Changes ahead for Netherlands legal entity qualification policy
Jian-Cheng Ku and Rhys Bane of DLA Piper Netherlands discuss the impact of potential changes to the legal entity qualification policy that has a proposed effective date of January 1 2022.
As of 2020, most EU member states have implemented the EU Anti-Tax Avoidance Directive II (ATAD II), an EU directive that aims to neutralise tax advantages arising from hybrid mismatches.
A hybrid mismatch is generally the situation where, due to differences between the legislation of two or more states, a payment is deductible in the state of the payor, but not taxed in the state of the payee (deduction/non-inclusion) or is deductible in two or more states (double deduction).
Netherlands implementation of ATAD II
The Netherlands implemented ATAD II in late 2019, after which it entered into effect on financial years starting on or after January 1 2020.
During the parliamentary proceedings in relation to the implementation of ATAD II, criticism was voiced about the fact that ATAD II only deals with the consequences of hybrid mismatches by neutralising deduction/non-inclusion and double deduction outcomes. The implementation of ATAD II does not deal with the root cause of hybrid mismatches.
Hybrid mismatches in relation to the Netherlands are common in cases where partnerships (that are similar to the Dutch limited partnership, or commanditaire vennootschap) are used in structures. This is because their tax qualification for Dutch tax purposes (i.e. whether such partnerships are considered pass-through or opaque) depends on a criterion unique to the Netherlands: the so-called ‘unanimous consent requirement'.
A legal entity that is considered similar to a Dutch limited partnership, is only considered pass-through if all partners (general partner(s) and limited partners) have to unanimously consent to the accession or replacement of partners.
This criterion often leads to situations where the Netherlands regards a partnership-like entity as opaque, where the state of residence of the partnership-like entity considers it transparent. This specific situation can, therefore, result in deduction/non-inclusion outcomes.
As a result of the criticism voiced in parliament during the implementation of ATAD II, the Dutch government announced that it would review the Dutch legal entity qualification policy and might come with changes to the policy.
On March 29 2021, the Dutch government released a legislative proposal that would see the legal entity qualification rules changed for public consultation. Under the legislative proposal, the ‘unanimous consent requirement’ would effectively lose its relevance, due to the abolishment of the Dutch open (opaque) limited partnership and changes in the definition of the Dutch open (opaque) mutual fund (fonds voor gemene rekening).
Under the legislative proposal, the Netherlands would keep the similarity approach (i.e. where foreign legal forms are treated similar to Dutch legal forms for tax purposes if they are considered similar).
However, this similarity approach would be supplemented with the fixed approach (i.e. where foreign legal forms are always considered opaque for tax purposes) in case of a legal form that is not similar to any Dutch legal form that is a resident for tax purposes of the Netherlands (i.e. effectively managed in the Netherlands) and the similarity approach (i.e. where foreign legal forms are treated the same for Dutch tax purposes as in their jurisdiction of residence) for non-resident entities (generally those non-resident entities that have a shareholding in a Dutch entity or in which a Dutch entity has a shareholding).
Due to the abolishment of the open (opaque) Dutch limited partnership, an exit tax would apply to (opaque) Dutch limited partnerships. There are several transitional measures that would mitigate the effective of the exit tax in whole or in part, however, these measures are generally limited in scope and may no provide any relief to non-EU/EEA companies.
The proposed effective date of the legislation is January 1 2022.
Key takeaways and next steps
The proposed changes in the Netherlands legal entity qualification policy may take away a large number of hybrid mismatches caused by the Dutch ‘unanimous consent requirement’ and would make the Dutch legal entity qualification policy more comparable to that of other (EU member) states.
However, these rules may result in an exit charge becoming due as of January 1 2022, if nothing is done by taxpayers.
In relation to the US, however, the abolishment of the Dutch open limited partnership could result in an exit charge, followed by (continued) application of the Dutch ATAD II rules, due to an unfortunate concurrence of these rules.
The public consultation closed on April 26 2021, with 35 responses to the public consultation (which is a large number of responses). The Dutch Ministry of Finance will now likely review the responses and the Dutch government will probably have a final legislative proposal by September 21 (budget day) if the intended effective date remains January 1 2022.
Given the issues raised in these responses, we would expect at least some substantive changes to the legislative proposal.
Partner, DLA Piper
Associate, DLA Piper