Netherlands 2012 Budget - Impact on Dutch Inbound M&A

On April 14, the 2012 tax policy document of the Dutch Ministry of Finance was issued. Recently, Dutch State Secretary of Finance Mr. Weekers provided answers1 to questions raised by Dutch parliament on the tax policy. The Agenda contains the following four corporate income tax measures that, if approved by Parliament, would enter info effect on January 1, 2012.

1. Reduction of the corporate income tax rate

The agenda contains a proposal to reduce the corporate income tax rate to 24% (from the current 25% rate).

2. Limitation of deduction for leveraged acquisitions 

The most common structure for a Dutch inbound acquisition is to leverage a Dutch holding company, which then purchases the shares in a Dutch target. Under a Dutch tax consolidation, the interest at the holding company is effectively offset by the profits of the target.The Fiscal Agenda proposes the following measures to counter the above offset:

• Interest on the first € 500,000 remains fully deductible;
• Interest on the amount exceeding € 500,000 would be subject to the following limitations:
  • If a debt to equity ratio of 3:2 is exceeded, the interest will only be deductible against the purchasing entity’s own taxable income (and not against the consolidated income); 
  • Interest expense not deducted in a given year can be carried forward and utilized against the purchasing entity’s own taxable income in future years.
• Structures with a tax consolidation established prior to 2007 will likely be grandfathered, but this is not entirely clear yet.

With respect to the debt-to-equity ratio calculation the following should be taken into account:

• The difference between the outside basis (purchase price of target company) and the inside basis (of the assets of target company) will reduce the consolidated tax equity. This goodwill deficit can severely impair the equity available for the debtto-equity calculation. Mr. Weekers has indicated that this may be remedied through a 10-year phased write down of the goodwill.
• Debt present at the target company must also be included in the calculation. This likely will be a discussion point in Parliament since more then just excessive acquisition debt is affected.
• The debt-to-equity ratio applies equally to internal and external loans.

3. Exemption from foreign source PE generated income

A cornerstone of the Dutch corporate income tax system is the Dutch participation exemption. It provides a full exemption for qualifying dividends from and capital gains on foreign and domestic subsidiaries. Capital losses are not deductible, but as a special exception, liquidation losses are deductible. Similarly, foreign source income generated through permanent establishments (PE) are also exempt from Dutch tax. However, the PE exemption mechanic has an anomaly in that losses of PEs are deductible against Dutch source income (under application of a recapture provision). This anomaly now will be corrected where all PEs results (either profit or loss) are excluded from the Dutch head office taxable base. Similar to liquidation losses for subsidiaries, losses realized upon termination of a PE remain deductible. Currency exchange and translation results remain a part of the Dutch taxable base, but can easily be avoided by applying the foreign currency as functional currency for the Dutch tax payer/head office (most commonly applied when all activities are conducted through the PE). It is expected that the issue of currency translation results will be further discussed in the Parliamentary debate. Under the Dutch participation exemption, the subject to tax test for subsidiaries has been let go. As a result, it is now possible to have shareholdings in qualifying companies that are not subject to tax (in absence of corporate income tax, such as a number of Middle Eastern countries, under a tax holiday or reversed hybrids) qualify for the participation exemption. In alignment with these rules, the subject to tax requirement for PEs will also be eliminated (but for passive financing PEs, the current credit system will remain in place).

4. Expenses for generation of exempt income; Bosal leak 

The Fiscal Agenda mentions that further focus will be on the Bosal leak. Under the 2003 European Court of Justice Bosal’s case,² interest associated with loans used for equity investments into participation exemption subsidiaries was ruled deductible. In response, the Dutch legislator enacted thin capitalization and anti-base erosion legislation in order to close that budgetary leak. The legislator is contemplating revisiting this legislation, but neither the Fiscal Agenda nor the aforementioned answers to Parliament contain specifics.

Going forward

A bill containing the legislative proposal and commentary to the suggested legislative changes is expected to be released on September 20 as part of the presentation of the 2012 budget. During parliamentary proceedings, the above measures can be further amended or enhanced. It is expected, though, that any final legislation would become effective January 1, 2012.

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Letter of August 16, 2011 to the Chairman of the Second Chamber of Parliament , reference number AFP2011/532 

²2003 case of Bosal Holding BV vs. staatssecretaris van Financien (C-168/01)