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The Netherlands Tax Treatment of Subsidiaries with Special Reference to Credit Regimes

European taxation, 2009, p. 235 – 240.

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This article investigates the Netherlands tax treatment of subsidiaries in the light of EC law and from the perspective of the Common Market. In this regard, the article focuses on the new Netherlands credit system and its compliance with EC law, especially regarding the rules determined by the European Court of Justice in Cadbury Schweppes, Test Claimants in the FII Group Litigation, Meilicke, Columbus Container and Test Claimants in the CFC and Dividend Group Litigation.

1. Introduction
Initially, the author provides an overview of the Netherlands tax treatment of subsidiaries (see 2.). Thereafter, he elaborates on the technical aspects of the credit regimes, including Netherlands “controlled foreign company” (CFC) rules (see 3. and 4.). Finally, the author analyses whether or not the Netherlands tax treatment of subsidiaries, including the participation exemption, complies with EC law and agrees with the objective of the Common Market (see 5.). The author does not address in detail the technical aspects of the Netherlands participation exemption, as this has been done many times.1

2. Treatment of Subsidiaries – General Overview
Traditionally, there were two possible tax treatments of income and gains from subsidiaries, i.e. either full exemption or full taxation, the latter with only a credit for withholding taxes. From 2007, the Netherlands has, however, introduced two new possibilities, i.e. a fixed credit for deemed underlying taxes and an ordinary credit for real underlying taxes. In this regard, the following Schedule indicates which regime applies.
<Schedule>

It is outside the scope of this article to provide a detailed answer to all of these questions. Briefly, in general, a shareholding is a shareholding in a subsidiary if at least 5% of the nominal share capital in a company or corporation is held. Smaller shareholdings may qualify in certain circumstances. Interests in other types of entities may also qualify. A subsidiary is a low-taxed passive subsidiary if its assets consist of for more than half of a (deemed) passive nature and its tax burden is less than 10% of the taxable profit calculated using Netherlands rules and its assets consist of less than 90% real estate assets.A subsidiary that is subject to taxation but receives only exempt income benefits from a tax holiday or any other (special) regime that results in a zero tax bill is not considered to be effectively subject to taxation. Only taxation by the state in which the subsidiary resides is taken into account for the purposes of the 10% tax burden test.

3. Treatment of Subsidiaries – The Credit Regimes

3.1. Introduction
There are two credit regimes, i.e. a fixed credit that assumes an underlying tax of 5% and a real credit in respect of underlying tax. The Netherlands legislator has reduced the scope of the credit in respect of the real underlying tax to situations falling within the scope of the EC Parent-Subsidiary Directive.3

3.2. Calculation of the credit – in general
Under both credit regimes, the credit is not a full credit, but, rather, an ordinary credit maximized to the Netherlands corporate income tax attributable to the income or gain less the related expenses. In addition, under both credit regimes, the credit for underlying tax can be claimed together with a credit for withholding tax. A credit for foreign withholding tax on dividends is an ordinary credit and the credit for Netherlands withholding tax on dividends is a full credit.4 If the participation exemption applies, the foreign withholding tax cannot be credited and cannot even be deducted as an expense.5
In addition, if the participation exemption applies, a Netherlands subsidiary can distribute a dividend without withholding tax.6

There is no special provision dealing with the coincidence of a credit for underlying tax and a credit for with- holding tax. On the basis of the wording of the law on the credit for underlying tax, the credit for underlying tax should first be calculated. The corporate income tax taken into account in this calculation is the corporate income tax before any credit for withholding tax. Thereafter, the credit for (foreign) withholding tax must be calculated. The way in which a credit for foreign withholding is calculated depends on the wording of the tax treaty with the source state. Generally, the amount of the credit is the lesser of (1) the foreign withholding tax and () the amount of the Netherlands tax attributable to the dividend less related expenses.7 Example 1 illustrates how the credit works and the effect of maximizing the credit to the Netherlands corporate income tax attribut- able to the grossed up dividend less related expenses.
<example>

3.3. EU subsidiaries – underlying tax
The Netherlands legislator created a very narrow window to credit the real underlying tax. The possibility is almost limited to the situations in which the EC Parent- Subsidiary Directive prescribes that either an exemption or a credit for underlying tax is given. This means that the subsidiary and the parent must meet most of the requirements of the EC Parent-Subsidiary Directive, i.e.:8

– the subsidiary must be a resident in a Member State;
– the subsidiary must not be considered to be a resident of a third country under a tax treaty between the Member State of residence and the third country;
– the subsidiary must be subject, without the possibility of an option or of being exempt, to a tax referred to in Art. 2 of the EC Parent Subsidiary Directive; and
– both the parent and the subsidiary must have a legal form as stated in the annex to the EC Parent-Subsidiary Directive.

The minimum holding period requirement and the minimum participation requirement as included in the EC Parent-Subsidiary Directive do not apply. Instead, the shareholding must be a subsidiary for Netherlands pur- poses (see 2. for the definition of a subsidiary). It also appears that the legislator made a minor error. The law stipulates that the parent must not be considered to be a resident of a third country under a tax treaty between the Member State of residence and that third country. The law does not, however, explicitly state that the parent company must be a resident of a Member State. This appears to be contradictory. In theory, it is feasible that a parent company with a residence in a third country and a permanent establishment (PE) in the Netherlands has a legal form stated in the annex. It is, therefore, unclear as to whether or not in that situation a credit for the real underlying tax can be obtained.

The amount of tax that can be credited, in respect of dividends from qualifying EU subsidiaries, is the amount of tax attributable to the dividend. The burden of proof lies with the taxpayer. Not only the amount of tax paid by the direct subsidiary is taken into account, but also the amount of tax paid by its subsidiaries and indirect sub- sidiaries, provided that these meet the requirements of the EC Parent-Subsidiary Directive on residency, legal form and liability to tax and provided a 5% interest is held.9

This raises various questions, including the following. Can the amount of creditable tax exceed 10% of the grossed up dividend? The wording of the law does not preclude this. This appears to be unusual, as, if the tax burden is at least 10%, it could be expected that the parti- cipation exemption would apply. There are, however, two differences between the calculation of the creditable tax and the calculation of the tax burden for the participation exemption. First, the calculation of the creditable tax is, in principle, the amount of tax that was actu- ally paid on the commercial profit that is distributed and the 10% tax burden test is based on the tax burden on the taxable profit of the subsidiary calculated by Nether- lands tax rules. As a result of difference between commercial and taxable profit, for example, non-deductible expenses, the tax burden could be greater than 10% of the commercial profit, but less than 10% of the taxable profit. Second, the calculation of the creditable tax relates to the profit that is distributed. The tax burden test refers to all profits. Accordingly, it appears that the creditable tax can exceed 10% of the grossed up divi- dend.

Is only the tax due in the country of residence of the subsidiary be taken into account or also tax paid in other countries? The wording of the law does not exclude that tax paid in other countries can be credited as well. The explanatory notes as well as the debate in Parliament did not address this issue, and neither does the policy decree on participation exemption and credit regimes.10 Given the wish to comply with the EC Parent-Subsidiary Dir- ective, it could be expected that it is not intended to give a credit for taxes paid by the subsidiary outside the European Union. The wording of the law does not, however, state a restriction and, if the wording of the law is clear, generally the wording of the law is followed.

How to deal with domestic and foreign withholding taxes that were credited by the subsidiary against its corporate income tax liability? Domestic withholding taxes are, in principle, regarded as a “pre-levy”, i.e. the amount of domestic withholding tax that is credited is regarded as profit taxation paid by the subsidiary. For Netherlands domestic taxpayers, Netherlands withholding taxes and income taxes are an integrated system and, generally, a similar foreign system is treated in the same way. The treatment of foreign withholding taxes may be different, especially regarding the amount of surplus that can be carried forward. The question is, therefore, whether or not a foreign withholding tax is regarded as taxation on profits. In the author’s opinion, it is, as it taxes a gross profit derived within a certain country. There are, how-ever, different opinions on this matter.

How to deal with distributions of pre-acquisition profit reserves? In the author’s view, the amount distributed and the underlying tax should be taken into account. At the same time, the book value of the subsidiary should, however, be reduced accordingly. This reduction is a deductible item and, therefore, the sum of the distribu- tion and the reduction is (approximately) nil. As the credit is limited to the Netherlands corporate income tax on the distribution less related expenses, no actual credit is granted in this situation.

4. Treatment of Subsidiaries – CFCs
Various sources state that the Netherlands does not have CFC legislation.11 This is true in the sense that the Netherlands does not have legislation that attributes the income of foreign subsidiaries to a Netherlands parent. The Netherlands does, however, have legislation that has a comparable effect. Specifically, under certain circum- stances, a Netherlands parent must annually revalue the shareholding in a subsidiary to fair market value. The amount of revaluation is part of the taxable profit of the Netherlands parent. The revaluation is obligatory in the following circumstances:1

– the subsidiary is a low-taxed passive subsidiary;
– the parent holds alone or together with related parties an interest of at least 25%; and
– 90% of the direct and indirect assets of the subsidiary are free passive assets.

The revaluation is taxable profit. The amount must be grossed up by multiplying it by 95/100, unless the subsidiary is not effectively subject to taxation on its profits. The Netherlands taxpayer can apply a deemed credit for 5% underlying tax, unless the subsidiary is not effectively subject to taxation on its profits. The real underlying tax cannot be credited, even by EU subsidiaries.

Revaluation cannot be avoided. Even if the subsidiaries distribute its entire profit immediately after closing the year, the law still requires a revaluation every year-end. There is also no motive test or test on economic reality.

The annual revaluation reduces the possibilities to credit the real underlying tax for dividends. First, a revaluation must be taken into account (5% credit, subsequently a dividend and depreciation for a similar amount). This is illustrated in <Example 2>.

In practice, however, the effect may be limited. The credit available in year is greater if in year the subsidiary is profitable and an upward revaluation must be taken into account. If the upward revaluation equals depreciation, the maximum of the corporate income tax attributable is equal to the corporate income tax on the grossed up div- idend.

5. EC Law

5.1. Recent ECJ case law

On the basis of the European Court of Justice (ECJ) decision in Test Claimants in the FII Group Litigation,13 Meilicke14 and Columbus Container,15 the author concludes that the ECJ finds a credit system to be a sufficient equivalent to an exemption system for dividends and profit attribution. The author can see the logic if a com- parison is made between domestic and foreign dividends. Under a credit system, taxation in the country of the parent company does not result in a higher tax burden on foreign dividends than on domestic dividends, assuming that expenses and withholding taxes are also treated equally.

On the basis of Cadbury Schweppes16 and Test Claimants in the CFC and Dividend Group Litigation,17 the author also concludes that CFC legislation is only permitted if the subsidiary is not really established in the other Member State and/or if it does not employ real economic activities in that state. The threshold is quite minimal and it is sufficient if the place of effective management is located in that Member State. It could, however, be argued that a similar German regime was permitted in Columbus Container. The author is of the opinion that this is not the case, as the way in which the German court posed the question was such that the acceptability of CFC was not in question and the question only related to credit or exemption.18

The author also considers that it is important to appreciate that the ECJ did not rule on a situation regarding the taxation of capital gains. It may be tempting to argue that the case law on dividends also applies to capital gains, but such an extrapolation is, in the author’s opinion, not self-explanatory. Generally, in a credit system, capital gains on shares are fully taxed or taxed insofar the gain relates to hidden reserves (goodwill). It is more difficult to argue that, in such a situation, a credit system is equi- valent to an exemption system. Many also, legislators as well as scholars, recognize that a capital gain is a different type of benefit to income and requires a different tax treatment.

5.2. Netherlands system compliant with EC law?

Before 2007, it was all or nothing, i.e. either an exemption applied or there was full taxation, the latter resulting in accumulated taxation if the subsidiary also paid tax. From 2007, there are two “in-between flavours”, i.e. a fixed credit and a real credit for underlying tax. This fixed or real credit is an improvement in situations in which full taxation used to apply.

Prima facie, the Netherlands rules appear to be compliant with EC law. In particular, there are no rules that treat a foreign investment as such worse than a domestic investment. The anti-abuse provisions apply to both foreign and domestic subsidiaries. For dividends from qualifying EU subsidiaries, an exemption or a real credit is given.

Following a closer examination, the author, however, has certain doubts. The Netherlands anti-abuse rules do not include a case-by-case approach, as required by the ECJ.19 And although the anti-abuse rules apply also to Netherlands subsidiaries, this only has an effect in a limited number of situations, i.e. Netherlands exempt investment funds, Netherlands 0% rate investment funds, Netherlands companies applying the royalty box special regime 20 and possibly also Netherlands companies with foreign real estate or a foreign PE. In all other situations,21 the tax burden of a Netherlands sub- sidiary satisfies the 10% tax burden test. In other words, “ordinary Netherlands subsidiaries” always pass the test. “Ordinary foreign subsidiaries” may fail the test, even if the nominal tax rate exceeds 10% and no special exemp- tions apply. For example, this may be the case if a timing difference applies, if under Netherlands law certain special rules on depreciation would apply (if the subsidiary were resident in the Netherlands) or if certain items are deductible abroad and not under Netherlands rules. The investment in such foreign subsidiary could still, how- ever, be a bona fide investment that should not be regarded as abusive.

Another problem is whether or not the Netherlands has correctly implemented Art. 4(1a) of the EC Parent-Subsidiary Directive. This clause refers to tax transparency. The Netherlands CFC rules do not treat a subsidiary as tax transparent and do not assess the subsidiaries profit at the level of the parent company in a formal way. The Netherlands CFC rules have, however, a similar effect. The ECJ has held previously that, although a tax may have a different name, substance over form may result in taxation being disallowed 22. Accordingly, it could be argued that, under the Netherlands CFC rules, a credit for real underlying tax should be granted if the sub- sidiary is a qualifying EU subsidiary.

The Netherlands CFC rules may also make it impossible to obtain, in practice, a credit in respect of real underlying dividends (see Example in 4.). Specifically, each year, the profit of the subsidiary results in a taxable reval- uation with regard to the parent company. If, in the sub- sequent year, the profit is distributed, this reduces the value of the subsidiary. In fact, this results in a similar sit- uation as “purchased dividends”. The dividend does not add to the taxable profit, as, at the same time, there is a deductible devaluation. This can be regarded as being contrary to Art. 4 of the EC Parent-Subsidiary Directive. Accordingly, it may be that the Netherlands CFC regime is not fully compliant with EC law.

The Netherlands credit regimes differentiates between dividends and capital gains. In practice, the credit regimes apply in more situations with regard to foreign subsidiaries than for domestic subsidiaries, where more often the exemption system applies. In the author’s view, it should not make a difference as to whether the parent company receives its benefits through dividends or through capital gains. A sale of shares may result in the loss of credits, as the seller cannot apply the credit for real underlying taxes and the purchaser cannot apply a credit at all due to the purchased dividend treatment.

Finally, the Netherlands treatment of foreign withholding taxes on dividends is not compliant with EC law. With regard to domestic withholding tax, a full credit is given that does not affect the credit for underlying corporate income tax. In the author’s opinion, withholding taxes on dividends from EU subsidiaries should qualify for the same treatment, unless EC law requires that the source Member State grants a full refund to the foreign parent.

5.3. The Common Market perspective

With regard to the Common Market, taxation should be neutral, i.e. taxation should not distort investment allocations between the Member States. Generally, the author is of the view that implementing credit systems between full taxation and full exemption can be regarded as an improvement from the Common Market perspective. Specifically, this offers the possibility of a more precise tax treatment.

The author considers that several markets can be distinguished. There is a market for investment funds, not being real estate funds, for raising investment capital. In this market, the treatment of investment in Netherlands and foreign funds is basically the same. If they benefit from a favourable tax regime, the participation exemption does not apply and the credit method applies, and, if an interest of at least 25% is held, the Netherlands CFC rules apply. In these situations, there is capital export neutrality (CEN). In the author’s view, CEN is a better option than capital import neutrality (CIN), if it concerns liquid investments and not participations in local enterprises.24 Accordingly, in the author’s opinion, in this respect the Netherlands rules are acceptable from the Common Market perspective.

There is also a market for individual asset management. Also here, the author thinks that CEN should be preferred over CIN. Specifically, if an asset manager could offer a higher net return even if he makes a lower gross return, due to tax benefits in his state of residence, this would assist underperforming asset managers and, therefore, distort the choice of asset managers. If the rules applying to the investor result in CEN, the tax burden on the return on liquid investments would always be the same and the level of taxation in other countries would be irrelevant.

There is also a real estate market, both in funds and asset management. Real estate is primarily competition in local markets, i.e. properties compete with neighbouring properties. Real estate is an investment that uses more local government services than other investments. Accordingly, with regard to real estate investments, CIN is preferable. In order to avoid discouraging investments by foreigners, each investor should have the same tax burden on net rental income and net capital gains.5 The Netherlands rules are intended to apply CIN (an exemp- tion) to foreign real estate companies. The threshold of 90% real estate is, however, very high, so that there are many situations in which CEN may apply to real estate subsidiaries instead of CIN. The Netherlands rules on valuation and depreciation of real estate also differ materially from what is common in other Member States. Consequently, subsidiaries with more than 50% but less than 90% passive foreign real estate may not qualify for the Netherlands participation exemption, even if they are normal companies subject to a nominal tax rate exceeding 10%. This may favour investments in Nether- lands real estate. Accordingly, in this respect, the Nether- lands rules could be improved. For instance, it could be considered to include a rule that real estate is deemed not to be a passive asset.

Finally, there is the situation of group finance entities. Certain group finance assets are deemed to be “true passive assets”. The author states that a real group finance company is, in practice, not an entity competing with others. As a result, from the Common Market perspec- tive, the tax treatment is not so relevant, as it cannot really distort competition between group finance entities.

For the sake of completeness, the author would like to state that, in general, intermediary holding companies do not fall within the Netherlands credit regimes and the Netherlands CFC rules, but, rather, under the exemption system. In particular, intermediary holding companies holding active subsidiaries generally have sufficient good direct and indirect assets. This is often even the case if the intermediary holding company holds excess liquidities and or receivables on its subsidiaries.

6. Conclusions

In 2007, the Netherlands changed its rules regarding the tax treatment of subsidiaries. An important element is that, next to an exemption and full taxation, a deemed credit and a real credit regime now exist. In the author’s view, the Netherlands system has improved. Nevertheless, in certain specific situations, the Netherlands rules may not be compliant with EC law and/or not result in what, in the author’s opinion, is best from the Common Market perspective.

Notes.

1. For example, see M.V. Lambooij and S. Peelen,“The Netherlands Holding Company – Past and Present”, Bulletin for International Taxation 8/9 (2006), pp. 335-343.
2. Art. 1 Wet op de vennootschapsbelasting 1969 (CITA).
3. ouncil Directive 90/435/EEC, as amended by Council Directive 2003/123/EC.
4. Art. 13aa and Art 23c CITA.
5. Art. 10(1)(e) CITA and Art. 36(1) Besluit voorkoming dubbele belasting 2001.
6. Art. 4 Wet op de dividendbelasting 1965.
7. In the absence of a tax treaty with the source state, the credit is only granted if the source state is listed as “developing country”. No Member States is listed as such.
8. Art. 23c(3) CITA.
9. Art. 23c(4) CITA.
10. Parliamentary dossier 30 572 and Decree 2008/257M.
11. For example, IBFD, Europe – Corporate Taxation, 12.4
12. Art. 13a CITA.
13. ECJ, 12 December 2006, Case C-446/04, Test Claimants in the FII Group Litigation v. Commissioners of Inland Revenue, Paras. 33-74.
14. ECJ, 6 March 2007, Case C-292/04, Wienand Meilicke, Heidi Christa Weyde, Marina Stöffler v. Finanzamt Bonn-Innenstadt, Paras. 14-21.
15. ECJ, 6 December 2007, Case C-298/05, Columbus Container Services BVBA & Co. v. Finanzamt Bielefeld-Innenstadt, Paras. 26-57.
16. ECJ, 12 September 2006, Case C-196/04, Cadbury Schweppes plc, Cad- bury Schweppes Overseas Ltd v. Commissioners of Inland Revenue, Paras. 29-75.
17. ECJ, Order, 23 April 2008, Case C-201/05, The Test Claimants in the CFC and Dividend Group Litigation v. Commissioners of Inland Revenue, Paras. 70-86.
18. ECJ, 6 December 2007, Case C-298/05, Columbus Container Services BVBA & Co. v. Finanzamt Bielefeld-Innenstadt, Para. 25.
19. ECJ, 12 September 2006, Case C-196/04, Cadbury Schweppes plc, Cad- bury Schweppes Overseas Ltd v. Commissioners of Inland Revenue, Para. 55.
20. If the interest box special regime applied, a subsidiary applying this regime may also fail the 10% tax burden test. In the author’s opinion, it is, how- ever, unlikely that this special regime, in its current form, would apply.
21. There is some uncertainty as to how to deal with foreign taxes, especially foreign taxes in relation to foreign real estate or a foreign PE in respect of the 10% tax burden test. Depending on how the test must be applied, a Nether- lands company with foreign real estate or a foreign PE may fail or never fails.
22. ECJ, 4 October 2000, Case C-294/99, Athinaiki Zithopiia AE v. Elliniko Dimosio (Greek State), Para. 27.
23. In principle, the Netherlands subsidiary can abstain from withholding tax on a dividend if the parent can apply the participation exemption. If, how- ever, tax is withheld, the full credit applies.
24. F.P.J. Snel, “Systems to prevent accumulation of taxation in parent-subsidiary relationships”, Intertax 005-11, pp. 59-50.
25. Id.