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Parliament Amends Interest Deduction Legislation
To limit the interest deduction on excessively leveraged participations, the Dutch government has submitted a Bill to Parliament introducing a new interest deduction limitation rule. The proposed Bill should only affect a limited group of taxpayers and allows for a lenient method of calculating the potentially restricted interest. The proposal includes rules to limit aggressive tax planning structures and emphasises the intention of the Netherlands to remain an attractive investment and holding country.
The Bill is passed by the Lower House, but still needs to be passed by the Upper House of Dutch Parliament and should be effective as of 1 January 2013. Taxand Netherlands examines these changes and looks at the wider impact on organisations with Dutch activity.
The proposed new rule is intended to address what is known as the 'Bosal gap' referring to the EU court case, in which the EU court held that a Dutch provision disallowing a deduction for costs in relation to a foreign participation was in conflict with EU law.
Taxpayers can now deduct interest expenses related to loans taken out to finance their participations provided that no limitations rules (eg anti-base erosion, thin-cap and acquisition holding rules) apply. At the same time, these taxpayers may benefit from the participation exemption as income derived from qualifying participations will be exempt. The government considers this to be a mismatch which needs to be repaired. Instead of introducing unattractive earnings stripping rules, the government has proposed a clear and understandable rule under which corporate taxpayers may be limited in deducting excessive participation interest expenses.
Based on the new rule a taxpayer may not deduct excessive participation interest expenses relating to loans taken out from both affiliated and third-party creditors. The deduction may apply irrespective of whether the taxpayer uses the loan to finance a Dutch or a foreign participation. No specific link between the financing and the subsidiaries needs to be present and therefore all companies with participations and debt need to review the impact of the new rule. The amount of the excessive participation interest expenses will be determined according to a specific formula.
Insofar as the combined acquisition price of the (qualifying) participations exceeds the fiscal equity of the company, the participations are deemed to be excessively leveraged. Interest expenses and related costs incurred on this excess financing is in principle not deductible. An amount of EUR750,000 of interest expenses (per year) will not be affected by the new rule. In a simplified form the formula is:
((Participations - Equity) / All debt) x (interest and related costs) - EUR750,000 = non deductible interest)
The formula can be illustrated as follows:
The fiscal balance sheet of company A consists of the following assets and liabilities (average amounts):
The profit before interest deductions is EUR25m. Company A pays interest expenses of EUR30m on its debt. Under the current rules, company A therefore reports a loss of EUR5m (i.e EUR25m - EUR30m).
The excess financing amounts to EUR150m (i.e EUR400m - EUR250m). Interest expenses incurred on this excess financing compared to the total debt is in principle non-deductible:
EUR30m x (EUR150m/EUR450m) = EUR10m. After deducting the threshold of EUR750,000, the amount of non-deductible interest expenses is EUR9.25m. Under the new rules, company A thus reports a taxable profit of EUR4.25m (EUR25m - EUR30m + EUR9.25m).
Please note that the proposed Bill includes various details such as the use of the average equity/value of participations, the calculation of the value of the participations, the impact of other interest deduction rules and how to deal with mergers/fiscal unities.
To maintain an attractive investment climate, the new rule only aims to limits the interest deduction relating to excessively leveraged tax structures. Therefore, an exception is proposed for companies which are expanding their business activities. Generally, the interest expenses relating to such an expansion remains deductible. However, this exception is not applicable in case of aggressive tax structures such as double-dip structures or hybrid financing.
In case a company qualifies as an active group financing company, loans used to actively finance group companies may be disregarded in establishing the excess financing. This exception is especially relevant for entities involved in treasury and cash pooling activities.
Furthermore, the State Secretary also proved to be sensitive to the criticism on the burden of proof for the business expansion exception, which is clearly at the level of the taxpayer. Although in principle the burden of proof remains at the taxpayer, an exception has been made for acquisitions and capital contributions of participations in fiscal book years that Furthermore, the State Secretary also proved to be sensitive to the criticism on the burden of proof for the business expansion exception, which is clearly at the level of the taxpayer. Although in principle the burden of proof remains at the taxpayer, an exception has been made for acquisitions and capital contributions of participations in fiscal book years that started on or before 1 January 2006. Taxpayers may opt to disregard 90% of the acquisition price or capital contributions for these subsidiaries.
The new rule is in principle an efficient mechanism and still allows for interest deductions related to (foreign) subsidiaries provided that business activities are being financed. Although the main rule is quite simple, the definition of the exception related to business activities is far from clear and could result in discussions with the tax authorities. The new rule is in addition to existing interest deduction restriction rules. That being said, it is becoming more complicated to obtain an interest deduction in the Netherlands. The expectation, however, is that the interest deduction rules will be simplified in the future.
The new rule will become effective from 1 January 2013, if approved by the Upper House of Parliament (likely in the coming month). Apart from the exception for acquisitions and capital contributions in or before 2006, there is no further grandfathering. Therefore, companies should now check whether the new rule has an impact on their tax position.
Multinationals should focus on reducing or avoiding the adverse consequences of the new rules, for example equity contributions, or refinancing could prove beneficial.
Your Taxand contact for further queries is:
T. +31 20 301 6633
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