Netherlands announces changes to tax treatment of Brazil interest on equity payments

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

On August 27, the Netherlands Ministry of Finance published guidance describing the new Dutch policy with respect to the tax treatment of interest on equity payments under the Netherlands-Brazil tax treaty.

Under new decree No. 2020-14853, interest on equity payments (in Portuguese, “juros sobre capital próprio”) is treated as interest for purposes of the treaty and no longer as dividends (income from shares).

The change may have significant tax consequences for Dutch holding companies.

Brazilian tax treatment of interest on equity payments

The Brazilian tax system provides for the deductibility of part of the dividend that a Brazilian shareholding pays to its shareholders.

Under Brazilian civil law, the interest on net equity is considered a dividend payment made on regular equity. The instrument is therefore classified as equity for Brazilian tax purposes.

The payment is not equated with interest, but it is deductible for Brazilian corporate income tax purposes. A withholding tax at the rate of 15% is levied on interest on equity payments (a 25% rate applies for beneficiaries located in low-tax jurisdictions).

Dutch tax treatment of interest on equity payments

 For Dutch corporate income tax purposes, interest on equity payments are considered income derived from shares.As of January 1, 2016, the Dutch participation exemption no longer applies to income from qualifying participations insofar these payments are tax deductible at the level of the participation.

This anti-hybrid rule was implemented as a result of the amended EU Parent-Subsidiary Directive and aims to prevent situations of double non-taxation.

With reference to the OECD BEPS Action 2, the Dutch government did not limit the scope of the anti-hybrid rule to EU situations. Hence, the anti-hybrid rule also applies to non-EU participations.

As a result of the addition of the anti-hybrid rule, the Dutch participation was excluded for interest on equity payments made by Brazilian subsidiaries to Dutch shareholders.

This would mean that interest on equity payments was taxed at a net base (after deduction of contributable costs to the shareholding) against a corporate income tax rate of 25% (16.5% for the first EUR 200,000 [USD 236,478] of taxable profit).

Under the treaty, the Netherlands is obliged to grant a tax sparing credit of 25% for dividends and 20% for interest. Under the old policy, the tax sparing credit of 25% was sufficient to off-set the corporate income tax of 25%, resulting effectively in no Dutch taxation on interest on equity payments.

New policy

Under the new policy, the Dutch Ministry of Finance qualifies interest on equity payments as interest for purposes of the treaty and no longer as dividends (income from shares).

As a result, Dutch taxpayers that receive interest on equity payments are no longer eligible to a tax sparing credit of 25% for the Brazilian withholding tax, but a credit of 20% applies.

The change in applicable tax sparing credit may have significant tax consequences for Dutch holding companies as a tax sparing credit of 20% may not be sufficient to off-set all Dutch corporate income tax due on interest on equity payments made by Brazilian companies.

 Timing

 The guidance states that the new policy applies as of August 28.

The decree does not provide for any grandfathering clause for existing tax rulings / agreements concluded with the Dutch tax authorities on the treatment of interest on equity payments as dividends under the treaty.

Hence, as of August 28, according to the decree, interest on equity payments made by a Brazilian subsidiary to a Dutch holding company can –if all the required conditions are met- only qualify for a tax sparing credit of 20%.

What can this possibly mean for you?

 Under the new Dutch policy, interest on equity payments from Brazilian subsidiaries no longer qualify for a tax sparing credit of 25% but will be credited against a rate of 20%.

This may result in that the tax position of Dutch holding companies with respect to dividend payments made by Brazilian subsidiaries switches from a tax-free position (after credit) to a net payable tax position.

We recommend that taxpayers identify whether there are any interest on equity arrangements in place in their structure and subsequently analyse whether the change of tax sparing credit may impact their (net) tax position.

Furthermore, taxpayers need to be aware that the change in policy may nullify any tax ruling or other agreement concluded with the Dutch Tax Authorities regarding the Dutch tax treatment of interest on equity payments.

It is worthwhile to note that the position of the Ministry of Finance is debatable, and the decree itself does not have the force of law.

Taxpayers should consider if they want to follow this position or the position under the treaty that interest on equity payments should qualify as dividends.