Netherlands Tax Alert - 20 September 2012
2013 budget includes repeal of thin capitalization rules
By Pie Geelen, Jochem Temmerman and Aart Nolten
The Netherlands’ proposed 2013 budget published on 18 September 2012 includes the abolition of the thin capitalization rules. If approved, the rules will be repealed as from 1 January 2013.
Abolition of the rules has been expected because a more specific interest deduction limitation applying to the excessive debt financing of acquisitions of participations was adopted earlier in 2012. At the time the excessive debt financing rules were proposed, the Dutch Ministry of Finance indicated that the thin capitalization rules might be abolished provided the negative budget impact (EUR 30 million) could be offset by other measures; this appears to have been achieved.
The scope of the new rules on excessively debt-financed participations is different from that under the thin capitalization rules, so companies will need to carefully assess the impact on their debt-financed participations.
The thin capitalization rules were introduced in 2004 in response to the decision of the European Court of Justice in the Bosal case, in which the court ruled that the Dutch tax provision disallowing the deduction of interest expense incurred in connection with investments in foreign participations was incompatible with EU law.
Under the thin cap rules, an interest deduction on loans granted by related entities is disallowed to the extent a debt-to-equity ratio of 3:1 is exceeded. Exceptionally, if the debt-to-equity ratio of the group to which the Dutch company belongs exceeds 3:1 and the Dutch company is able to demonstrate that its debt-to-equity ratio is in line with that of the group, the interest generally is deductible to the extent the higher debt-to-equity ratio of the group is not exceeded.
Under the corporate income tax rules, a taxpayer can deduct interest expense related to loans obtained to finance the acquisition of a participation (provided no other limitations exist), while at the same time, the taxpayer can benefit from the participation exemption because income from a (qualifying) participation is not considered taxable income.
Excessive debt financing rules
The new rules, which will apply as from 2013, target structures that exploit the above mismatch (known colloquially as the “Bosal gap”) in Dutch law by limiting the deductibility of interest (and related costs) on “excessively” leveraged acquisitions of participations. The interest deduction restriction will apply to loans obtained from third parties as well as group members, and regardless of whether the loan is used to finance Dutch or non-Dutch participations.
The new rules will not disallow all interest deductions related to the acquisition of a participation, however. The restriction will be triggered where the combined acquisition price of all participations held by the company exceeds the company’s equity for tax purposes; in this case, the company will be deemed to have financed the acquisitions with debt (“acquisition debt”), and the acquisition of the participations will be deemed to be excessively leveraged. Any interest expense (or related costs) incurred on the excess financing (to the extent the expense exceeds EUR 750,000) will be nondeductible.
It should be noted that the acquisition price of additional investments in subsidiaries with operating activities will not be taken into account in determining acquisition debt, meaning that a taxpayer’s “real” investments will not be affected. However, such investments will have to be taken into consideration to determine the acquisition debt if the taxpayer tries to achieve an additional tax benefit with that investment. Examples of such an additional tax benefit could be a double deduction of the acquisition financing costs (double dip financing structure) or a financing structure with no pick up (a hybrid loan is used, etc.).
The government is expected to issue administrative guidance on the application of the excessive debt financing restriction before the end of 2012.