Consultation on legislative changes of the arm’s length principle rules and introduction of reverse hybrid rules (ATAD2)

On 4 March 2021, the Dutch Ministry of Finance presented two legislative proposals for consultation. The first legislative proposal consists of rules aimed to unilaterally neutralize certain mismatches which arise under the application of the at arm’s length principle. This legislative proposal intends to implement the broadly politically accepted recommendations of the advisory committee taxation of multinationals. This advisory committee was established by the Dutch Ministry of Finance in order to investigate ‘how multinationals can pay taxes more fairly in the Netherlands’.
 
The second legislative proposal relates to amending the reverse hybrid rules, thereby implementing the last part of ATAD2 requiring EU Member States to include certain provisions combating hybrid structures and payments. The main part of the ATAD2 rules have been included in the domestic laws of the Member States as from 1 January 2020 (see our tax alert of 19 July 2019), except for the reverse hybrid rules which should apply from 1 January 2022.
 
Summary of the consultation proposals
 
At arm’s length principle
Based on the current Dutch tax rules, the same terms and conditions must be applied to transactions between affiliated entities, as would be applied between non-affiliated entities under similar circumstances. (the so-called “arm’s length principle”). The at arm's length principle inter alia implies that in case the terms and conditions of an affiliated party transaction are not at arm's length, same terms and conditions will be re-qualified for Dutch tax purposes into terms and conditions that meet the at arm's length principle.
 
Under the proposed new rules, downwards fiscal profit adjustments, recognition of higher tax losses and value increases of assets acquired from affiliated parties (the value increases are also referred to as ‘informal capital contributions’) under the application of the at arm's length principle will be denied, in short, if the taxpayer cannot reasonably prove that no corresponding upwards adjustment will be included in the tax base in the jurisdiction of the affiliated party.
 
However, these new rules do not apply to situations in which transfer pricing mismatches exist due to tax rate differences. Under the proposal, mismatches remain to exist if for example the corresponding upward adjustment is included in the tax base in the jurisdiction of the affiliated party, but is taxed at a lower rate.
 
In addition, a depreciation for tax purposes can be denied under the application of the proposed new rules if assets have been transferred to the Dutch taxpayer by an affiliated entity in book years starting on or after 1 January 2017 if the following conditions are met: 

1. The Dutch taxpayer received an asset from an associated entity in book years starting on or after 1 January 2017;
2. There is still a basis for depreciation at the beginning of that first financial year; and,
3. The asset would have been valued at a lower amount if the new rules would have been applied. 

If the above conditions are all met, the depreciation of the asset from the first book year starting on or after 1 January 2022 will be determined based on the lowest of the following two amounts: 

1. The value of the asset at the time of the transfer if the proposed new rules would have been applicable at that time; or,
2. The book value of the asset at the time immediately before the first book year starting on or after 1 January 2022. 

For the assessment of the amount of the downwards fiscal profit adjustment or recognition of higher losses, only the adjustment leading to the recognition of ‘business-like’ profits or expenses in respect of transactions between affiliated entities is relevant. The before-mentioned implies that so-called secondary adjustments are not taken into consideration. In other words, income from participations (deemed dividend) included in the fiscal profit as a consequence of the re-qualification under the application of the at arm’s length principle are disregarded for the assessment of the amount of the downwards fiscal profit adjustment or recognition of higher losses.
 
Reverse hybrid rules (ATAD2)
Reverse hybrid situations concern entities which are treated as transparent in the jurisdiction of incorporation or registration (and therefore not subject to tax) and as non-transparent in the jurisdiction(s) of their participants. Typically, a Dutch CV may be part of a reverse hybrid situation.
 
Under the application of the proposed reverse hybrid rules, tax transparent entities will under certain conditions be treated as opaque entities for Dutch tax purposes. As a consequence, such entities will become subject to Dutch corporate income tax and its distributions subject to withholding taxes.
 
The reverse hybrid rules apply to entities incorporated or registered under Dutch law or residing in the Netherlands insofar at least 50% of its voting rights, capital interests or rights to a share profit of such entity is directly or indirectly held by an ‘associated entity’ and if the jurisdiction of the ‘associated entity’ qualifies the entity as non-transparent.
 
In line with the ATAD2, the reverse hybrid rules will not apply under the application of an escape rule for Collective Investment Vehicles (CIVs) if the following conditions are all met:

1. The CIV qualifies as an ‘undertakings for collective investment in transferable securities’ (UCITS) as referred to in article 1 of the UCITS Directive¹ or an ‘alternative investment fund’ (AIF) as re-ferred to in article 4, sub k of the AIFM Directive² ;
2. The CIV is widely held;
3. The CIV holds a diversified portfolio of securities; and
4. The CIV is subject to investor-protection regulation.

Entry into force and retroactive effect
Although after the consultation process the legislative proposals shall have to be submitted and discussed in Parliament, it is expected that the legislative proposal will enter into force on 1 January 2022. With respect to the determination of the depreciation for tax purposes the amendment of the arm’s length principle shall have retroactive effect, because of the effective look back to transactions that have taken place between a Dutch taxpayer and an affiliated entity between 2017 and 2021.
 
Take away
Considering the envisaged changes in Dutch legislation in respect of the arm’s length principle rules and the introduction of the reverse hybrid rules, we recommend to assess whether the announced changes may impact existing corporate structures and arrangements and whether any steps should be taken in order to mitigate adverse tax consequences.

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1 | Directive 2009/65/EU
2 | Directive 2011/61/EU