Netherlands adds new minimum substance requirements to conditional withholding tax anti-abuse rule

By Roderik Bouwman & Rhys Bane, DLA Piper, Amsterdam

The Dutch government has published regulations clarifying its new conditional withholding tax on interest and royalty payments, which became effective on January 1.

These regulations, issued on December 31, 2020, address an anti-abuse rule contained in the new law.  

Conditional withholding

As of January 1, the Netherlands levies a conditional withholding tax on some interest and royalty payments at a rate of 25%.

The withholding tax is conditional, as it applies to interest or royalties paid to an entity established in a low tax jurisdiction.

Further rules impose taxation when interest and/or royalty payments are allocated to a permanent establishment in a low tax jurisdiction or if the payments are made to a hybrid or reverse hybrid entity.

In addition, an anti-abuse rule provides that the new tax will apply where the principal purpose or one of the principal purposes is avoiding the conditional withholding tax at another level, and the structure is considered artificial (that is to say, it does not reflect sound business motives).

Low tax jurisdictions

Countries considered ‘low tax’ for conditional withholding tax purposes are those already on the list of low-tax countries for Dutch CFC and ruling practice purposes.

The following jurisdictions are on the 2021 list, blacklisted by virtue of being low tax (statutory corporate income tax rate <9%): Anguilla, Bahamas, Bahrain, Barbados, British Virgin Islands, Cayman Islands, Guernsey, Isle of Man, Jersey, Turkmenistan, Turks and Caicos Islands, United Arab Emirates and Vanuatu.

The following countries are blacklisted by virtue of being included on the EU blacklist: American Samoa, American Virgin Islands, Anguilla, Barbados, Fiji, Guam, Palau, Panama, Samoa, Seychelles, Trinidad and Tobago, and Vanuatu.

Minimum substance requirements

The new regulations clarify when the conditional withholding tax will apply in situations where interest or royalties are paid to an entity not established in a low tax jurisdiction, with the principal purpose or one of the principal purposes of avoiding the conditional withholding tax at another level, and the structure is considered artificial.

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.

The new regulation also addresses how to determine whether a structure is considered artificial.

The regulation gives the taxpayer the opportunity to shift the burden of proof that the structure is artificial to the Dutch tax authorities if certain minimum substance requirements are met.

These minimum substance requirements are:

1. At least half of the statutory (executive) board members of the beneficiary to the interest or royalty income are a resident of or are established in the State in which the beneficiary is established;
2. 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;
3. The beneficiary has qualified personnel for the adequate execution and registration of the transactions to be concluded by the beneficiary;
4. The board decisions of the beneficiary are taken in the State in which the beneficiary is established;
5. The principal bank accounts of the beneficiary are maintained in the State in which the beneficiary is established;
6. The administration of the beneficiary is kept in the State in which the beneficiary is established;
7. The beneficiary has EUR 100,000, multiplied by the country of residence factor, in relevant salary expenditure; and
8. The beneficiary has office space available for a period of at least 24 months in the State in which the beneficiary is established, where the activities in relation to the interest and royalty payments are performed.

If the above-mentioned minimum substance requirements are met, the Dutch tax authorities (not the taxpayer) must establish that the beneficiary to the interest and/or royalty income enjoys such income with the principal purpose or one of the principal purposes of avoiding the conditional withholding tax at another level and that the structure is artificial.

In the past, the minimum substance requirements often functioned as a safe harbor (i.e., if these substance requirements were met, the anti-abuse rule would not apply).

This has changed as of January 1, 2020 (and also applies to the conditional withholding tax) due to the so-called ‘Danish beneficial ownership cases’ of the Court of Justice of the European Union.

The Dutch tax authorities would likely do this by demonstrating that given the interest and/or royalty flow going through the intermediate company, meeting the minimum substance requirements, as listed above, is not enough to consider the structure non-artificial.

This could be the case if there are significant inbound and outbound interest and/or royalty flows, with minimal staff (e.g., the beneficiary to the income only meets the above-mentioned minimum substance requirements and has no further substance).

The substance requirements are substantially similar to the substance requirements in place for the Dutch non-resident taxpayer rule, the Dutch controlled foreign corporation (CFC) rules, spontaneous exchange of information to source countries in case of financial services entities, and the Dutch domestic dividend withholding tax exemption.

Key takeaways

If intercompany interest and/or royalty payments are made from a Dutch company to a non-resident company (not being a resident in a low tax jurisdiction) and such interest and/or royalties are on-paid to a low tax jurisdiction, taxpayers will need to substantiate that this interest and/or royalty stream is not set up with one of the principal purposes of avoiding the Dutch conditional withholding tax that would apply in case of direct payments to a low tax jurisdiction or that the structure should not be considered artificial.

Meeting the minimum substance requirements listed above is a starting point in this respect. However, the Dutch tax authorities may still successfully challenge the structure even if these minimum substance requirements are met.

Accordingly, the amount of substance required for the structure not to be considered artificial should be assessed on a case-by-case basis.

Given the involvement of low tax jurisdictions in such intercompany financing and/or licensing activities, it is generally unlikely that taxpayers can obtain an advance tax ruling on the non-application of the Dutch conditional withholding tax.

This may be different in the case where, given the overall activities performed in the Netherlands, the intercompany financing and/or licensing only forms a small part of the activities performed by the Dutch resident taxpayer (and forms part of the core business processes of the taxpayer) and the beneficial owner of the interest and/or royalty payments is an active intercompany financing and/or licensing company.

• Roderik Bouwman is a partner and the Global Co-Chair of the DLA Piper Tax Group and is based in Amsterdam.

• Rhys Bane is an associate, at DLA Piper, Amsterdam.