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New Dutch – Japanese Tax Treaty Signed Benefits Investors
For more than 400 years, Japan and the Netherlands have had a very good trade relationship. The new tax treaty between Japan and the Netherlands is of great importance due to significant inward and outward investment to and from Japan through Dutch companies. Taxand Netherlands and Taxand Japan review the changes to the treaty and impacts on investments going forward.
On 25 August 2010 representatives of Japan and The Netherlands signed a new treaty in Tokyo to avoid double taxation. The new treaty replaces the one concluded between the two countries in 1970.
The most important change in the new tax treaty is that it will significantly reduce the withholding tax rates applicable to dividends and royalties. This will ensure that the Netherlands will remain one of the most important trading partners of Japan. The treaty will also introduce new provisions aimed at preventing tax evasion and abuse of the treaty.
The main differences between the new treaty and the current treaty can be summarised as follows:
Reductions or exemptions of withholding tax
The most important reduction is a full dividend withholding tax exemption for beneficial owners of shareholdings representing at least 50% of the voting rights in a subsidiary (subject to other specific requirements such as a 6 month holding period and the limitation of benefits requirements). Under the current treaty, a minimum 5% dividend withholding tax rate applies. A Dutch Coop structure can still be considered in structures where the requirements for the 0% rate under the new treaty cannot be met.
Due to the introduction of the participation regime in the Japanese tax regime, the 5% dividend withholding tax cannot be credited against Japanese taxable income. This will result in a significant tax cost upon the repatriation of profits. The new treaty will eliminate this cost (provided that the requirements for the 0% rate are met) and will, as a result, make the Netherlands an even more attractive location for holding companies of Japanese multinationals.
The withholding tax on royalties will also be reduced to 0% (from 10%). This is only relevant for royalty payments by Japanese companies to a Dutch company, as the Netherlands does not levy royalty withholding tax. The interest withholding tax rate will also be reduced to 0% for qualifying financial institutions such as banks (please note that the Netherlands does not levy withholding tax on interest).
The withholding tax rates are in line with recent tax treaties concluded by Japan with Australia, France, the UK and the US. These withholding tax rates are, however, significantly lower when compared to other typical holding/finance locations.
Please find an overview in the table below:
* Provided LOB rules are met or a pension fund with qualifying voting power of 50%. If voting power is less than 50% but more than 10%, a dividend WHT rate of 5% will apply.
** Provided LOB rules are met.
Limitation on benefits
The 0% withholding tax rates are only applicable if the so-called "limitation of benefits" requirements are met. These requirements are also included in the recent tax treaties that Japan has concluded with the United States, Australia and the United Kingdom, and are based on the limitation of benefit rules included in most of the US tax treaties. The limitation on benefits rules provide that a resident of either country is only entitled to all treaty benefits if such a resident qualifies under one of the limitation of benefits tests. Examples of such tests in this treaty are the stock-exchange test, the equivalent beneficiary test and the headquarter test. The Japanese tax authorities, in general, require foreign companies wishing to apply the benefits of the treaty to complete a form in order to determine whether the limitations on benefits rules are met.
These requirements should easily be met in the normal investment structures of Japanese companies into or through Dutch companies. However, current structures should be reviewed. VMW Taxand has developed flowcharts to determine easily whether the limitation of benefits requirements can be met.
Mutual agreement procedure
The mutual agreement procedure to resolve double taxation is now included in more detail. A case should be presented to the competent authorities within three years. If the authorities have not been able reach an agreement within two years of the presentation, the treaty also includes an arbitration procedure. The arbitration panel will consist of three independent arbitrators.
Transfer pricing adjustments
A transfer pricing adjustment made by one of the contracting States will be followed by an appropriate adjustment of the other contracting State, provided that both contracting States agree to the adjustment. The competent authorities must, if necessary, consult each other in this regard.
Tokumei Kumiai structures
Multinationals have frequently structured investments into Japan through Japanese silent partnerships (Tokumei Kumiai or TK) structures with a Dutch silent partner because, under the current treaty, distributions of the TK can be made free of Japanese corporate income tax and withholding tax.
The protocol to the new Netherlands-Japan tax treaty gives Japan the explicit right to tax any income and capital gains from silent partners in a TK. This effectively means that distributions from a TK to a Dutch resident partner will incur Japanese withholding tax of 20%. The attractiveness of Dutch TK structures will therefore be reduced by the new treaty, but the TK structure may still be beneficial as the current effective corporate income tax rate in Japan is approximately 41%
The capital gains article now contains a specific provision under which the source state is allowed to levy tax on the alienation of shares in companies whose value consists of at least 50% of immovable property.
The Protocol to the treaty explicitly allows the Netherlands to qualify income from liquidation proceeds and from purchase of own shares as dividends rather than capital gains.
It was expected that a new tie-breaker rule based on a mutual agreement procedure would be included for determining the residency of dual-resident corporate entities. The final text of the treaty, however, mentions that the residency shall be determined relative to the place of the head/main office, and does not include a specific mutual agreement procedure.
The treaty includes an article that reduces the qualifying shareholders percentage from 25% to 10% for the application of the foreign dividend exclusion on dividends received by Japanese companies, provided that the company owned those shares for more than six months prior to the dividend.
Entry into force
The treaty still needs to be ratified by both countries. Due to the delay in the formation of a new coalition government in the Netherlands, the ratification procedure may also be delayed and the new treaty may enter into force as of 1 January 2012 instead of 2011. A grandfathering period of twelve months applies where any person elects to continue to apply the current treaty because the person has greater benefits under the current treaty.
The current Dutch - Japanese tax treaty stems from 1970. Given the many Japanese investments in the Netherlands, there is a clear need to update the treaty to ensure that the Netherlands continues to be one of the most attractive investment and holding locations for Japanese multinationals. The proposed new treaty introduces welcome changes to sustain current investment and attract future trading by Japanese companies. Current structures should be reviewed in order to determine whether the new lower withholding tax rates apply and whether the limitation of benefits requirements has been met. Current TK structures for investments into Japan may need to be changed once the treaty enters into force.
Your Taxand contacts for further queries are:
T. +31 20 757 09 05
T. +31 20 30 166 32
T. +81 3 3222 1401
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