The move is a trend mirrored around Europe as governments look for ways to raise revenue and trim deficits.
If passed, the measure would apply from January 1 2013 and would mean that taxpayers cannot deduct interest expense on excessive debt. There are no grandfathering provisions.
Response to Bosal
The Bill is a response to the Bosal ECJ case, which affirmed that the distinction in treatment of interest expenses between Dutch subsidiaries (for which the interest expense was deductible) and foreign subsidiaries (for which the interest expense was not deductible) contravened the European principle of freedom of establishment.
As a result, interest expense related to foreign subsidiaries became deductible in the Netherlands from January 1 2004. As part of the nation’s fiscal tightening, the Dutch parliament sent a proposal to government in June 2011 to solve the issues created by Bosal. The main problem was that taxpayers could deduct interest expenses related to loans taken to finance their participations, while at the same time benefitting from the participation exemption because income derived from qualifying participations is exempt.
The legislative proposal – estimated to reduce the Dutch budget deficit by €150 million ($190 million) – would restrict participation interest expense deductions where the taxpayer’s debt level relating to subsidiaries is excessive. This would apply to interest expenses relating to loans taken out from both related and third-party creditors, and the deduction would also apply regardless of whether the taxpayer is using the loan to finance a Dutch or a foreign participation.
The proposal has been met with optimism because the restrictions are preferable to more stringent earnings stripping rules which could have been considered.
“In general the reaction has been positive as the calculation method is easy and most companies will not be affected by the proposed bill,” said Marc Sanders, partner at VMW Taxand. “No earnings stripping or other more severe alternatives will be introduced.”
Wider European trend
“Going forward, EU governments will have to raise taxes where they can and where they are not raising taxes, implement more tax discipline in areas like interest deductions and using losses,” said Conor Hurley, of Arthur Cox in Ireland.
Sweden is one country that has already recently taken action in this regard.
“In March, the Swedish government proposed new legislation which will entail further restrictions on the deductibility of interest expenses on inter-company loans,” said Peter Utterström, partner at Delphi, in Stockholm.
Sanders said he would not be surprised if the trend continues to be taken up around the continent, with the Dutch legislation providing a possible blueprint for other jurisdictions.
“My experience is that a lot of countries look at the Netherlands for ideas on new rules for restrictions on interest deductions, so we may therefore also export this one. Restrictions on interest deductions are certainly a trend in Europe,” said Sanders, who also referenced recent changes in Spain that are more severe and include earnings stripping rules.
There may be further related legislation released by the Dutch government, and Sanders said the elimination of thin capitalisation rules for Dutch law is being “seriously considered”. He said this would be beneficial for Dutch-based companies and would reduce the administrative burden.
The legislation details a formula that would determine whether or not a company is excessively leveraged. If the combined acquisition price of the qualifying participations is greater than the equity of the company, the participations will be deemed to be excessively leveraged.
There is a €1 million threshold contained in the legislation whereby interest expenses up to this amount will not be affected by the proposal, and therefore will remain deductible.
“The €1 million threshold provides relief for small and mid-sized companies. The main relief for Dutch-based multinationals and Dutch holding companies is the so-called expansion participations. These are excluded for the calculation method from the value of the participations,” said Sanders.
Many companies will fall outside of the scope of the new rule, but taxpayers still need to assess the likely implications for their specific situation, and enact changes before the proposed implementation date of January 1 2013 if necessary.