Netherlands Releases New Permanent Establishment Decree

On July 1, 2022, the Netherlands published its decree on profit allocation to permanent establishments, or PEs. This decree replaces the previous decree (dated Jan. 15, 2011) on profit allocation to PEs. The aim of the new decree is to provide clarity about the way in which the Dutch Tax Authorities (DTA) determine and evaluate the allocation of profit to PEs.

The DTA’s policy has always been focused on applying the arm’s length principle when attributing profit to a PE. The country where the PE is located is allowed to tax its profits to the extent that they are attributable to the PE. How much profit is attributed to the PE depends on the functions performed, assets used, and risks borne—all of which must be documented.

The new decree applies both to the PE of a foreign company operating in the Netherlands and to a Dutch taxpayer with a PE abroad. Before I list the main changes introduced by the new decree, I will summarize the DTA’s approach to the attribution of profits to PEs, under both the old and new decrees:

• The DTA apply the Organisation for Economic Cooperation and Development’s (OECD’s) functionally separate-entity approach.
• The DTA consider the capital allocation method as the preferable authorized OECD approach to attribute equity and debt to a PE.
• The DTA consider the fungibility approach as the preferred authorized OECD approach regarding the allocation of funding costs to a PE.
• The DTA only allow a charge of internal interest between a head office and a PE in instances of certain treasury functions. However, the existence of such a treasury function does not automatically imply a deemed internal interest (tax deduction).
• A PE’s deemed royalty fees, based on a head office allocation, may be tax deductible for Dutch corporate tax purposes, assuming such allocation is in accordance with the functional analysis.

Authorized OECD Approach

The 2010 OECD report, confirmed the functionally separate-entity approach as the authorized OECD approach (AOA). The DTA also confirmed this approach in both the 2011 and 2022 decrees. This AOA approach contains the following steps for companies to take:

• The attribution of assets, risks, and capital to the PE based on a functional analysis. In this first step, in general, the assets and risks must be attributed to the place where the “significant people functions” are performed.
• The attribution of the PE’s profits based on the functional analysis and application of the arm’s-length principle. For this second step, companies should apply the applicable transfer pricing method under the OECD transfer pricing guidelines. With respect to allocation of interest expenses to the PE, the DTA prefers the fungibility approach.

Equity and Interest Allocation

The DTA consider, with respect to the attribution of interest expenses to a PE (based on the PE’s functions, assets and risks), the capital allocation method to be the preferable AOA.

Example of the capital attribution method, per the 2011 decree

Let’s assume, as an example, that the balance sheet of an enterprise as a whole has debits of 400 (comprising assets) and credits of 400 (comprising equity of 150 and debt of 250).

The AOA first requires that assets are attributed to the PE. Where, on the basis of an analysis of the enterprises’s significant people functions, the assets to be attributed to the PE amount to, say, 200, then financing for an amount of 200 must be attributed to the PE.

It is only where the enterprise is not financed at arm’s-length, and consequently has a (too) high interest burden, that the DTA will forego this comparison and allow the thin capitalization approach.

Furthermore, the DTA prefer the fungibility approach to determine the PE’s arm’s-length attribution of the funding costs. In this approach, the total interest cost of the whole enterprise is attributed on a pro rata basis to the PE, and the historic link with the loan is of no importance.

Dependent Agency PE

Based on the 2011 and 2022 decrees, the DTA generally would not allocate separate, additional profits to a dependent agency PE of a foreign principal, provided the agent receives an arm’s-length remuneration for the services performed. The DTA seem to advocate the single taxpayer approach. Under this approach, in all circumstances, the payment of an arm’s length reward to the dependent agent PE fully extinguishes the profits attributable to the dependent agent PE.

There are nevertheless several other countries, such as France, Italy and Spain, that seek to allocate substantial additional profits to a dependent agent PE. This may create double taxation if the Netherlands, as the country where the head office is located, has an opposing view. Such double taxation might be resolved under the applicable income tax treaty/arbitration convention.

New Decree

The most important changes in the new decree relate to the base erosion and profit shifting (BEPS) project of the OECD and the object exemption, introduced in 2012 in the Corporate Income Tax Act. In addition, a number of editorial changes have been made, and references to other decisions and documents have been updated. Below is a brief overview of the three most important changes.

Risk allocation, control over risk

The decree refers to the updated 2022 OECD transfer pricing guidelines. Specifically, the new decree refers to the fact that control over risk consists of the decision-making power to seize, postpone, or reject a high-risk opportunity and the ability to make decisions about whether and how to follow up on such an opportunity. It is noted in the decree that it is important that both the PE and the company have the capacities to do this and that they also perform it functionally.

Object Exemption

With effect from Jan. 1, 2012, the object exemption was introduced in the Dutch Corporate Income Tax Act for (foreign) PEs. This object exemption for foreign corporate profits eliminates both the positive and negative results of the foreign PE from the worldwide taxable profits of a Dutch taxpayer. For the attribution of profit to PEs in treaty situations, the applicable article in the treaty is relevant. For the attribution of profits to PEs in non-treaty situations, one must refer to the most recent text of Article 7 of the OECD Model Tax Convention.

Double Non-taxation

If and insofar as a taxpayer makes different choices in the profit allocation in the countries concerned that lead to a part of the profit of the PE not being subject anywhere to corporate tax, the DTA may deviate from its policy and arrive at an outcome that does not result in any double non-taxation.

Final Observations

The new decree provides an explanation of the way in which the DTA assess the profit allocation to PEs. The number of substantive changes in the new decree compared to the decree of Jan. 15, 2011, is limited. The amendments to the new decree mainly consist of a new section on the object exemption already introduced on Jan. 1, 2012, and a response to international developments, such as the amendments to the OECD transfer pricing guidelines. Most of the other changes concern editorial matters and updated references to other decisions and documents.

It should be noted that companies having a Dutch local file on intercompany transactions must also document any and all PE profit allocations. Also, it remains possible to request a preliminary consultation with the DTA to obtain certainty in advance in respect of the profit attribution to a PE.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Eduard Sporken is a director at Meijburg & Co.

The author may be contacted at: sporken.eduard@kpmg.com