Guidance on Dutch tax treatment of hybrid entities
When planning for an investment, merger or acquisition, either abroad or in the home country, companies have to decide what type entity they will use for this purpose. Company law is far from harmonised within the EU. All European countries know companies that can be compared with a BV or NV (like a Sarl, Ltd, SA, AG or Plc) but all these countries also know a variety of other entity forms. When crossing the borders of the EU the choice of entity forms becomes even larger. As an investor you will find yourself in a candy store full of more or less exotic varieties to choose from.
For tax purposes it will be relevant to determine how the tax treatment of the entity is in both the jurisdiction where that entity will be established and the jurisdiction where the investors/participants are resident. Basically there are two options: (1) the entity may be recognised as a legal entity subject to taxation on a standalone basis or (2) the entity may be seen as a mere extension of the participants (like a partnership) whereby the participants themselves are subject to tax instead of the entity (so-called tax transparency).
Due to the fact that local entity forms and corresponding legal and tax treatment vary significantly, the treatment that a certain country does not mean that The Netherlands tax authorities will follow this treatment in all cases. In a Decree of the Ministry of Finance of 18 December 2004 it is again stated that any foreign entities shall be subjected to Dutch criteria to determine whether that entity is transparent or non-transparent. The tax treatment of the entity that is applied abroad has no real relevance for this Dutch test.
It may well be that an entity is treated is treated as transparent in its home country but is seen as a non-transparent corporate entity in The Netherlands. In other cases an entity may be regarded as a non-transparent corporate entity in the country of residence whilst as a transparent entity in The Netherlands. Such entities are often referred to as hybrid entities. It goes without saying that such differences in qualification create tax opportunities as well as threats. Special areas of interest here are the possibilities to offset foreign (start-up) losses, timing of profit recognition as well as the deductibility of interest.
The Decree of 18 December 2004 gives guidance in the determination of transparency for Dutch corporate income tax purposes. Four questions are seen as crucial to qualify a potential hybrid entity:
1 Can the entity hold legal title of its business assets?
2 Has at least one participants full personal liability for the debts and obligations of the entity?
3 Has the entity a capital divided into shares?
4 Can new participants join the entity or can participants be replaced without the consent of all other partners?
The Decree not only details the critical characteristics of entities but also lists over 100 foreign entity types and indicating whether that entity is, for Dutch tax purposes, transparent or non-transparent. This helps investors in selecting the most appropriate structure.
If a company holds an interest in an entity that is treated as transparent abroad but as non-transparent in The Netherlands, application of the participation exemption on this interest is questionable. In a separate Decree the Ministry of Finance describes that such companies holding an interest in a foreign hybrid entity should make a special request to the Dutch tax authorities to be able to benefit from the participation exemption. In principle, this request must be made not later than 17 June 2005.
