The Netherlands - Tax
Draft Decree on foreign entity qualification published for public consultation
As highlighted in our previous quarterly updates in 2023, in addition to the changes concerning the Dutch tax treatment of limited partnerships (reference is made to our updates published in 2023), effective as from 1 January 2025 the Tax Qualification of Legal Entities Act (the “Act”) introduces a new framework to assess the tax transparency of both domestic and foreign legal entities. The Act, a significant component of the Dutch 2024 budget, was ratified in late 2023.
Recently, the Dutch legislator published a draft 'Decree Comparing Foreign Legal Entities' ("Consultation Decree") for public consultation. Pursuant to the Consultation Decree, foreign legal entities should be compared to Dutch legal entities to determine whether they qualify as transparent or non-transparent for Dutch tax purposes. The consultation was open between 5 February and 18 March 2024.
Summary of the Act
The objective of the Act is to further harmonize the Dutch legal entity qualification rules with international standards and mitigate disparities in the qualification of legal entities, both domestic and foreign. The Act outlines the following steps for determining whether a foreign legal entity is considered transparent or non-transparent:
(i) In case a foreign legal entity is comparable to a Dutch legal entity according to the Consultation Decree, its tax qualification aligns with the Dutch tax qualification of the corresponding Dutch entity.
(ii) In case the foreign legal entity is not comparable to a Dutch legal entity based on the Consultation Decree, qualification depends on the corresponding jurisdiction:
a. If the foreign legal entity is based in the Netherlands, it is qualified as non-transparent and taxed independently (fixed method).
b. If the foreign legal entity is not based in the Netherlands, its qualification will follow the tax qualification from the jurisdiction where the foreign legal form is based (symmetrical method).
The Consultation Decree aims to determine whether a foreign legal entity is comparable to a Dutch legal entity.
Key takeaways of the Consultation Decree
As starting point for the assessment of comparability characteristics of various Dutch legal entities are outlined in the Consultation Decree. These characteristics include aspects such as the capital/share structure, member/partner liability and governance. The comparability of foreign legal entities is assessed based on these characteristics.
The Consultation Decree is accompanied by a comprehensive list of legal entities, indicating their comparability to Dutch entities (if any) or lack thereof. This qualification in this list is in principle binding (with some exceptions), which seems contrary to the current qualification practice under which the list is only an indication of (non-)transparency.
For legal entities not listed, the assessment pivots on whether a Dutch legal entity with similar "nature and structure" exists. This assessment of comparability is also made on the basis of the characteristics included in the Consultation Decree.
If no comparable Dutch legal entity is identified, or if comparability exists with multiple Dutch legal entities, the foreign legal entity is deemed non-comparable. In such case, the abovementioned fixed or symmetrical method should be applied.
As a result of the change in qualification of the Dutch limited partnership, it is important to assess whether the qualification for foreign limited partnerships in the structure will also change from a Dutch perspective.
Motion to amend the Dutch carried-interest regime has been passed by Dutch Parliament
On 9 April 2024, the Dutch Parliament has passed a motion seemingly targeting carried interest taxation of private equity managers. Along with this motion, four other motions have been passed to, generally, target high net-worth individuals.
Current Dutch carried interest taxation following the so-called ‘lucrative interest’ regime
Currently, if shares (or receivables or other property rights) are considered a so-called ‘lucrative interest’, the income from such shares (or receivables or other property rights) is subject to tax in Box 1 (progressive rates up to 49,5% (2024 rate)), thereby effectively being taxed as income from employment.
The first requirement for a lucrative interest to exist is if shares, receivables, or other property rights (either held directly or indirectly) are considered in whole or in part as remuneration for work and/or knowledge. The second requirement for a carried interest is that the shares must have such favourable conditions that there will be an excessive (lucrative) remuneration of the manager compared to the main investor(s). A share class is lucrative if there are multiple share classes and:
(i) it concerns a subordinated class of shares and the nominal value of such subordinated shares is less than 10% of the total nominal value of all shares; or
(ii) it concerns preference shares and the annual preference interest rate is at least 15%.
In order to counter potential abuse of the abovementioned (formal) ratios of shares, a carried interest is also considered present if the total investment (i.e., nominal value + share premium) on the subordinated shares is less than 10% of the total investment on the shares and the company, including shareholder loans.
However, if the individual holds a carried interest indirectly, through a holding company, the individual may opt for taxation in Box 2 (against more favourable rates; which is meant for taxation of substantial interests) if at least 95% of the proceeds from the carried interest is distributed in the same (calendar) year up to the individual and the individual declares it as income from Box 2 (maximum 33% rate in 2024) in the personal income tax return over that (calendar) year.
Requested amendments in the Dutch lucrative interest regime
In the motion, relating to the Dutch carried interest regime, it is requested to abolish the possibility to apply the more favourable Box 2 tax rate (see above), with respect to carried interests of managers in the private equity sector. Although this wording might seem narrow, we expect that it might meant as an amendment of such Box 2 taxation on all lucrative interests (i.e., not only for carried interests of private equity managers).
Additionally, it is requested that the Dutch government assesses the effect of double tax treaty protection on carried interest schemes and subsequently (re)negotiates the double tax treaties if taxation on carried interests may be allocated to the other relevant state, precluding the Netherlands from effectuating the progressive Box 1 taxation (which is the case under most of the Dutch treaties).
At the moment, there is no (draft) legislative proposal to amend the Dutch lucrative interest regime. At this stage, double tax treaties are also not actively (re)negotiated for this purpose. The effect and corresponding timeline of the abovementioned passed motion remains an interesting topic to monitor in the period ahead, but we expect to know more towards Budget Day (17 September 2024).