The current global economic crisis and news reports regarding multinational corporations' business structures to avoid or minimize taxes have led to a sense of unfairness at the broader level of the public. The OECD's Base Erosion and Profit Shifting (BEPS) Action Plan, published July 19 2013, tries to address these concerns, minimize gaps that enable taxpayers to leave income untaxed, and better align the right to tax with economic activity. The Netherlands is an active member of the OECD and a strong supporter of transfer pricing initiatives within the OECD, including the BEPS project and the intangibles discussion draft.
The OECD states that determining an arm's length transfer price is not an exact science. In line with this approach, the Dutch tax authorities aim to be flexible and to ensure that their demands do not result in an unrealistically high administrative burden for taxpayers as they determine arm's length transfer prices. However, the Netherlands has recently increased its focus on transfer pricing. As part of that effort, the Dutch tax authorities have expanded the size of the advance pricing agreement (APA) team and increased its capacity by hiring additional transfer pricing experts.
This article highlights two recent developments that may have a major impact on taxpayers within the Dutch transfer pricing landscape, as well as on an international level:
- The requirement that substance be present in the taxpayer's organizational structure; and
- A recent ruling of the Dutch Supreme Court that disallows a deduction for losses under cross-guarantees.
Implementation of substance is crucial
Because the Netherlands basically follows the OECD transfer pricing guidelines, the recent OECD initiatives on BEPS are of major importance for Dutch transfer pricing. One of the main goals of the OECD BEPS group is to develop solutions to counter harmful regimes more effectively, taking into account transparency and substance. This goal is incorporated in item number 5 of the BEPS Action Plan, which states that the OECD will focus on improving transparency, including compulsory spontaneous exchange of rulings related to preferential regimes, and on requiring substantial activity for any preferential regime.
The Netherlands is one of the few countries that have substance requirements in place. In this respect, it does not only follow the OECD transfer pricing guidelines, but it also demands that the necessary level of substance actually be implemented in the taxpayer's business and operational structure. This approach is also reflected in recent developments in APA discussions and tax audits conducted by the Dutch tax authorities.
No deductibility of credit loss resulting from cross-guarantees
It is common for multinational organizations to enter into umbrella arrangements with financial institutions that enable group companies to borrow money under more favourable conditions than they could obtain on a stand-alone basis. Under such arrangements, the bank benefits by assuming less risk, and will therefore lend money at a lower interest rate. Under umbrella agreements, a bank provides funding to a group on the condition that all companies are jointly and severally liable for the full amount of the credit facility. Thus, group companies may be held liable for the default of another group company, and may suffer a loss when the bank seeks recourse.
On 1 March, 2013, the Supreme Court of the Netherlands ruled that a loss under a cross-guarantee agreement is not deductible from the group company's taxable income, because such a loss can be compared to an agreement between related parties, that is, companies of a group.
In the case at hand, a Dutch group company had incurred losses because of the default by other group companies. The Dutch group had received a credit facility from a banking consortium. A Dutch group company (together with other group companies) declared itself jointly and severally liable for the full amount of the credit facility. No remuneration was paid for the guarantee it had given. When the Dutch group company paid an amount under the guarantee and could not claim it back from other group companies, a write-off was booked for that amount. The Court ruled that the Dutch company could not deduct this loss from its taxable income.
With this ruling, the Supreme Court deviated from previous case law on non-business-motivated loans, such as the Supreme Court judgment of November 25 2011. This ruling is seen as a deviation from previous case law on non-business motivated loans and guarantees and may have significant impact within the Netherlands but also at the international level.
The Supreme Court's judgment seems to disregard the arm's length nature of the guarantee structure. It seems that charging guarantee fees across the group would not change the conclusion of the Supreme Court. Further, it is not clear whether any guarantee fees paid would be deductible from the Dutch group company's taxable income. The Dutch tax authorities are not expected to allow a deduction from the Dutch taxpayer's corporate taxable income. This treatment may result in double taxation or no taxation in cross-border umbrella agreements, and may have to be resolved through mutual agreement procedures or the European Union Arbitration Convention.
In light of the court case discussed, it is advisable for taxpayers to review their transfer pricing policies, and in case they have entered into an umbrella loan arrangement, to establish intercompany agreements that include a determination of the fees paid and costs borne in case of default, to mitigate the risk of non-deductibility of any losses resulting from a default by a group company under an umbrella loan arrangement.