Importance of meeting Substance Requirements – The Netherlands

March 24, 2023

AGN EMEA Taxation Task Force (TTF) Newsletter

Does your client have a Dutch holding (finance) company or Dutch operations which are held by a foreign holding (finance) company with a limited function? If the answer is yes, it is important to consider the substance requirements. For tax purposes, the substance requirements are probably more relevant than expected!

What are the substance requirements?

An introduction: Substance requirements are important to meet in order to obtain certain Dutch tax benefits and avoid the application of Dutch anti-abuse measures in case of distributions to foreign entities (including dividend, costs payments and capital gains realized by foreign entities). The various requirements help to attribute functions to a holding/finance company with a limited function. The minimum substance requirements are enumerated in the attachment at the bottom of this article. In particular, the requirements under #vii and #viii (which are additionally introduced in 2021) need attention.

What is the goal of the substance requirements?

Since the introduction of the OECD BEPS measures, tax avoidance and tax evasion have been heavily anticipated by governments around the world, including the Netherlands. Furthermore, within the EU, various anti-abuse tax provisions have been developed based on this development. The Dutch tax regulations are in line with these global and EU developments.

Avoid application of anti-abuse tax measures:

In order to apply the anti-abuse tax measures, at least two main tests need to be met (cumulatively).

The first test is whether or not the principal or main purpose of the structure is the avoiding of tax (referred to as “the subjective test”). For this test, one should think away from the receiving party. If the tax position of the distributing entity or the overall group (including the final shareholder) would be worse in the latter situation, the main purpose of the structure is considered the avoiding of tax.

The second test is whether or not the structure is considered artificial or exists of a series of constructions which are not based on legitimate business reason reflecting economic reality (referred to as “the objective test”). This test is subject to interpretation. In the Netherlands, this test can be met by complying with the substance requirements (mentioned in the attachment). Until 2020 this was even a safe harbour. As of 2020, this is not allowed anymore as a result of the EU Danish beneficial owner court cases. By meeting the substance requirements, the burden of proof that the structure is artificial is shifted to the Dutch tax authorities now.

Obtaining certain benefits for Dutch companies:

Apart from avoiding the anti-abuse provisions, the substance requirements work as a tool to obtain certain benefits for Dutch holding and finance companies.

Below we further explain how the above works out in practice and we will provide examples.

How it works out?

Avoid application of anti-abuse tax measures:

If the principal or main purpose of the structure is the avoiding of tax (tested by thinking away the receiving party, we refer to the above subjective test), meeting the substance requirement can avoid application of anti-avoidance provisions and negative tax consequences (the objective test). This can be illustrated by the following examples.

Examples of how it works:

Artificial structure – A Swiss individual holds a Dutch operational entity through a Luxembourg entity that has no function. In a Dutch court case, the structure was considered artificial (thus not meeting the objective test) in the situation that an NL BV without a function was moved to Luxembourg and acted as Lux holding.

As a result, the Luxembourg company may be considered interposed between the Dutch company and the Swiss individual with the principal purpose or one of the principal purposes of avoiding dividend withholding tax or income tax.

If, in this situation, the Luxembourg entity would meet the substance requirements, the burden of proof would at least be shifted to the tax authorities in order to prove that the structure does not reflect sound business reasons.

Back-to-back arrangement with a tax haven – The Netherlands have introduced a new conditional withholding tax on interest and royalty payments to an entity established in a low tax jurisdiction (IRWHT). According to the guidance, principal purpose is determined by tracking the interest or royalty flows.

Assume, for example, that a Dutch resident company pays interest to a Luxembourg resident company (not a low tax jurisdiction), and this Luxembourg resident company (directly) on-pays this amount to a company established in the British Virgin Islands. In such a case, the Luxembourg company may be considered interposed between the Dutch company and the British Virgin Islands company with the principal purpose or one of the principal purposes of avoiding the conditional withholding tax at the level of the British Virgin Islands Company (subjective test).

If the Luxembourg entity would meet the substance requirements, the burden of proof would at least shift to the tax authorities that the structure does not reflect sound business reasons.

Unexpected scope and recommendations – A Belgium individual holds a Dutch operational entity through a Belgian holding entity. Taking into account the above remarks, we would suggest that such entity have a certain function and preferably meets the Dutch substance requirements in order to shift the burden of proof that the structure is artificial to the Dutch tax authorities (while one may probably not expect that such type of situation could fall within the scope of the discussion with regard to substance requirements). Therefore, it is important to consider the function of such type of entity, try to meet the substance requirements and avoid artificial structuring.

Obtaining certain benefits for Dutch companies:

A Dutch entity that primarily provides financial services, such as holding and finance services, the substance requirements are relevant for the following reasons:

If it would like to agree on an APA/ATR with the Dutch tax authorities, it needs to meet the substance requirements; otherwise, there is no possibility of concluding such an agreement;
If an entity does not meet the substance requirements, it will need to report this in its CIT return, including an explanation of which requirements are not met;
An (unconditional) tax residency certificate may not be issued to the Dutch entity anymore;
Information exchange with other countries will take place in order to inform the other country about the lack of substance.

Attachment:

The minimum substance requirements for Dutch tax purposes:

i. At least half of the statutory (executive) board members of the beneficiary are a resident of or are established in the State in which the beneficiary is established;
ii. The statutory (executive) board members that are a resident of or are established in the State in which the beneficiary is established have sufficient professional knowledge to properly perform their duties, which duties at least include decision-making, on the basis of the beneficiary’s own responsibility and within the framework of the normal group involvement, in relation to transactions to be concluded by the beneficiary with respect to interest and royalty, as well as ensuring proper settlement of the transactions entered into;
iii. The beneficiary has qualified personnel for the adequate execution and registration of the transactions to be concluded by the beneficiary;
iv. The board decisions of the beneficiary are taken in the State in which the beneficiary is established;
v. The principal bank accounts of the beneficiary are maintained in the State in which the beneficiary is established;
vi. The administration of the beneficiary is kept in the State in which the beneficiary is established;
vii. The beneficiary has EUR 100,000, multiplied by the country of residence factor, in relevant salary expenditure; and
viii. The beneficiary has office space available for at least 24 months in the State where the beneficiary is established, where the activities related to the interest and royalty payments are performed.