The Netherlands Introduces Withholding Tax on Interest and Royalties

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The Netherlands enacted a new tax law in December 2019 to implement a withholding tax (WHT) on Dutch source interest and royalties to related entities in low-tax jurisdictions (LTJ) and in abusive structures, as of January 1, 2021.

This WHT is not intended to bring tax revenue. Rather, the WHT is intended to end international flow-through structures where the Netherlands is used as gateway for payments to LTJs; a study has shown that an estimated 22 billion euros ($24 billion) annually flows through the Netherlands to LTJs. The WHT is also intended to end structures causing tax base erosion through such payments.

The WHT potentially leads to taxation on Dutch source interest and royalties.

In short, the WHT will be imposed in three situations:

first, if accrued to an entity in an LTJ (which may be a low-tax jurisdiction or an EU blacklisted jurisdiction);
second, if accrued to an entity that is considered interposed to avoid the WHT and the structure cannot be considered to reflect economic reality;
third, if accrued to a hybrid entity (unless an exception applies).

The WHT is levied at the same rate as the (main) Dutch corporate tax rate, which is planned to be 21.7% for 2021 (25% for 2020). Where the WHT is due under Dutch domestic law, the WHT may be limited under an applicable EU directive or under an applicable tax treaty.

Any WHT due should be withheld by the entity paying interest or royalties. The WHT should be remitted to the Dutch tax authorities (DTA) by filing a tax return within one month after the calendar year in which the interest or royalties are deemed to have been received.

This WHT does not materially impact the dividend withholding tax (DWT) which already applies to beneficiaries of distributions on equity instruments of Dutch tax resident entities.

Qualifying Paying Entities and Qualifying (Related) Beneficiaries

Whether WHT is due depends particularly on whether interest and royalties have a Dutch source and are paid to related entities in an LTJ (or in abusive structures).

Dutch Source—Qualifying Paying Entities

The WHT potentially applies to interest and royalties with a Dutch source in the following situations:

first, if paid by a Dutch tax resident entity (incorporated under Dutch law or incorporated under foreign law but Dutch tax resident). The rules include a fiction that an entity incorporated under Dutch law is always deemed to be a Dutch tax resident entity;
second, interest and royalties are even considered Dutch sourced when paid by a foreign permanent establishment (PE) of a Dutch (deemed) tax resident entity;
third, interest and royalties are considered Dutch sourced if paid by a Dutch PE of a nonresident entity.

Threshold for Related Beneficiaries

Parties are related where the beneficiary holds a qualifying interest in the paying entity, where the paying entity holds a qualifying interest in the beneficiary, or if a third party holds a qualifying interest in both the beneficiary and the paying entity. Parties are also related where they do not hold a qualifying interest on a stand-alone basis, but do hold a qualifying interest together with other members of a so-called collaborating group.

A “qualifying interest” is defined as having such influence on the decision-making process of the entity that the activities of the entity can effectively be determined. Such influence will in any case be deemed present where the interest represents more than 50% of the voting rights. This threshold was chosen so that the WHT would only be evaluated under the EU freedom of establishment and would not need to be evaluated under the EU freedom of capital, which could make it more difficult to uphold the WHT in relation with non-EU third states.

Concept of Low-Tax Jurisdiction

The concept of LTJ means (i) jurisdictions that are blacklisted by the EU, and (ii) jurisdictions with no profit tax or a profit tax with a statutory tax rate of less than 9%.

The last published EU blacklist in the preceding year will be decisive.

The statutory rate of profit tax at October 1 of the preceding year will be decisive, i.e., the effective profit tax rate of the entity is irrelevant. Special tax regimes and territoriality of a tax regime can be ignored.

Each year, before year-end, the Netherlands will publish an exhaustive and binding list of LTJs for the next year.

For year-end 2019, the published list of LTJs for 2020 (relevant only to Dutch CFC rules for 2020) included: the U.S. Virgin Islands, American Samoa, Anguilla, the Bahamas, Bahrain, Barbados, Bermuda, the British Virgin Islands, the Cayman Islands, Fiji, Guam, Guernsey, the Isle of Man, Jersey, Oman, Samoa, Trinidad and Tobago, Turkmenistan, Turks and Caicos Islands, the United Arab Emirates, and Vanuatu.

For jurisdictions that qualify as LTJs and with which the Netherlands has concluded a tax treaty, a transitional period of three years will apply, meaning that the WHT will apply not earlier than 2024 for those LTJs. A three-year transitional period also applies for (treaty) jurisdictions that are put on the list in later years. The transitional period is intended to respect that the treaty parties could not previously consider this new WHT, and to allow the treaty parties to open negotiations. The Netherlands will aim for the possibility to effect the WHT also in treaty situations save for reductions in case of substantive business activities of the beneficiary.

Direct Beneficiaries (Including Hybrid Entities)

The DWT will be due by a beneficiary resident in an LTJ according to all circumstances, tax rules or other rules of that jurisdiction. The latter means that incorporation under the rules of an LTJ may imply the levy of WHT. An exception to DWT applies if the beneficiary is (also) considered tax resident in another jurisdiction which is not an LTJ and that considers the beneficiary as a taxable beneficiary for interest and royalties.

The WHT will also be due by a beneficiary resident in a jurisdiction which is not an LTJ if the interest or royalties are attributable to a PE of the beneficiary in an LTJ. This applies regardless of whether the income is effectively low-taxed or high-taxed (e.g., if the home jurisdiction of the entity only grants a tax credit for PE income).

The WHT may also be due in the case of payments to a related beneficiary through a reverse hybrid entity if the reverse hybrid entity is transparent from a Dutch perspective (so that the Netherlands sees a payment to the beneficiary behind the reverse hybrid) but is considered non-transparent in the jurisdiction of the beneficiary (so that the beneficiary is not taxed).

An exception applies if the reverse hybrid is considered non-transparent in its jurisdiction (so that there is taxable pick-up). In that case, the reverse hybrid entity may be considered as the beneficiary. The test whether the beneficiary is in an LTJ needs to be done in the jurisdiction of the reverse hybrid (and the same applies for the test whether there is an abusive structure).

The WHT may also be due in case of payments to a related beneficiary if the beneficiary is a hybrid entity, specifically if the beneficiary is considered non-transparent from a Dutch perspective (so that the Netherlands sees a payment to the hybrid entity) but is considered transparent in the jurisdiction of the beneficiary (so that the beneficiary is not taxed in its jurisdiction).

An exception applies if the hybrid entity is considered transparent in the jurisdiction of the related participants in the hybrid (so that there is taxable pick-up in the jurisdiction of the participants). In that case, the participants may be considered as the beneficiary. The test whether the beneficiary is in an LTJ needs to be done in the jurisdiction of the participants (and the same applies for the test whether there is an abusive structure).

Abusive Structures Through Intermediate Entities

If the qualifying beneficiary is not established in an LTJ, it should be reviewed whether the beneficiary should be considered abusive. A typical example would be a beneficiary in a jurisdiction which is not an LTJ which acts as a flow-through to a beneficiary in an LTJ. The possible abuse should be evaluated on the basis of a subjective test and an objective test: when both are met, WHT will be due.

For the subjective test, the decisive question is whether avoidance of Dutch WHT is the main purpose or one of the main purposes for the presence of the beneficiary in the structure. The subjective test will require a look-through approach to verify whether there would be a higher WHT to the indirect beneficiary in the financing structure (particularly if it would be in an LTJ). In case of multiple intermediate entities, the look-through approach would stop at the first entity in the financing structure that is in an LTJ (rendering the indication of abuse) or would stop at the first entity in the financing structure that is there based on valid business reasons (thus, not abusive, under the objective test).

For the objective test, the decisive question is whether the structure should be considered artificial because it was not set up for valid business reasons that reflect economic reality.

This will be the case if there is no economic activity in the jurisdiction of the beneficiary that justifies that interest or royalties flow through that beneficiary. Whether the burden of proof is on the entities or on the DTA depends on whether certain published “relevant substance requirements” are met at the level of the beneficiary. If so, the DTA would need to prove that the structure is nevertheless abusive. If not, the entities would need to prove either sufficient economic activities in relation to the interest or royalties or other valid business reasons for interposing the beneficiary.

The Dutch relevant substance requirements comprise the (usual) conditions that at least half of the board is composed of residents, the board members have the required professional knowledge, the company has qualified employees, the management decisions are taken in the residence country, the bank account is maintained there, and that the bookkeeping is maintained there. In addition, the entity should incur annual salary expenses relevant to the activity of at least 100,000 euros and the company should have its own office space at its disposal with the usual facilities for its functions for at least 24 months.

Concepts of Interest and Royalties

The concept of interest is very broad and interpreted economically. It includes remuneration in any form for making funds available through a loan. A loan is a debt arising from a loan agreement or an agreement comparable thereto, such as a financial lease. There is no exception to the WHT for interest which is non-deductible based on interest deduction limitations (e.g., anti-abuse or earnings stripping).

The concept of interest also includes costs related to loans such as handling and advisory fees. Furthermore, it also includes interest in the form of accrual or coupon interest. This means that WHT may also apply to zero-coupon loans (or loans issued with a lower than market interest) that were issued at a discount and that will accrue to nominal value.

The concept of royalties is fully aligned with the meaning of the concept under the most recent version of Article 12 of the Organization for Economic Co-operation and Development (OECD) Model Convention. Non-recurring payments can also qualify.

The interest and royalties potentially subject to WHT need to be determined on an arm’s length basis, meaning that WHT may also be due on interest and royalties that are not actually payable but that are only imputed on the basis of a transfer pricing correction.

Both interest and royalties are deemed to have been received at the moment that they:
(i) are paid or credited;
(ii) are made available for use by the recipient;
(iii) start to incur interest; or
(iv) become demandable and collectable (whichever comes first).

Moreover, interest and royalties accrued per year-end but not yet taken into account based on the foregoing criteria are deemed to have been received per year-end.

Basically, the WHT is levied on the basis of accrual. Interest and royalties already taken into account upon accrual basis are excluded when actually paid.

Rate of WHT and Tax Treaty Reduction

The WHT is levied at the same rate as the (main) Dutch corporate tax rate, which is planned to be 21.7% for 2021 (25% for 2020). If the paying entity takes the WHT for its account by paying the interest or royalties without WHT, there will be a gross up of the WHT due.

If the WHT is due under Dutch domestic law, it should be reviewed whether the levy is limited in whole or in part under an applicable tax treaty (or under an EU directive). In this respect, there will first be the three-year transitional period for (treaty) jurisdictions first listed as LTJs, during which the WHT will not apply. The tax treaty reduction may be particularly relevant thereafter.

The reduction may also be relevant where the WHT would be due in a deemed abusive structure with an intermediate entity in a jurisdiction that is not an LTJ. A tax treaty (or the EU Interest and Royalties Directive) may provide for reduction subject to the conditions thereof. Of course, reduction may be forfeited under a “principal purpose test” under a tax treaty, particularly after the multilateral instrument (MLI) takes effect. Finally, tax treaty reduction may also apply in cases where WHT is due for payments to hybrid entities. The WHT could be reduced if the tax treaty contains a specific look-through rule or a rule implementing Article 3 of the MLI.

Some Administrative Aspects

Any WHT due should be withheld by the paying entity when interest or royalties are deemed to be received by the beneficiary. The WHT should be remitted to the DTA upon filing a tax return within one month after the calendar year in which the interest or royalties are deemed to have been received. If WHT is not withheld and remitted, the DTA may levy WHT by tax assessment, and may choose whether to levy from the paying entity or the beneficiary.

Entities generally have some obligations to provide information to the DTA upon request, including information on or held by related entities. For WHT an additional obligation will apply to voluntarily actively report information upon discovery of previous omissions. This obligation, which elapses only after five years after the calendar year, needs to be fulfilled within two weeks after discovery.

Late remittance of WHT will be subject to taxation interest (currently 8%). Non-compliance with WHT or with the information requirements may be subject to penalties.

The DTA will have more possibilities than usual for collection of WHT as several parties may be held liable for WHT. This applies for directors of the paying entity, for the beneficiary as such, and for the directors of the beneficiary. Directors will have the possibility to excuse themselves if they can prove that they are not to blame for non-remittance.

Final Remarks

Although the WHT is not intended to bring tax revenue, it does involve additional legislation to be considered and an additional monitoring and administrative burden, particularly for issuers of financial instruments. Although sometimes it will be easy to recognize whether WHT is due (and the structure should be amended), other cases may be more difficult to recognize, e.g., hybrids, intermediates, collaborating shareholders. In any event, it is the paying entity that has an obligation to verify and keep record of the (non)applicability of the WHT.

The WHT is intended to end international flow-through structures to LTJs (and to limit tax base erosion). Flow-through structures to other jurisdictions are deliberately not subject to WHT, to avoid economic distortions and negative impact on the Dutch investment climate. However, these are now subject to more stringent rules through other initiatives against tax avoidance: for example, implementation of the MLI, introducing the principal purpose test, stricter advance tax ruling policy and transfer pricing policy, increased substance requirements and increased transparency and exchange of information.

The Netherlands recognizes that a unilateral measure such as the WHT could mean that such structures will not entirely end but will be routed through other jurisdictions to LTJs; e.g., through other jurisdictions that do not levy withholding tax on interest and royalties and that also have a beneficial tax treaty network with source countries. Luxembourg may be on the shortlist as an alternative, as Luxembourg seems able to meet both criteria. Nevertheless, the Netherlands considers the introduction of WHT an appropriate step against tax avoidance.

Although taking unilateral steps, the Netherlands also considers tax avoidance an international problem that should preferably be addressed on a coordinated international basis. Therefore, the Netherlands is actively participating in initiatives against tax avoidance, including the BEPS project, the MLI, and the work packages of the OECD for modernization of the tax system, i.e., Pillar One on amendment of the criteria for taxable presence and on amendment of profit allocation, and Pillar Two on measures aimed at multinational enterprises to pay a certain minimum level of tax (by countering low-taxed income with income inclusion, switch over from exemption to credit, non deductibility and/or withholding tax).

The WHT and Pillar Two have some common elements: in particular, the reference to the taxation of the beneficiary, and the sanction of WHT on undertaxed payments. There are also differences, such as the focus on the statutory tax rate rather than on the effective tax rate, which was considered too complicated for the current practice. The method for determining the effective rate and the required level of minimum taxation are indeed among the many open points of Pillar Two. In any event, the work on Pillar Two is ongoing and the OECD has set an ambitious time frame. The Netherlands have expressed an interest in continuing to be actively involved therein.

Martijn Juddu is a Senior Associate with Loyens & Loeff N.V. (Amsterdam).

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.