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An update of this article is available: 2022 Tax plan: Preventing mismatches when applying arm's length principle.
On 4 March 2021 the Dutch Government presented a consultation document on proposed legislation that unilaterally addresses transfer pricing mismatches. Companies, advisors and other interested parties can respond to the proposal until 2 April 2021.
The purpose of the proposed legislation is to remove mismatches that arise as a result of the application of the arm's length principle that give rise to situations where profits of multinational companies remain untaxed. This principle ensures market-conform business profits. However, as not every country applies this principle (in the same way), there may be situations where the profits of multinational companies remain untaxed.
The proposed legislation may lead to a higher taxable profit in the Netherlands in situations where currently, on the basis of the arm's length principle, certain costs are taken into account in the Netherlands, for which there is no corresponding income recognised within the group. As a result of the proposed measures, the expense will not (or not fully) be taken into account if a corresponding amount is not taxed (or is taxed at a lower amount) as income at the level of the affiliated company. This will particularly occur if the affiliated party is established in another country. In this way, the measure aims to counteract tax planning that takes place through so-called informal capital structures..
The current tax law is based on the principle that affiliated entities must trade with each other on a commercial basis. This means that affiliated entities are expected to operate among themselves for tax purposes as independent entities would do under comparable circumstances. This principle is known as the arm's length principle.
In practice, however, it often occurs that entities do not trade with each other on a market-conform basis. Based on the current profit determination rules, the profit in such cases is corrected by adjusting the fees that the entities charge to each other for tax purposes in a manner that is market-conform. This goes both ways: if a fee is too low, it is adjusted upwards. But also vice versa: if a fee is too high, it is reduced to a market-conform lower amount. This may concern, for example, interest, rental or lease instalments, but also the price that is charged when assets (business assets, intellectual property, etc.) are transferred .
If a Dutch entity pays no or too little remuneration to an (often foreign) affiliated entity, then under the current legislation the Dutch entity may apply a remuneration at an amount that would be at arm's length (i.e. if the entities were not affiliated with each other). This can then lead to an (additional) deduction when determining the taxable profit in the Netherlands: a downward adjustment of the profit. Because the amount is not actually paid, a corresponding counterentry needs to be reflected in the bookkeeping of the paying entity. For tax purposes such a counterentry takes the form of an informal capital.
The proposed legislation stipulates that downward adjustments of profits in shareholding relationships are not allowed, insofar as the taxpayer does not make it plausible that a corresponding upward adjustment is included in the taxable income of the counterparty. In short, this means that in informal capital structures, the Netherlands does not allow deductions if the foreign country does not subject the corresponding benefit to tax. Consider, for instance, the deduction of the imputed interest in the case of an interest-free loan which, according to the case law of the Dutch Supreme Court, must be regarded as informal capital. A taxpayer wishing to benefit from a downward adjustment must demonstrate:
Furthermore, the proposed legislation addresses the double non-taxation that can occur when an asset is transferred from a foreign company to a Dutch company, with the transferring company taking into account a low(er) transfer price, while the acquiring Dutch company capitalises and depreciates the asset at a high(er) arm's length price. Under the proposed legislation, the activation of the asset at the higher price will not be taken into account in the Netherlands if the taxpayer does not make it plausible that a corresponding increase in profit tax has been applied at the level of the foreign transferring entity.
The planned date of the entry into force of the proposed legislation is 1 January 2022. The amendments that the proposed legislation brings are immediately applicable to the so-called informal capital structures in the cost sphere. An example of this is the imputation of interest costs in the case of an interest-free loan.
In order to have an impact on existing informal capital structures in the sphere of transferred assets, a provision has been proposed that aims to limit - under certain conditions - the depreciation on business assets transferred by another entity to the Dutch taxpayer in the five years preceding the first book year starting on or after 1 January 2022 (i.e. the intended date of entry into force of the proposed legislation). This restriction means that, with effect from financial years commencing on or after 1 January 2022, depreciation can no longer be based on the higher transfer price, but on an adjusted one. It is therefore important to note that certain existing informal capital structures are also affected by proposed legislation.
In a nutshell, a situation can arise that the Netherlands applies the arm's length principle and the other country does not, or not in the same way. In international situations, such a mismatch can lead to part of the profits of a group not being taxed. Although these situations are known and are in line with laws and regulations, their effect is no longer desirable for the legislator.
On 15 April 2020, the Advisory Committee on the Taxation of Multinationals ("Commission ter Haar") published the report ‘Op weg naar balans in de vennootschapsbelasting.’ (in English: "Towards a balance in corporate tax"). The report recommends a number of basic variants and a number of additional measures. In one of the basic variants, the Committee recommended not to apply the arm’s length principle if this principle leads to a reduction in the taxable profit in the Netherlands, insofar as the other country involved in the transaction does not include it in its base (informal capital).
Following this report, in the Offer Letter accompanying the 2021 Tax Plan package, the Dutch Government announced a separate bill amending the arm's length principle (tackling informal capital structures). The submission of this bill was scheduled for the spring of 2021. This has now happened with the publication of the Consultation Document.
Maarten de Wilde
Director, PwC Netherlands
Tel: +31 (0)63 419 67 89
Michel van Dun
Senior Manager, PwC Netherlands
Tel: +31 (0)61 042 11 99