Netherlands Tax Haven

The Netherlands (Holland) Income Tax Treaty

Most of the bilateral income tax treaties that the United States has entered are not with tax haven countries. In fact, very few tax havens have double taxation agreements with the U.S. Most U.S. tax treaties are with industrial nations like the UK and the Netherlands. Nevertheless, the tax planner should not pass over these high tax jurisdictions when drafting a business plan. The Dutch tax system is famed for the benefits offered the “holding company”. The Netherlands Participation Exemption can lead to substantial tax savings when combined with the tax benefits offered under the U.S.-Netherlands tax treaty.

Treaty Benefits Overview

Tax treaties are “reciprocal agreements”. Under the U.S.-Netherlands tax treaty the U.S. dividend withholding tax rate is reduced from 30% to 15%, and to 5% when a Dutch company has a “substantial holding” in the U.S. Company paying the dividend. A “substantial holding” is 10% of the U.S. Company’s stock.

To compensate for the USA’s reduction in rates, the regular Dutch dividend withholding rate of 25% is reduced to 15%, with a further reduction to 5% if the U.S. recipient corporation owns at least 25% of the voting stock of the paying company, or if the U.S. recipient and another U.S. company together own at least 25%, and each owns at least 10% of the voting stock of the Dutch company.

Dutch “Participation Exemption”

In 1995, the top Dutch corporate income tax rate of about 42% was significantly higher than the USA’s 34%, but Dutch tax reform goes much further than U.S. tax reform in providing tax relief for its corporations. A Dutch “holding company” that owns “at least 5%” of the par value of the paid-in capital in another foreign or domestic company from the beginning of the fiscal year can receive dividend distributions from the “subsidiary” 100% tax free.

Qualification Requirements

To qualify for the “participation exemption” the “downstream subsidiary” must meet the following conditions:

In the case of a foreign subsidiary, the company must be subject to a corporate income tax comparable to the Netherlands corporate tax, but the rate and amount of corporate tax paid is immaterial
The “participation” in the foreign subsidiary must be held for a business-related purpose, not as a mere “portfolio” investment. In this respect, if the Dutch parent company has a director on the board, or is actively engaged in the supervision of the subsidiary, then the company will qualify for the Participation Exemption, provided the foreign subsidiary is not directly or indirectly merely an investment company

Investment Impact

Combining the Dutch Participation Exemption with the treaty benefits can and does lead to substantial tax savings for Dutch based holding companies. It’s not surprising that by year’s end 1987 the Netherlands with some $48 billion in U.S. investments could claim the second highest direct investments in the U.S., surpassing Japan’s $32 billion, Canada’s $22 billion, West Germany’s $19 billion, and Switzerland’s $14 billion, and trailing only the United Kingdom’s $76 billion investments in the USA.

Treaty Benefits for Dutch Finance Companies

Under the U.S.-Netherlands tax treaty the 30% U.S. interest withholding tax is reduced to 0%. Moreover, under the Dutch tax system no interest withholding taxes on payments made to any nation (even to tax haven companies) are imposed on any Dutch company, as interest withholding taxes are unknown in the Netherlands. Because the Dutch maintain a network of tax treaties with many industrial nations reducing those nation’s interest withholding tax rates, the Netherlands make a first-rate base for the formation of an international bank or finance company.

Additional Advantages

Other reasons for basing in Holland include:

The willingness of the Netherlands corporate tax inspector to grant special tax rulings in favor of Netherlands based finance companies
Interest payments made to foreigners are fully deductible when computing Dutch corporate income taxes so long as the payment is made at “arms length”. Usually the Dutch corporate income tax inspector will “fix” the net taxable income of the company at a certain percentage of the total outstanding debt, or require that a certain “interest spread” between interest received and interest paid-out be used to calculate the tax. A “spread ruling” from the tax inspector of 1/8% or 1/4% can usually be “negotiated” by the tax advisor
So called “back-to-back loan arrangements” between a Dutch company and a tax haven entity is common, and not looked on unfavorably by the Dutch tax authorities

New U.S.-Dutch Tax Treaty

A new U.S./Netherlands income tax treaty was signed in Washington D.C. on December 18, 1992 after more than 10 years of negotiations. The new treaty replaces the current treaty, which has been in force since 1947, a period of 45 years.

The new treaty will take effect on or after January 1st of the year following its ratification and exchange of documents, consequently the new treaty will not be effective for fiscal year 1993.

Anti-Treaty Shopping Provisions

Anti-treaty shopping provisions aimed at limiting who can benefit from the new treaty are of great concern to international tax planners. Under the current U.S./Netherlands tax treaty, any company that could meet the Dutch or U.S. residency requirements would qualify for treaty benefits. Not so under the newly signed treaty.

The negotiations for the new treaty took some ten years to iron out because the Dutch resisted the U.S. efforts to insert its treaty shopping provisions. Generally speaking, the new treaty denies benefits to corporations owned by third-country shareholders, unless they can pass one of four special tests.

Stock Ownership Requirements

The anti-treaty shopping provisions [Limitation of Benefits Article (Article 28)] of the new treaty were based on the 1981 U.S. Treasury Department’s Model Treaty which stated that a corporation is not resident of a country for treaty purposes unless (1) at least 75% of its shares are owned – directly or indirectly – by individuals who are residents of that country, and (2) is not a conduit company to pass on deductible interest and royalties to residents of a third country. The new U.S.-Netherlands treaty reduces the stock ownership test to more than 50%.

One loophole under the 1981 U.S. Treasury Model Treaty was that the 70% stock ownership requirement could be met if the shares of the company were listed and its stock regularly traded on a recognized stock exchange in either country. Tax practitioners should note, the new U.S.-Netherlands income tax treaty contains this valuable loophole.

Applicability

The new treaty applies in general to residents of either the Netherlands or the U.S. The term “resident” also includes exempt pension trusts and other exempt organizations (i.e., charitable, scientific, religious and educational type organizations). Generally, interest and dividends paid by unrelated U.S. companies to a Netherlands pension trust would be 100% free of U.S. withholding tax, normally 30%.

Four Main Tests for Treaty Benefits

The Limitation of Benefits Article (Article 28) provides that a resident corporation is a resident for treaty purposes if it passes any one of the following tests:

The Stock Exchange Test
The Shareholder Test
The Active Trade or Business Test
The Headquarters Test

Stock Exchange Test

The Stock Exchange test is somewhat discriminatory in that it favors large, well capitalized companies that can afford the time and expense to get its shares listed (or are already listed) on one of the recognized Stock Exchanges. Nevertheless, the Stock Exchange test is probably the single most important test to consider, because once corporation goes to the trouble of being listed on the NYSE, NASDAQ, AMEX, Dutch, London, Paris or Frankfurt Stock Exchanges it will qualify for all the treaty benefits, even if it is a mere conduit company channeling interest into an offshore affiliate based in a tax haven.

Conduit Companies – Bank & Finance Companies

A conduit company typically borrows money from an offshore company domiciled in a tax haven country and relends the money to a U.S. company. Under both the new and the current U.S.-Netherlands tax treaty, the 30% U.S. interest withholding tax is reduced to 0%. Additionally, under the Dutch tax system no interest withholding taxes on payments made to any nation (even to companies domiciled in tax havens) are imposed on any Dutch company. Interest withholding taxes are unknown in the Netherlands.

The new tax treaty restricts the use of third party conduits, unless the conduit’s stock is regularly traded on one of the recognized stock exchanges, or unless the conduit meets other rather stringent tests described below.

Stock Exchange Test for Subsidiaries

Non-publicly traded companies also qualify for treaty benefits if (1) more than 50% of the aggregate vote and value of their shares are owned by five or fewer companies, each of which meets the stock listing and trading standards, and (2) they are not conduit companies (or if they are conduits, they pass either the “conduit test”, “the base reduction test”, or the “conduit base reduction test”).

“Conduit Test”

Under the new U.S.-Netherlands treaty, a conduit company is one that, in any year, makes deductible payments of interest and royalties equal to 90% or more of its aggregate receipts of interest and royalties.

A conduit traffics in treaty withholding rates, and may be unrelated to either the payer or the payee of interest and royalties in back-to-back loan and royalty arrangements. The conduit is compensated by a thin spread between the payment it receives and the payments it makes. In Rev-Rule 84-153 and 84-154, the U.S. unilaterally attacked conduit arrangements by denying treaty benefits on the basis that the conduit did not have dominion and control over the payments that quickly pass through its hands.

Under the new U.S.-Netherlands treaty, a conduit passes the base reduction test if its payments of deductible interest and royalties to companies that are not entitled to benefits of the treaty (i.e., third-country residents) are less than 50% of its gross income.

“Base Reduction Test”

The treaty provides that a conduit gets treaty benefits if it passes the “base reduction test”. A company passes the test if its payments of tax deductible interest and royalties to companies not entitled to the benefits of the treaty (i.e., third-country residents) are less than 50% of its gross income. This means that companies of substance can have offsetting interest income and interest expense (or royalty income and royalty expense) without losing their treaty benefits.

“Conduit Base Reduction Test”

This test is easier than the conduit test and can be used as an alternative for the Stock Exchange test for subsidiaries or publicly listed companies (more than 50% ownership by 5 or fewer public companies). The test is the same as the base reduction test except that deductible interest and royalties are taken into account only if they are made to associated enterprises in whose hands they will be taxed at a rate less than 50% of the Dutch rate (the Dutch corporate rate is 40% on profits up to Dfl 250,000 and 35% thereafter). Consequently, payments made to most tax haven companies are the only ones that will be considered.

Non-Publicly Traded Companies

A non-publicly traded company qualifies for treaty benefits if (1) more than 50% of its shares are owned, directly or indirectly, by “qualified persons” (i.e., U.S. citizens and residents of the Netherlands and U.S.), and (2) it meets the “base reduction test”.

Active Trade or Business Test

A company not qualifying for treaty benefits under one of the above tests can still qualify if it is engaged in a trade or business in the residence country that is complementary to its (or a related party’s) activities in the treaty partner.

A trade or business in the residence country is “substantial” if the average of the following three ratios exceeds 10% and each exceeds 7.5% for the preceding year:

The value of the assets in the residence country to the value of assets in the source country
The gross income in the residence country to the gross income in the source country
The payroll expense in the residence country to the payroll expense in the source country

Since the activity in the source country qualifies if it is carried on by a commonly controlled company (i.e., member of the same multinational group), an example of the benefit would be manufacturing subsidiary of a Japanese multinational in The Netherlands (i.e., Toyota Netherlands) licensing know-how to a related manufacturing company in the U.S. (i.e., Toyota USA) that is in the same business. Withholding on royalties would be zero instead of 30% (the U.S. statutory rate).

Headquarters Test

“Headquarters” status gives a company full treaty benefits, but most small and medium size enterprises won’t be able to meet the treaty’s strict requirements to qualify as a “headquarters company”.

A “headquarters company” must provide a substantial portion of the supervision and administration of the group, which can include group financing (although financing cannot be its principal function).

A “headquarters company” consists of at least five companies operating in at least five different countries, each of which generates 10% of the gross income of the group. The gross income generated in any one of the countries (other than the residence country) cannot exceed 50% of the gross income of the group, and not more than 25% of its gross income can be from the source country.

Dividends

Both the new and the current U.S.-Netherlands tax treaty lowered the U.S. 30% dividend withholding rate to 15% and 5% respectively. But the new treaty is actually superior to the current treaty in that to qualify for the lowest 5% dividend withholding rate, the recipient company need only own 10% of the payer’s voting stock. Under the current treaty, the recipient company has to own 25% of the payer’s voting stock.

Dividend withholding is 15% for all other shareholders (including individual shareholders and corporations owning less than 10% interest in the payer).

Interest and royalty withholding taxes are reduced to 0% under both the current and the new treaty.