Box 3: From Soap to Chaos

In the summer of 2024, I addressed the Box 3 saga. Those who thought that peace regarding this tax had returned for the time being are mistaken. The Supreme Court has taken on the role of legislator, and the legislator is now at a loss. It is, therefore, a good moment to outline the current state of affairs once again.

First, let’s talk about the Supreme Court. The Supreme Court is not there to act as a legislator, but it occasionally does so, especially when the legislator makes significant errors or fails to produce necessary legislation. A recent example of this is the case law regarding loans that are not at arm's length. And now, we have Box 3. A distinguishing feature of both interventions by the Supreme Court is that it has created chaos. The case law regarding loans that are not at arm's length is inscrutable, complex, and the problem could have been resolved much more simply. But that’s a discussion for another time. Regarding Box 3, the Supreme Court ruled in the summer of 2024 that it is, with respect to investments, in violation of the European Convention on Human Rights (ECHR) and that taxpayers are allowed to demonstrate that their actual return is lower than the statutory fixed return. As such, this is, of course, a sympathetic starting point. But everyone can feel it: the burden of proof lies with the taxpayer, and it will be quite a hassle to calculate that actual return. After all, this is not explicitly stated in the law, and the Supreme Court initially did not say much about it. However, gradually, more cases are coming to the Supreme Court with the question of how to calculate that actual return in different situations. The Court must provide answers, as it has taken the place of the legislator.

Here is a brief overview of the decisions made by the Supreme Court. It is logical that actual income, such as interest, dividends, and rent, is included in the return. A significant issue lies in value changes, especially concerning shares and real estate. The Supreme Court applies the capital appreciation method for this, meaning the value change over a year, regardless of whether it has been realized. This is, of course, undesirable: unrealized income should not be taxed. However, the Supreme Court believes this is the most fitting within the Box 3 system, which is based on the return for a year, realized or not. Another point concerns the costs of investments: the Supreme Court finds that these cannot be taken into account and are therefore not deductible. This is not much of an issue for shares, but it is very different for real estate. Financing costs—interest, in other words—are, however, deductible. Unsurprisingly, this leads to significant frustrations among property owners, especially if they have high maintenance costs. Furthermore, concerning real estate, it has been decided that holiday homes must be valued based on their WOZ value and that no benefit for living enjoyment needs to be considered for holiday homes in personal use. In particular, landlords of real estate have already indicated their intention to litigate again, especially regarding the non-deductibility of costs. Additionally, the actual return must be calculated over the entire Box 3 assets; one cannot engage in a type of cherry-picking by asset type. Furthermore, loss compensation between years is not allowed. Are we done with this? Certainly not: several cases are pending in court where decisions still need to be made.

Now, onto the legislator. In short, it boils down to the fact that they also seem to be at a loss. The first action is that the introduction of a new system has been postponed for the third time, now until 2028. So, there are still a few nights to sleep on it. Additionally, there was an internet proposal, and the Council of State has provided advice on the proposed system. That advice is quite damning. What does the legislator want? The legislator obviously wants to tax actual income from capital, such as interest, dividends, rent, etc. There is nothing wrong with this, and it is not controversial. The problem lies in the capital changes: the increases and decreases in the value of the assets in Box 3. The proposal is to tax these according to a capital appreciation system, whereby annual positive and negative capital changes are taxed regardless of whether they have been realized. Only for real estate is an exception made: for those assets, a capital gains tax applies. In other words, capital changes are only considered if they have actually been realized. The problem, of course, lies with the capital appreciation tax: under such a system, tax is levied on income that has not actually been earned, thus effectively taxing fictitious income. It is already certain that litigation will follow immediately after implementation. It is also extremely peculiar: shares held in Box 2—substantial interest—are taxed according to a capital gains system, while shares in Box 3 are taxed based on a capital appreciation tax. Consider family businesses where the share capital has been diluted through inheritances and family members have stakes of 5% or more, and others with stakes of less than 5%. Suppose a share increases in value by 10% in a year but is not sold. The Box 2 shareholders pay no tax, while the Box 3 shareholders pay the full amount. Another example: one investor invests in real estate while another invests in a real estate fund and thus holds shares in it. Again, suppose that the value increases by 10% in a year. The first investor is taxed on capital gains, meaning only when the real estate is sold. If he does not sell, no tax is owed that year. The second investor, however, is taxed annually and thus, in this case, is taxed on the 10% increase in value. This is not only incomprehensible but also disrupts the investment and real estate markets. We are far from done with the objections against this capital appreciation tax, but for now, that’s enough. The solution is simple: only tax capital gains, not capital appreciation.

Peter Kavelaars is a Professor of Tax Economics at Erasmus University Rotterdam and of counsel at Deloitte Dutch Caribbean.