On April 14, 2011, we informed you about the Tax Agenda that Deputy Minister of Finance Mr. Weekers had sent to the Lower House that same day. In his letter of May 26, 2011, the Deputy Minister replied to written questions from the Lower House on the Tax Agenda. Below we summarize the most relevant additions to the changes previously announced by the Cabinet, thereby concentrating on the consequences for corporate income tax. Please refer to our earlier memos for more background on the Tax Agenda.
1. Acquisition holding companies
The Deputy Minister has confirmed that the essence of the proposed interest deduction limitation is to no longer allow interest costs relating to the acquisition of a business to be deducted from the taxable profit of the acquired business, by means of a fiscal unity. The aim is to put a 'tax brake' on what the Cabinet regards as an imbalance, whereby the acquirer of a Dutch business excessively burdens this business with debt. This measure appears to be broadly supported in the Lower House.
The Deputy Minister has further confirmed that:
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businesses will only be subject to the measure if the profit made by the acquisition company is insufficient for it to carry the financial burden of the acquisition on its own;
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the interest deduction will not be limited if after the acquisition a sound debt/equity ratio exists. The Deputy Minister regards a sound debt/equity ratio as being at least 2:3 – this presumably being at the fiscal unity level. This ratio is decidedly more strict than the 1:3 standard applied in the current thin cap rules. Please note that the value of the participations will be deducted from the equity;
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the first EUR 500,000 will always be deductible;
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the goodwill gap will be added to the equity, and this adjustment will be decreased over a 10-year period;
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no distinction will be made between loans granted by third parties, and debt to affiliated entities. This is to prevent acquisition holding companies becoming burdened with excessive third party loans.
The Deputy Minister also notes the following in reply to the questions raised by the Lower House.
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Given that the underlying assumption of the proposed measure is to prevent an acquired business having to ‘consume’ its profit for tax purposes as a result of excessive debt financing, it is not considered appropriate to assess if this interest has been included in the creditor’s tax base. According to the Deputy Minister, such a rebuttal provision would make the measure less effective, while making the system more complicated. We note that Section 10a Corporate Income Tax Act ("CITA") currently does contain such a 'compensatory tax'.
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The measure does not apply to acquisitions made before January 1, 2007, so the new measure would directly replace the old measure that was abolished as of January 1, 2007. (The general import of the old provision was, however, included in the abovementioned Section 10a CITA.) It may be questioned whether an acquisition debt incurred before 2007, but refinanced after 2007, will also fall outside the new measure.
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The Deputy Minister is not in favor of a regulation which would see the debt/equity ratio at the moment of the acquisition being decisive. If this were to be the case, the taxpayer would, on the one hand, be unable to correct an unsound debt/equity ratio, while, on the other hand, the deductibility of the interest would in later years also be guaranteed even if, after the acquisition, the actual debt/equity ratio had rapidly deteriorated.
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According to the Deputy Minister, it should not be presumed that debt, of which the interest is non-deductible according to another provision, could be included as equity.
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The Deputy Minister has indicated that when determining the amount of debt, consideration may be given to disregarding debt that, in accordance with the arm's length principle, is interest-free. This already applies under the current thin cap rules.
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Still to be looked into is how situations where the equity has become negative, for example, due to a recession, should be taken into account.
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The Deputy Minister has indicated that he cannot confirm whether debt that has been incurred in the context of an acquisition to finance an existing debt of the acquired company (i.e. refinancing), would not qualify as 'acquisition debt'. According to the Deputy Minister, acquisition debt arises when the acquisition holding company takes over the debt.
2. Source exemption permanent establishments
At the request of the Lower House, the Deputy Minister has also addressed the comments made by the Dutch Association of Tax Advisors ("NOB").
He admits that the implementation of the source exemption will not result in simplified legislation.
In his opinion, this also applies to the alternative put forward by the NOB to leave the current system as is, but to add back any deducted foreign losses (excluding losses that cannot be used abroad) to the profit after five years.
In addition, the alternative does not completely remove the timing benefit of operating through a permanent establishment, rather than through a subsidiary.
The Deputy Minister has also confirmed his intention to only implement the source exemption in corporate income tax and not to extend it to personal income tax; one of the reasons being the practical problems of implementation. He does not foresee any conflict with European law by not allowing losses incurred by a foreign permanent establishment to be deducted from the profit in the Member State where the company is established.
3. Lowering of tax rate
The Deputy Minister considers the maximum corporate income tax rate to be one of the most distinctive features of a tax regime. For businesses looking to establish a business in Europe, the tax rate is an important factor in deciding which European country to locate to. The Deputy Minister expects the European trend of lower corporate income tax rates to continue. According to the Deputy Minister, a lower tax rate will encourage businesses to invest more and make more profit.
4. Tax treatment of participation interest/thin cap rules
The Deputy Minister indicated in the Tax Agenda that the Chairperson of the Head Offices Top Team had been asked to prepare a report on the tax treatment of participation interest (the Bosal gap), and to present his findings to the Cabinet on June 14, 2011. The Cabinet will subsequently prepare a reaction to the report. In reply to questions raised by the Lower House, the Deputy Minister stated that the Cabinet's reply and findings will be made public and will be presented to the Lower House. The Cabinet's choice for dealing with the participation interest will, at the very latest, be made public once the bill on corporate income tax has been submitted.
According to the Deputy Minister, the earnings stripping measure that had previously been put forward in the Consultation Document of June 2009 is too general in nature and would have only a limited impact on artificial group loans and debt-financed acquisitions.
The Deputy Minister has confirmed that the current deduction limitation for under-capitalization (thin cap rules) can be abolished if a deduction limitation for participation interest is implemented.
5. No notional net worth deduction/addition to income for tax purposes
The implementation of a notional net worth deduction/addition to income for tax purposes would mean a fundamental change to corporate income tax. Detailed research is required, and the expected loss of budgetary revenue that on balance would result, would need to be covered.
Because the Deputy Minister wishes to avoid major and prolonged uncertainty on corporate income tax, he is not intending to consider other measures.
6. Next steps
The Finance Standing Committee of the Lower House is scheduled to debate the Tax Agenda with the Deputy Minister on June 6, 2011. The plenary session is scheduled for June 16, 2011. According to the planning schedule included in the Tax Agenda, the Cabinet is, at any rate, intending to include the measures described under 1 and 2 above in a separate Corporate Income Tax Bill to be presented on Budget Day in September 2011. This bill is expected to come into effect on January 1, 2012