Dear FS professional,
This newsletter contains an update with respect to the Funds for Mutual Accounts and the UK Criminal Finances Act. This newsletter also includes a summary of the CJEU court ruling about the VAT exemption for cost-sharing groups, which does not apply to the financial and insurance sector. As this VAT exemption is frequently applied in this sector (both in the Netherlands and in other EU Member States), the ruling from the CJEU will likely have a significant impact.
Lastly, the latest edition of Frontiers in Finance is now available online; please click here to access the publication.
If you would like to know more about the topics included in this newsletter, please contact us.
Partner, Financial Services Tax Group
Table of Contents
- 1. Decree hybrid financing
- 2. VAT exemption for cost-sharing groups does not apply to the financial and insurance sector
- 3. Update regarding Funds for Mutual Accounts
- 4. Automatic Exchange of Information (AEOI) – update
- 5. Questions referred to the CJEU on input VAT recovery
- 6. UK Criminal Finances Act (CFA)
1. Decree hybrid financing
In Dutch corporate income tax (CIT) the tax characterization as loan or equity generally follows the civil law characterization. However, in some occasions, the civil law (and therefore fiscal) characterization is unclear. This could lead to a hybrid mismatch between tax consequences for the borrower and the lender. The State Secretary of Finance has recently published his policy on the characterization of certain (hybrid) money supplies and the fiscal treatment of payment on these for CIT and dividend tax purposes. The starting point of the decree is that the presence of a repayment obligation, that prevails on the claims of shareholders, is for civil law purposes the principal indicator for debt characterization. The decree does not bind taxpayers.
Perpetual loans with debt liability
A perpetual is not made available for a certain period of time but permanently. It usually has a repayment obligation only in case of liquidation or bankruptcy of the lender. However, for situations in which parties agree that in case of liquidation of bankruptcy, the holders position will be equally in rank to preference shareholders (‘pari passu’), the decree states that the holder of a perpetual shares in the losses of the company in the same way as a shareholder, i.e. they are equally liable for the company’s debts. According to the decree, this equal status results in the perpetuals with debt liability to be characterized as equity for both civil law and tax purposes and, therefore, the payments on such perpetuals to be non-deductible.
As, in principle, the Dutch participation exemption does not apply on payments on perpetuals with debt liability, this leads to double taxation. Therefore, the decree contains an approval on the basis of which the participation exemption is deemed to apply on payments on such perpetuals, provided certain conditions are met. The decree also contains an approval that no dividend withholding tax is due on payments on perpetuals with debt liability.
Money supply with a fixed maturity
The decree also describes the situation of a money supply that includes a repayment obligation with a fixed maturity while the lender is also materially liable for the debts of the company in case of liquidation or bankruptcy. The Secretary of Finance has declared that in that situation the money supply is still considered a loan, in principle even if the fixed maturity exceeds 50 years. If, however, in the latter case there are additional reasons to assume that the loan should be qualified as equity (e.g. the interest paid in fact depends on profits), he may still take the position that the money supply has to be qualified as equity (so that payments will be non-deductible).
According to the decree, debt liability may also result in the interest paid being effectively contingent upon the profits, if, for example, it is combined with a fixed interest rate that can be deferred by the payer in the absence of profits. The money supply is, according to the Secretary of Finance, then considered a qualifying ‘profit participating loan’ (‘deelnemerschapslening’). Remunerations on such a loan are non-deductible, while under certain conditions, the lender may apply the participation exemption on the received payments. In such cases, double taxation is prevented. Contrary to payments on perpetuals with debt liability, payments on a qualifying profit participating loan are, in principle, subject to Dutch dividend withholding tax. However, based on the assumption that a withholding exemption applies, this should not lead to double taxation either.
The position taken in the decree is not in line with current case law, and it seems unlikely that the civil law characterization as equity is correct. However, although taxpayers are not bound by this decree, the tax authorities are so that taxpayers can rely on the approvals in the decree if necessary.
The decree described above entered into force as per 29 August 2017.
2. VAT exemption for cost-sharing groups does not apply to the financial and insurance sector
On September 21, 2017 the Court of Justice of the European Union (‘CJEU’) rendered judgments in the DNB Banka (no. C-326/15) and Aviva (no. C-605/15) cases and in the infringement proceedings initiated by the European Commission against Germany (no. C-616/15). The CJEU ruled that the VAT exemption for cost-sharing groups does not apply to the financial and insurance sector. In addition, the CJEU ruled that a general limitation of the VAT exemption for cost-sharing groups, such as occurs in German national VAT legislation, which restricts the exemption to health professions, is contrary to the VAT Directive.
3. Update regarding Funds for Mutual Accounts
During the summer period several new documents have been published on Funds for Mutual Accounts (“FGR”). Below we discuss the Competent Authority Agreement (CAA) between the Netherlands and Indonesia and the request under the government information ‘public access’ legislation concerning the allocation of tax identification numbers to open FGRs.
Competent Authority Agreement (CAA) concerning the closed FGR between the Netherlands and Indonesia
On June 23, 2017 the competent authorities of Indonesia and the Netherlands reached a mutual agreement regarding the application of the treaty between the Government of the Netherlands and the Government of Indonesia for the Avoidance of Double Taxation with respect to Taxes on Income and on Capital Gains (‘Tax Treaty’). Both authorities agree that a closed FGR is fiscally transparent and is not a resident of the Netherlands under either Dutch law or article 4 of the Tax Treaty. Therefore, a closed FGR is not able to claim benefits in its own right under the Tax Treaty. Since a closed FGR is fiscally transparent, all income and gains are allocated to the investors in the closed FGR in proportion to their participations in the fund.
In the CAA it is stated that an FGR may claim the benefits of the Tax Treaty on behalf of the investors if among others the investors are residents of the Netherlands under the Tax Treaty and meet the requirements and procedures as set forth in Indonesia domestic regulation on tax treaty implementation.
If you would like to read more, please click here.
Request under the government information ‘public access’ legislation concerning the allocation of tax identification numbers to an open FGR
On June 6, 2017, the State Secretary of Finance received a request under the government information ‘public access’ legislation (in Dutch: ‘WOB-verzoek’) concerning the documents on the allocation of tax identification numbers to open FGRs. As a result of this request, three documents have been published.
The published documents provide insight into the policy of the Dutch Tax authorities regarding the qualification criteria whether an FGR is subject to corporate income tax or not. If an FGR is subject to corporate income tax, the Dutch Tax authorities allocate a tax identification number to the FGR in question.
If you would like to read more, please click here.
4. Automatic Exchange of Information (AEOI) – update
Under the US Foreign Account Tax Compliance Act (FATCA) and the Common Reporting Standard (CRS), Financial Institutions are required to report information on financial accounts to local tax authorities. These local tax authorities subsequently automatically exchange this information with the relevant foreign tax authorities. FATCA and CRS are also together being referred to as Automatic Exchange of Information (AEOI).
While FATCA reporting started in 2015, the first CRS exchanges occurred this September. The OECD reported that 102 jurisdictions have currently committed to implement the CRS, 49 jurisdictions were committed to start exchanges this September, with the remaining 53 jurisdictions expected to begin exchanges in September 2018.
KPMG UK has developed an AEOI reporting tool for the submission and validation of relevant data. This tool can also be used by Dutch Financial Institutions. For more information on this tool, please click here for a short video.
5. Questions referred to the CJEU on input VAT recovery
National Courts in EU jurisdictions have referred questions on the right to input VAT recovery to the Court of Justice of the European Union (“CJEU”) in various cases.
(i) Input VAT recovery by foreign branches
Case C-165/17 (Morgan Stanley & Co International) referred to the CJEU deals with a French branch of a company incorporated under UK law. The output of this French branch (qualifying as a fixed establishment for VAT) contains a mix of financial services to local clients and support services to its UK head office. An issue had arisen with the French tax authorities on the level of input VAT recovery by the French branch. Please note that France allows taxpayers to opt for taxation of certain financial services. The referring French Court has asked the CJEU:
- Which deductible proportion (pro rata) should be applied in the EU jurisdiction of the foreign branch when the purchases of this branch are exclusively used for the transactions of its head office, i.e. the deductible proportion:
- according to the transactions carried out in the EU jurisdiction of the foreign branch and according to these local rules;
- applicable in the EU jurisdiction of the head office; or
- combining the rules applicable in the EU jurisdictions of the foreign branch and head office?
- The rules of which EU jurisdiction should be applied when the purchases of the foreign branch are used for both local transactions carried out in the EU jurisdiction of the foreign branch and transactions of the head office, particularly in relation to the concept of ‘general costs’ and deductible proportion (pro rata).
The abovementioned case pending before the CJEU is particularly relevant for financial institutions with foreign branches purchasing goods/services that are (partly) used for activities of the head office. This case interacts with principles of input VAT recovery considered by the CJEU in earlier cases, e.g. case C-388/11 (Le Credit Lyonnais) and case C-393/15 (ESET).
(ii) Input VAT recovery in relation to deal and holding costs
The Supreme Court of Ireland has requested the CJEU to render a preliminary ruling in Case C-249/17 (Ryanair). The two questions posed to the CJEU concerned the deductibility of VAT on professional services. Ryanair had purchased these services because the company wished to acquire shares in its competitor, Aer Lingus. The High Court of Ireland had earlier ruled that the VAT on these professional services could not be deducted, because the takeover attempt had ultimately failed. The outcome in this case could be particularly significant to, for example, private equity firms and the M&A practice within groups. For a more detailed note click here.
In Case C-502/17 (C&D Foods Acquisition), the CJEU has been asked by a Danish Court whether a taxpayer who incurred due diligence costs for an attempted sale of shares, which had ultimately failed, is entitled to VAT recovery in relation to those costs. In this particular case, the taxpayer was already providing management and IT services to the subsidiary of which it intended to sell the shares, albeit that the remuneration for these services was equal to the cost price (employee costs) with a markup of 10%.
In Case C-320/17 (Marle Participations), a French Court has asked the CJEU whether the lease of immovable property by a holding company to its subsidiaries could be considered direct/indirect involvement in the management of these subsidiaries, as a basis for concluding that the acquisition and holding of shares in these subsidiaries are an economic activity for VAT purposes. This is relevant to determine the level of input VAT recovery of the holding company.
6. UK Criminal Finances Act (CFA)
On September 30, 2017, new offenses will come into force under the UK’s Criminal Finances Act (CFA). Pursuant to the new legislation, organizations that are involved in facilitating tax evasion, regardless of their intentions, may face criminal prosecution and unlimited financial penalties. The only line of defense that an organization can have against being criminally liable for failing to prevent the evasion, is that it had ‘reasonable procedures’ in place (e.g. risk assessment, due diligence, monitoring and top-level commitment).
Although tax evasion and the facilitation thereof are already criminal offenses under existing UK law, it has proven difficult to allocate criminal liability to an organization where these occur. It is envisaged that under the new legislation this will no longer be the case. Please note that tax avoidance is currently not a criminal offence, and neither does it fall within the scope of the new offenses.
Organizations within the scope of the new offenses are those that - regardless of UK presence/residency - facilitate UK tax evasion. Furthermore, organizations that facilitate foreign tax evasion fall within the scope if they carry on business in the UK or if the actual facilitation of tax evasion took place in the UK.
With the considerably broad scope that may result in prosecution of UK and foreign organizations, the UK government has taken a big step toward effectively countering worldwide tax evasion and hopes to inspire other jurisdictions to adopt similar measures.
Please contact Robert van der Jagt if you would like to know more about this topic.