dutch participation exemption should be denied to holding companies that have no substance in the Netherlands. In September 2020, the Dutch Secretary of Finance concluded that probably the Netherlands should exchange information with respect to the holding companies without sufficient substance with the jurisdictions in which these companies claim benefits under the Parent Subsidiary Directive or tax treaties.
Another option that was considered but dismissed by the Dutch Ministry of Finance was an anti-abuse rule that would give the DTA the opportunity to deny the application of the Dutch participation exemption in abusive situations. Such a rule would lead to uncertainty for taxpayers since the absence of substance is not necessarily an indication of tax abuse. However, as mentioned above Dutch holding companies without sufficient substance and consequently nexus with the Netherlands most likely would not be able to proceed with the advance tax ruling and address this uncertainty.
The information exchange on Dutch holding companies that do not meet all requirements for sufficient substance is expected to become effective in 2022.
No draft legislation that would implement these requirements into Dutch domestic law in this respect is available now. The probable main reason for this is the recent Communication on Business Taxation for the 21st Century, published by the European Commission in May. This Communication, among other measures that are supposed to ensure fair and effective taxation, suggests a legislative proposal setting out union rules to neutralise the misuse of shell entities lacking sufficient substance for tax purposes. The draft of this proposal should be prepared by Q4 2021, and it is not clear whether the European Commission will choose to set up the framework for information exchange between the tax administrations or deny ‘the benefits linked to the existence or the use of abusive shell companies’ or even both. Thus, the substance requirements for the holding companies in the EU including the Netherlands may change very soon.
Another aspect of the substance requirements in Dutch legislation is that they are also incorporated in controlled foreign company (CFC) rules that provide for exemption if a CFC carries on genuine economic activities in the foreign jurisdiction. Sufficient substance in the foreign jurisdiction is a sign such genuine activity.
Finally, actual substance is important in the context of application of tax treaties. Under the BEPS project international tax treaties have been amended under the so-called Multilateral Agreement, which introduced the principal purpose test (PPT). Not meeting the PPT will deny a taxpayer access to the benefits of a tax treaty. Substance is a reliable objective criteria of real business conducted in certain state in order to meet the PPT and to gain access to tax treaties.
Therefore, considering pressure from the OECD and the EU Commission that entails tightening anti-abuse tax legislation it is advised to give proper consideration to substance requirements in the Netherlands and keep an eye on changes in this respect.