The decree addresses the following six issues: |
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On August 18 2004, the Dutch Under Minister of Finance published a decree amending and supplementing the Transfer Pricing Decree of March 30 2001. With this new decree, the Ministry of Finance wishes to remove uncertainties and facilitate a more flexible approach within the scope permitted under the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). The new decree is dated August 16 2004, and it also took effect on that date. The decree was replaced on August 21 2004 to correct two inaccuracies (see section 3 below). Below, the term "decree" only refers to the decree of August 21 2004.
Intra-group services and shareholder activities
Activities that qualify as intra-group services must, as a rule, be recharged to group companies. The "old" transfer pricing decree stated that, according to the arm's-length principle, a service qualifies as an intra-group service if:
the service is performed for the benefit of a group entity and adds economic and commercial value to that group entity; and
that group entity would normally be prepared to pay for this service.
Activities that a party performs in the capacity of a shareholder do not need to be recharged. The decree lists a number of shareholder activities that do not qualify as intra-group services, subdivided into the following five main categories.
Activities that relate to the legal structure of the company itself regarding:
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the implementation of the requirements referred to in Book 2 of the Dutch Civil Code;
the implementation of the statutory documentation requirements for tax purposes to the extent that these are requirements that the company itself must meet;
Activities that relate to issuing or splitting shares in the company itself or comparable securities on capital markets and activities relating to applying for or maintaining a Dutch or non-Dutch stock exchange listing of the company as such;
Activities relating to the introduction of and compliance with statutory rules regarding the supervision of share transactions;
Activities relating to the introduction of and compliance with statutory rules and codes of conduct on corporate governance at the level of the company as such or the group as a whole; and
Activities relating to reporting to various interested parties concerning the company as such or the group as a whole.
According to the decree, the group as a whole consists of the company as such and its direct and indirect subsidiaries. The list set out above is not exhaustive. Activities that are not included in the list must be assessed on the basis of the Transfer Pricing Decree and the OECD Guidelines. Section 7.10 of these OECD Guidelines provided the following specific examples of shareholder activities:
costs of activities relating to the juridical structure of the parent company itself, such as meetings of shareholders of the parent company, issuing of shares in the parent company and costs of the supervisory board;
costs relating to the reporting requirements of the parent company including the consolidation of reports; and
costs of raising funds for the acquisition of its participations.
In addition, the decree addresses "mixed" activities. The concept of mixed activities refers to activities that qualify in part as intra-group services and in part as shareholder activities. The examples of mixed activities mentioned in the decree include "consolidation" activities, activities in the field of M&A, and activities of the board of management. These examples are explained further in the decree. According to the decree, the activities may be qualified as intra-group services or shareholder activities on the basis of any method that yields a result that is in accordance with the arm's-length principle.
A ruling request may be filed with the Dutch Revenue as regards the qualification of activities as intra-group services or shareholder activities. If a taxpayer wishes certainty regarding both the qualification of the activities and the arm's-length nature of the transfer price used, it may apply for an advance pricing agreement (APA) with the Dutch Revenue. The national APA team of the Dutch Revenue in Rotterdam will then have to issue a binding opinion regarding the APA request.
Support services
The Transfer Pricing Decree states that remuneration for intra-group services can only qualify as being at arm's length if an appropriate profit mark-up was taken into account. This principle has also been incorporated into the decree.
Pursuant to the OECD Guidelines, the decree states, however, that the Dutch Revenue need not make any adjustment for certain support services where the taxpayer limits the charge to all the relevant costs that it actually incurred. In this way, taxation of a profit mark-up in the Netherlands can be avoided. The decree concludes that services in the following fields can generally be regarded as such support services:
accounting;
legal affairs;
tax affairs; and
human resources.
The examples given in the decree show that the Dutch Revenue will, however, make a profit mark-up adjustment if the costs concerned relate to:
activities that are part of, or add more than marginal value to, the group's core business operations: or
services that are rendered to third parties on a more than incidental basis.
According to the decree, the Dutch Revenue itself will have to provide reasonable evidence of 1) or 2) above. However, if a ruling request is filed (in accordance with the procedure described in section 2 above), it will be up to the taxpayer to provide reasonable evidence that neither 1) nor 2) apply.
For the purposes of assessing whether support services are involved, the following aspects are important:
The nature of the activities. The following activities generally do not qualify as support services, because the decree refers to these as core business operations: production, procurement, sales, marketing, product development and other R&D;
The relative scope of the support services within the group compared to the core business operations, based on a number of specifically mentioned factors;
The added value of the activities.
The costs concerned are the direct and indirect costs, and the overhead costs. These costs are further explained in the decree and also include financing expenses and extraordinary expenses, such as severance fees, reorganization expenses and wages in kind. A functional analysis carried out by the taxpayer must show which costs are relevant. Such a functional analysis is required as part of the transfer-pricing documentation requirements.
The matters set out above apply irrespective of which legal entity within the group carries out the support services. A "shared service center" is mentioned as an example.
Contract research
In certain situations in which group company A (service provider) concludes an agreement with group company B (principal) and develops intangible fixed assets for the account and risk of principal B (contract research), remuneration based on a cost-plus method will qualify as arm's-length remuneration.
According to the decree, A must carry out the contract research activities and B must manage these activities, bear the expenses and risks and become the beneficial owner of the resulting assets. The decree mentions the following aspects that are relevant to the management of these activities:
decision-making;
planning;
budgeting;
performance measurement;
remuneration;
adjustment/redefinition of areas of operation;
determining commercially valuable areas; and
assessing the likelihood that research will, or will not, be successful.
According to the decree, the question as to which party bears the risks will be answered on the basis of the terms of the contract, unless:
these are not divided between the parties in line with the functions performed, for instance if the principal does not have sufficient expertise or equity; or
it is clear that these conditions do not correspond with the functions actually performed.
The above picture is the most striking example of a contract research structure as mentioned in the decree. As per the Dutch Ministry of Finance this structure does not qualify for a cost-plus transfer-pricing method for the European Headquarters (EHQ) and Research & Development NL (R&D NL) company. In other words, the Dutch tax authorities in this case will seek to disallow Company A to enjoy the residual profits at the expense of the Dutch company, if only because Company B lacks R&D substance and expertise.
Diagram 1: Contract research |
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Cost contribution arrangements
The question has arisen whether the paragraph concerning CCAs in the "old" Transfer Pricing Decree is in accordance with the CCA chapter of the OECD Guidelines. The CCA paragraph is withdrawn by the decree so as to avoid any uncertainties or misunderstandings and refers to the entire CCA chapter of the OECD Guidelines. A CCA may thus be described as a contractual framework agreed among business enterprises to share the costs and risks of developing, producing, or obtaining assets, services, or rights and to determine the nature and extent of the interest of each participant in those assets, services or rights. In conformity with the OECD Guidelines, the decree implies that a participant's contribution to a CCA will be consistent with the benefits that such a participant expects to receive under the arrangement. Furthermore, each participant in a CCA would be entitled to exploit its interest in the CCA separately as an effective owner thereof, and not as a licensee, and so without paying a royalty or other consideration to any other party for that interest.
The decree states that, in principle, both the relative share of each participant in the contributions to the CCA and the relative share of each participant in the total expected benefits must be established on the basis of the fair market value. The above diagram shows an example of a qualifying CCA.
Both the Transfer Pricing Decree and the decree further note that some countries do not accept that a profit mark-up is charged, even though they do accept that a fee is charged for the equity used for the activities. According to the decree, the Netherlands will accept the choice of a particular method in certain other countries, provided that the result is in accordance with the OECD Guidelines.
The decree takes the position that CCAs that existed on March 30 2001 that have been approved or would have been eligible for approval under the OECD Guidelines and the additional regulations in effect at that time for interpreting the arm's-length principle, will continue to be treated as such for tax purposes until January 1 2007. According to the decree, the Dutch corporate income tax reform should by then have taken effect.
Diagram 2: Cost contribution arrangements |
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Arm's-length pricing for the transfer of intangible assets
The Transfer Pricing Decree states that, when intangible assets, such as patents, are transferred, it may be difficult to determine the value of those assets at the date of transfer, because there is insufficient insight into the future benefits and risks. Under certain circumstances, the Dutch Revenue will adopt the position that it is not in accordance with the arm's-length principle to agree on a fixed price in advance in such cases. In this respect, it is important whether or not independent third parties would include an adjustment clause in the transfer agreement.
The decree provides new rules, supplementing those in the Transfer Pricing Decree, for the case where:
an intangible asset is transferred to a non-Dutch group company; and
the greater part of the intangible (that is, more than 50%) is licensed back to the Dutch transferor company and/or to Dutch entities associated with this company.
In such cases, a price adjustment clause is deemed to have been agreed upon between the contracting parties. This can only be avoided if the taxpayer makes a prima facie case that:
there are business reasons for the transaction; and
the value can be determined at the time the agreement is concluded to such an extent that independent third parties would also have agreed on a fixed price.
A similar approach is prescribed in respect of payments that have already been taken into account in the price of a good or service.
Crediting withholding taxes
Under a "mixed" contract, a payment is received that covers both intra-group services and the use of an intangible asset (royalties). This is comparable to situations in which payments are made under a CCA (for example, contributions or buy-out payments). The decree notes that if, a non-Dutch tax authority withholds tax in violation of a tax treaty, such withholding tax will not be eligible for crediting against Dutch corporate income tax. The decree states, however, that the Netherlands will actively promote a swift completion of mutual agreement procedures with the non-Dutch tax authority concerned so as to avoid double taxation.
EC arbitration convention
It has been reported by the Netherlands Ministry of Foreign Affairs that all of the EU member states which were EU member states before May 1 2004 have deposited the instruments of ratification regarding the protocol of May 25 1999 extending the EC Arbitration Convention (Convention 90/436/EEC of July 23 1990 on the elimination of double taxation in connection with the adjustment of profits of associated enterprises). Accordingly, the protocol will be effective from November 1 2004.
Dutch tax climate
The decree lists a number of shareholder activities that do not qualify as intra-group services and thus do not need to be recharged. In addition, it states under what circumstances support services may be recharged without a mark-up. This will help in creating a favourable tax regime for Dutch trade and industry, partly by reducing the risk of double taxation. In addition, the concepts of contract research and cost contribution arrangements are explained and brought into line with the OECD Guidelines. A thorough functional and financial analysis will become even more important since, without such an analysis, it will be difficult to realize the benefits offered by the new decree. The Dutch transfer-pricing documentation requirements that took effect on January 1 2002 provide for such an analysis.
However, with respect to arm's-length pricing for the transfer of intangible assets, the decree states that, if at the time of the transfer there is insufficient insight into the future benefits and risks, a fixed price (without an adjustment clause) will, under certain circumstances, be deemed not to be at arm's length. Non-Dutch withholding tax on intra-group services that is withheld in violation of a tax treaty is not eligible for crediting in the Netherlands. The Netherlands will, however, actively pursue mutual agreement proceedings with the relevant non-Dutch tax authority, if the taxpayer initiates such a procedure. However, in practice, this may prove to be a lengthy and costly procedure for the taxpayer.
Dave Rutges
(rutges.dave@kpmg.nl)
Eduard Sporken
(sporken.eduard@kpmg.nl) and
Tjebbe Hoogcarspel
( hoogcarspel.tjebbe@kpmg.nl)
