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!
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.
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.
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.
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.
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.
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.
A Dutch entity that primarily provides financial services, such as holding and finance services, the substance requirements are relevant for the following reasons:
The minimum substance requirements for Dutch tax purposes:
If you have any questions regarding tax issues in The Netherlands, please get in touch with Jeroen in ‘t Hout.
Jeroen in ‘t Hout
Tax Partner, International tax
Daamen & van Sluis
Mobile: +31 (0) 6 317 81 910