by Wiebe Dijkstra and Klaas Versteeg
The Dutch Ministry of Finance has issued for public consultation proposals for the revision of certain statutory limitations on the deductibility of interest for Dutch corporate income tax purposes. The main purpose of the proposed revisions is to fix a number of perceived loopholes with the aim to restrict what is considered as excessive leveraging of acquisitions of Dutch companies by private equity investors.
These proposals were issued in response to a critical report published by two members of parliament. Other more fundamental non-tax proposals set out in this report have not been addressed in the public consultation. Interested stakeholders can submit their input or propose amendments to the draft bill until 18 July.
Background
In general, interest payments made by a Dutch corporate taxpayer are deductible from taxable income. The interest deduction is subject to a number of statutory restrictions set out in Dutch tax law. The public consultation proposes to amend two of the statutory restrictions.
The first statutory provision to be consulted on is an anti-base erosion rule that applies to intra-group financing only. Pursuant to this rule, interest paid to a related party is in principle non-deductible if the loan was attracted in connection with a tainted transaction. This includes an acquisition by the taxpayer or certain related entities of a company that becomes a related entity after the acquisition. The interest is, however, deductible if the taxpayer proves that both the transaction and the financing thereof were entered into for valid business reasons or if the interest is subject to an effective tax rate of 10%.
The second statutory provision to be consulted on is a limitation on acquisition debt financing. This rule limits the deduction of interest on “excessive” acquisition debt from the taxable profits attributable to a Dutch target company. Subject to this rule and certain other limitations, creating the possibility to offset interest on acquisition debt against the taxable profits of a Dutch target is typically fairly easy to achieve by using a Dutch acquisition vehicle which either forms a fiscal unity or merges with the Dutch target on or shortly after the acquisition. The limitation in respect of acquisition debt financing is not limited to related-party debt, but also extends to third-party debt.
Whether acquisition debt is excessive is determined on the basis of the loan-to-purchase price ratio. In the year of the acquisition, a maximum loan-to-purchase-price ratio of 60% is allowed; this maximum percentage is reduced by 5%-points annually over the course of seven years, down to 25% in year eight and later years. Interest on acquisition debt is not deductible from taxable profits of the Dutch target to the extent the actual loan-to-purchase-price ratio exceeds the acceptable ratio (i.e. 60% in year 1 to 25% in year 8). A de minimis of EUR 1 million applies.
Recent developments & proposed changes
In August 2015, two members of Dutch parliament published the “Initiative Policy Document Private Equity: a halt to excesses.” This policy document provides for twelve measures to halt what they perceive as excesses of the private equity sector. The Dutch Ministry of Finance responded to the policy document in December 2015 and emphasizes the importance of private equity firms for Dutch businesses.
With respect to most of the proposals, the Dutch Ministry of Finance does not agree that amendments to the existing law are necessary at the moment. Hence, no amendments are currently to be expected in this respect. The Dutch Ministry of Finance does however endorse three technical proposals regarding the deductibility of interest payments. These proposals were published in June 2016 and the intention is for the changes take effect as from 1 January 2017.
First, the scope of the definition of related entity in the anti-base erosion rule applicable to intra-group financing would be extended. Under the current rules, the following entities are considered related:
- a company in which the taxpayer has an interest of at least 1/3;
- a company that has at least an interest of 1/3 in the taxpayer;
- a company in which a third party has an interest of at least 1/3 whilst this third party also has an interest of at least 1/3 in the taxpayer; and
- a company with which the taxpayer forms a fiscal unity.
Certain investment structures are arguably not captured by this rule if none of the investment entities providing loans hold a 1/3 or more (economic) interest in the acquisition company or each other. The draft bill provides that these kind of lenders will also be considered related with the acquisition company and the target if they act in concert and together hold an interest of at least one-third in the acquisition vehicle and target.
Second, changes to the acquisition debt financing rule would close the alleged loophole for avoiding the annual reduction of the loan-to-purchase-price ratio. This ratio is reduced by 5%-points annually over the course of seven years, down to 25% in year eight and subsequent years. The reduction of the loan-to-purchase-price ratio could possibly be avoided by incorporating a new acquisition company in the year after the acquisition and transfer the target company to this new acquisition company. After the transfer of the target company and each subsequent transfer, it could be argued that a new seven-year period starts and that again the maximum percentage could be deducted in the first year after the acquisition. After the proposed change to the acquisition debt financing rules, the transfer of the target company to a related entity will be ignored and no new term will start.
Finally, the mathematical rule to calculate the non-deductible amount of interest on acquisition debt would be changed. On the basis of a technical reading of the current statutory provisions, the mathematical rule does not work as envisaged by the legislature in the case of a ” true debt push down” transaction; i.e. the deduction of interest on the debt pushed down from taxable profits of the Dutch target is typically no longer effectively restricted pursuant to the acquisition financing rule. The consultation proposal aims to close this loophole.
The Dutch Ministry of Finance points out that the anti-tax avoidance directive of the EU, adopted on 17 June, also provides for a general interest limitation rule on exceeding borrowing costs; an earning stripping rule. The Ministry of Finance seems to suggest that the acquisition financing rule may be abolished upon the entering into effect of the earnings stripping rule, but is silent on the effects on the aforementioned anti-base erosion rule and another base erosion rule, not addressed in this alert.
Interested stakeholders can submit their input or propose amendments to the draft bill until 18 July.
Wiebe Dijkstra
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Klaas Versteeg
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