The long-awaited decree has been published! The conditions under which a director-major shareholder (DMS) with a self-administered pension can waive part of his pension entitlements without incurring tax penalties have recently been published. Reducing the pension benefit payments allows for a better spread of the available capital over the expected benefit period. This in turn can prevent a DMS at some point becoming dependent on welfare payments, or their surviving dependents not being provided for upon the unexpected decease of the DMS.
The situation that applied up until January 1, 2013
Until January 1, 2013, the Dutch tax authorities argued that in situations of fund deficits practically unenforceable entitlements could not be waived until the company had used up all its resources to make pension benefit payments. Only if it was subsequently liquidated would an undertaking be given that no tax would be levied. In all other cases, the tax levied could amount to as much as 72% (progressive tax rate plus 20% deemed interest) of the full value of the pension entitlement.
There may be many and varied reasons for failing to meet all pension commitments; caused by circumstances rather than any one person in particular. Just as in the case of pension funds, a company can, for example, be affected by low interest rates and disappointing stock exchange rates. Trading losses can also be a contributing factor.
Furthermore, past measures introduced by the government meant that the DMS could not adequately set aside capital for their pension (at least not by way of tax relief). As such, the tax relief available for pensions was often 30-40% too low. In the case of small legal entities, the provision for financial reporting purposes in respect of the pension commitments for the DMS may be set at the tax value, and that is also common practice. But many DMSs simply never realized that this approach in fact meant that too little capital was being set aside for their pension.
The difference between the corporate income tax rate (20-25%) and the personal income tax (up to 52%) also benefits the Dutch government. Moreover, if the value of the entitlement is set at the amount that would have been needed if the full pension commitment were to be deposited with a life insurance company, then tax is being levied on income that in actual fact was never deducted from the companys profit or from any income of the DMS.
Unfortunately, extremely strict conditions apply to the waiver. The most important are listed below. In principle, conversion may only take place on the pensions commencement date. However, a DMS whose pension commenced on January 1, 2013, has until December 31, 2015, to reach an agreement with the tax authorities. The fund deficit must be at least 25%. The pension can only be converted if the fund deficit is the result of business or investment losses. The burden of proof rests on the DMS, who will have to prove convincingly that this is the case. The released amount must be included in the profit. The conversion does not increase the acquisition price of the substantial interest. If, in the last seven years, pension allocations were made for amounts less than an insurance company would have charged, then the computation rules will have to be adjusted. In that case, 4% interest or the U yield will have to be taken into account. The same applies if in the last seven years a profit was distributed or share capital was repaid. Problems can also arise if the company holds a written down or impaired receivable on the DMS, an affiliated entity or an affiliated individual. All pension entitlements must be reduced by the same percentage. If a conversion takes place despite the fact that the decrees conditions have not been met, then the pension entitlement can be taxed at a maximum rate of 72%.
Fortunately, the tax authorities are willing to discuss individual cases in order to reach agreement on the conditions being met. However, this does require a large amount of information to be provided:
a) a computation of the pension as at its commencement date;
b) the pension agreement;
c) the value of the pension commitments for tax purposes as at the conversion date;
d) the valuation of all the assets and liabilities of the company which holds the pension (supported by proof thereof);
e) the computation of the reduction of the pension entitlements;
f) written statements indicating that all the individuals and company involved are in agreement;
g) in cases involving pension allocations that are too low, dividend distributions, share capital repayments, etc.: proof that the adjusted computation rules contained in the decree were followed.