Dutch corporate tax residency and substance may be affected by COVID-19 quarantine and travel restrictions

By Jian-Cheng Ku, Gabriël van Gelder, & Mehdi el Manouzi, DLA Piper Nederland N.V., Amsterdam

As business struggles with the impact of the pandemic outbreak of the coronavirus (COVID-19), many governments, including the Netherlands, have announced mandatory quarantines, prohibition of public gatherings, and travel restrictions to control the spread of the virus.

These limitations are affecting the mobility of personnel and are preventing some multinational group companies from holding physical board meetings or causing them to temporarily relocate board meetings to other countries. These changes could affect the tax residency of a company and potentially result in adverse tax consequences.

Moreover, because of the new restrictions, companies within a multinational group may not be able to host the ‘genuine economic activities’ they need to fulfill their function according to tax regulations.

We have taken a look at the Dutch substance requirements applicable to several tax provisions to see what the impact of COVID-19 restrictions may be on businesses. We address the Dutch corporate tax residency rules, eligibility to tax treaty benefits, the Dutch fiscal unity rules, implications for intra-group financing and licensing companies, the dividend withholding tax exemption, the non-resident substantial interest rules, the controlled foreign company (CFC) rules, tax ruling requests and transfer pricing.

Dutch corporate tax residency

A company that is tax resident of the Netherlands is subject to Dutch corporate income tax for its worldwide income and could be entitled to the benefits of the extensive Dutch tax treaty network.

Netherlands tax law prescribes that corporate tax residency is based upon all (relevant) facts and circumstances. This open-ended rule is shaped by established Dutch case law from which it follows that the place of effective management of the company is the most important criteria to determine corporate tax residency.

In practice, this means that the Netherlands is the place of effective management of a company if the board meetings and board decisions regarding key commercial and management matters exclusively take place there.

Dutch tax law uses a substance over form principle; hence, having a board meeting in the Netherlands in which decisions made outside the Netherlands are formalized (“signed off”) is not sufficient. The actual decision should be made in the Netherlands by the board members of the Dutch company while taking into account sufficient considerations.

The absence of board meetings or a decision to temporarily move board meetings outside the Netherlands could result in that company is no longer being considered a resident for Dutch tax purposes.

This could trigger adverse tax consequences and the denial of Dutch tax treaty benefits going forward. Furthermore, the jurisdictions in which the board member(s) reside could hold the view that the Dutch company is a tax resident in their local jurisdiction leading to potential double taxation.

Alternatively, foreign jurisdictions could conclude that a taxable presence in the form of a permanent establishment or dependent agent arises due to the activities of the board member(s) within their borders.

Lastly, board members of a foreign company living in the Netherlands and working from home due to the travel restrictions could potentially form a risk that the foreign company becomes a tax resident of the Netherlands and therefore subject to Dutch corporate income tax.

Eligibility to tax treaty benefits

Access to the benefits of the extensive Dutch tax treaty network requires that the taxpayer is a resident for Dutch tax purposes, i.e., effectively managed in the Netherlands.

A nonresident taxpayer will be denied access to Dutch tax treaties. Furthermore, if a taxpayer is considered to be a tax resident in more than one jurisdiction, tax residency for treaty purposes is determined on the basis of the effective place of management under the corporate tie-breaker rule of many tax treaties, including most Dutch tax treaties.

For tax treaties covered by the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI), residence is determined by competent authorities under a mutual agreement procedure.

Hence, an unintended change of tax residency due to prohibition of public gatherings and travel restrictions could impact the relief from foreign (withholding) taxes via tax treaties and give rise to discussions about beneficial ownership with source states.

Business should be prudent in assessing the impact of the eligibility for tax treaty benefits considering this matter could be at the discretion of foreign tax authorities in times where governments need tax revenue.

Fiscal unity

Dutch tax law allows a Dutch parent company and its Dutch subsidiaries to form a fiscal unity for Dutch corporate income tax purposes.

One of the requirements to join a fiscal unity is all companies must be a resident for Dutch domestic tax purposes; namely, the company must be effectively managed in the Netherlands for Dutch tax treaty purposes.

An unintended change of a company’s tax residency could lead to the break up of a fiscal unity potentially triggering a taxable event due to the deconsolidation rules of the fiscal unity regime.

Intragroup financing and licensing companies

Dutch tax law stipulates that intra-group financing and licensing companies (i.e., companies whose activities consist of 70 percent or more of (in)directly receiving and paying interest, royalties, rent, or lease installments) must meet certain minimum substance requirements with respect to their actual presence in the Netherlands.

Among these conditions is the requirement that at least 50 percent of the statutory (and competent) directors of the company are local residents and that the board of director’s decisions are made in the Netherlands.

If a company does not meet all the conditions, the Dutch tax authorities automatically exchange information with respect to the taxpayer to foreign (source) tax authorities.

This notification could lead to tax audits by the tax authorities of the source countries. Furthermore, it should not be expected that the Dutch tax authorities will support the Dutch company if the foreign tax authorities question the tax treaty claims.

It is advisable that businesses with a Dutch intra-group or licensing company assess the impact of the absence of board meetings or a decision to (temporarily) reallocate board meetings outside the Netherlands. Intragroup financing and licensing companies are required to specify in their Dutch corporate income tax return whether they satisfy the minimum substance requirements, thereby leaving the matter to inform foreign tax authorities at the discretion of the Dutch tax authorities.

Dividend withholding tax exemption

Substance requirements in Dutch tax law may also extend to the economic activities in other states. The Dutch dividend withholding tax exemption may be denied to non-resident corporate shareholders that hold an interest in a Dutch company when is determined that the company is part of an artificial arrangement or a series of arrangements if was not put in place for valid business reasons reflecting economic reality.

In principle, a nonresident corporate shareholder cannot be characterized as such an artificial arrangement if it fulfills a linking function between the business of the Dutch company and its ultimate shareholder and meets the Dutch minimum substance requirements. These substance requirments mandate that at least 50 percent of the statutory (and competent) directors of the company are local residents and the board of directors’ decisions are made in the jurisdiction of that company.

Non-resident substantial interest rules

Non-resident corporate shareholders holding a substantial interest (5 percent or more) in a Dutch company could be subject to Dutch corporate income tax with respect to income (e.g., dividends and capital gains) derived from that substantial interest, in addition to Dutch dividend withholding tax.

The Dutch non-resident substantial interest rules aim to counter artificial structures set up to avoid tax and only apply if the substantial interest is held with the main purpose or one of the main purposes to avoid Dutch personal income tax at the level of the (in)direct shareholder and the structure is artificial.

In principle, a nonresident corporate shareholder active as an intermediary holding company cannot be characterized as such an artificial arrangement if it fulfills a linking function between the business of the Dutch company and its ultimate shareholder and meets the Dutch minimum substance requirements. These substance provisions require at least 50 percent of the statutory (and competent) directors of the company to be local residents. The board of director’s decisions must be made in the jurisdiction of that company.

CFCs

As of 1 January 2019, the Netherlands has introduced new CFC rules in the Dutch Corporate Income Tax Act in line with the European Union Anti-Tax Avoidance Directive (ATAD 1).

The Dutch CFC rules allocate certain types of undistributed passive income (e.g., income from dividends, interest, and royalties) from (indirect) controlled entities that are tax resident in low taxed jurisdictions i.e., jurisdictions that are listed on the Dutch list of low-tax and non-cooperative jurisdictions or on the EU list of non-cooperative jurisdictions for tax purposes to the Dutch company holding the interest.

The CFC rules do not apply if the controlled entity carries out significant economic activities in the local jurisdiction.

In general, a controlled entity is considered to carry out significant economic activities if it meets the Dutch minimum substance requirements, inter alia at least 50 percent of the statutory (and competent) directors of the company should be local residents and the board of director’s decisions should be made in that company’s jurisdiction.

Ruling requests

Additional tax regulations to note include those in the Dutch tax ruling practice decree pertaining to tax rulings relating to cross-border structures, which took effect in July 2019.

A taxpayer requesting an advance tax ruling or an advance pricing agreement must have sufficient ‘economic nexus’ within the Netherlands, meaning that its presence needs to relate to operational activities in the Netherlands that are carried out for the benefit and risk of the Dutch company.

These activities need to fit in with the function of the Dutch company. As such, consideration must be given to whether the company employs enough people in relation to its overall size and/or its activities in the Netherlands. Not meeting the required economic nexus condition or a significant change of the relevant facts could impact the validity of existing rulings.

Again, here it is important to note that the employees that are relevant to the activities in the Netherlands may temporarily be restricted from assuming their regular work.

Transfer pricing aspects

Restrictions due to the COVID-19 measures may lead to to multinational group companies with reduced control of their business operations.

When factories are closed for an undetermined time, supply chains are revised, and employees sent home this changes the activities and responsibilities performed within a multinational group.

These changes could lead to a taxable event in many jurisdictions due to a transfer of the functions within the group. Therefore, multinational groups might need to consider modifying their intragroup transaction prices to reflect value-creation within the enterprise. Economic circumstances in a given market should likewise influence the price of intra-group transactions.

Political developments

The Dutch Association of Tax Advisors (NOB) has requested the Dutch Ministry of Finance to take a lenient approach towards the meeting of substance requirements during this unusual time.

The Ministry of Finance has given no response yet to this request as of writing, but we are monitoring the situation on an ongoing basis.

Other jurisdictions have issued communication or guidance concerning the application of their domestic tax regulations regarding the determination of the corporate tax residency. Although, the provided guidance differs among the countries, the common denominator is that the current circumstances are considered to be exceptional and some leniency will be considered insofar attributable to COVID-19.

Our assessment

Considering the current circumstances are exceptional and that the Dutch government has stated that the current situation qualifies as an emergency, we would expect leniency from the Dutch tax authorities in assessing the required substance in respect of the abovementioned tax arrangements.

Leniency is particularly expected if a case presented to the Dutch tax authorities is not questionable and is supported with proper documentation showing the intention of the company to meet the required substance requirements and to carry on the business in line with the facts of previous years.

Nevertheless, we would discourage taking the potential tax consequences as set out above lightly. Businesses should begin a high-level assessment of the potential tax impact of any postponements or reallocation of the board meeting of Dutch companies.

Postponing this assessment until the end of the fiscal year could mean that the consequences are final without the possibility of timely intervention.