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September 22, 2021 The Netherlands publishes draft legislation on reverse hybrid entities as final part of ATAD II implementation Executive summary On 21 September 2021, the Netherlands has published draft legislation to implement specific reverse hybrid entity provisions as mandated by the European Union (EU) Anti-Tax Avoidance Directive II (ATAD II). These provisions counteract hybrid mismatches resulting from reverse hybrid entities, i.e., entities that are considered transparent from a Dutch tax perspective and if at least 50% of the voting rights, capital interests or profit rights in the entity are directly or indirectly held by related participants that are resident in a jurisdiction that qualifies the entity as non-transparent. In such case and as mandated by ATAD II, the so-called “reverse hybrid entity” would become subject to Dutch corporate income tax, dividend withholding tax or conditional withholding tax unless an exemption applies. The proposed legislation will apply to fiscal years starting on or after 1 January 2022 and is still subject to parliamentary discussions. Detailed discussion Background As of 1 January 2020, the Netherlands has implemented the first part of ATAD II, which includes anti-hybrid provisions.1 These provisions counteract hybrid mismatches between both Member States of the EU mutually as well as between Member States of the EU and other third countries. ATAD II also included the obligation to implement specific reverse hybrid entity provisions, resulting in certain hybrid entities to become taxpayers. However, under ATAD II, deferral of the implementation of those reverse hybrid entity provisions was allowed up to 1 January 2022. The currently published draft legislation aims to implement the specific reverse hybrid entity provisions as set out in the second stage of ATAD II. The Netherlands had already implemented reverse hybrid entity provisions in late 2019, with effective date of 1 January 2022 (so they were not yet effective). Under the current proposed legislation, these earlier provisions are now revised and refined. Reverse hybrid entity provisions are introduced in the corporate income tax act, general tax act, dividend withholding tax act, the conditional withholding tax on interest and royalties and the personal income tax act. The parliamentary proceedings regarding this draft legislation contain various examples detailing the impact of the proposed provisions in specific situations. Corporate income tax Under the draft legislation, an entity is defined as a “reverse hybrid entity” if it is formed, entered into or incorporated under Dutch corporate law or residing in the Netherlands and is considered transparent from a Dutch tax perspective. In addition, at least 50% of the voting rights, capital interests or profit rights in the entity must be directly or indirectly held by related participants that are resident in a jurisdiction that qualifies the entity as non-transparent, for such entity to qualify as a reverse hybrid entity. A related entity is, in short, an entity that has an interest of at least 25%. Note that certain collective investment vehicles under the Netherlands Authority for the Financial Markets (in Dutch: Autoriteit Financiele Markten or AFM) or fiscal investment institutions (fiscale beleggingsinstellingen) are excluded under the definition of “reverse hybrid entity.” The proposal ensures that reverse hybrid entities become fully liable to corporate income tax in the Netherlands. This has the effect that reverse hybrid entities can be considered “resident” under tax treaties. However, taxable profits of the reverse hybrid entity are reduced by allowing a deduction based on a pro-rata approach: a deduction of taxable profit of the reverse hybrid entity is allowed equal to the profit allocable to the partners that consider the entity as transparent (i.e., partners that pick up the income directly), but only insofar this profit is included in a profit tax at the level of those partners. An entity that becomes a Dutch taxpayer as of 1 January 2022 pursuant to these reverse hybrid entity rules must prepare an opening balance sheet. This balance sheet should be prepared in accordance with the general rules for any opening balance sheet. Further, reverse hybrid entities are subject to the regular compliance obligations for Dutch corporate taxpayers, such as annual corporate income tax returns and local files for transfer pricing purposes. The proposed legislation includes various amendments to existing sections of the Dutch Corporate Income Tax Act:
General Tax Act The interest in a reverse hybrid entity is included under the definition of “share” but only insofar as the partner considers the reverse hybrid entity a non-transparent entity. Further, the reverse hybrid entity is defined as a “corporation.” This is relevant for the qualification of a reverse hybrid entity as a withholding agent for dividend and conditional withholding tax purposes (see section below). Dividend withholding tax Under the proposed legislation, the definition of a reverse hybrid entity under the dividend withholding tax refers back to the definition a reverse hybrid entity for corporate income tax purposes. A reverse hybrid entity will become a withholding agent for Dutch dividend withholding tax purposes. Dividend withholding tax can only apply on profits on “shares.” Based on the proposed definition in the General Tax Act, the interest in a reverse hybrid entity only qualifies as a “share” insofar as the partner considers the reverse hybrid entity a non-transparent entity. Consequently, distributions of profit to partners that qualify a reverse hybrid entity as transparent are not subject to dividend withholding tax. It is stipulated that a reverse hybrid entity does not have any paid-in capital; consequently, any distributions by a reverse hybrid entity are distributions of profit. A repayment of capital by a reverse hybrid entity is thus subject to dividend withholding tax, unless a domestic or treaty exemption applies. Under the proposed legislation, a reverse hybrid entity will be considered the full beneficial owner for a dividend income received. However, the reverse hybrid entity will not become a taxpayer for Dutch dividend withholding tax purposes insofar as the partner of the reverse hybrid entity: (i) considers the entity transparent; and (ii) would be able to apply the domestic dividend withholding tax exemption if such partner would have been the direct recipient of the dividend income (i.e., without interposing the reverse hybrid entity). This is relevant for situations where a Dutch resident entity, e.g., a BV, makes a distribution to a reverse hybrid entity as defined in the proposed legislation. Conditional withholding tax on interest and royalties The proposed amendments to the conditional withholding tax on interest and royalties are similar to the amendments to the dividend withholding tax. The definition of a reverse hybrid entity under the conditional withholding tax refers back to the definition of a reverse hybrid entity for corporate income tax purposes. Further, a reverse hybrid entity becomes a withholding agent for the conditional withholding tax insofar as its partners consider the reverse hybrid entity a non-transparent (taxable) entity. Under the proposed legislation, a reverse hybrid entity will be considered the full beneficial owner for the interest and royalty income received. A reverse hybrid entity also becomes liable to conditional withholding tax insofar as: (i) its partners consider the reverse hybrid entity a transparent entity; and (ii) the partners that hold a controlling interest in the reverse hybrid entity would have been liable to the conditional withholding tax if such partner would have been the direct recipient of the interest or royalty income (i.e., without interposing the reverse hybrid entity). This is relevant for situations where, e.g., a Dutch resident entity makes an interest or royalty payment to a reverse hybrid entity as defined in the proposed legislation. Personal income tax The proposed amendments to the personal income tax ensure that reverse hybrid entities will be in scope of the substantial interest regime. Further, foreign taxpayer rules will be amended to ensure that participants in a reverse hybrid entity that consider the reverse hybrid entity as transparent remain in scope of the foreign taxpayer rules. Timing & next steps The proposed legislation will enter into force as of 1 January 2022 and will apply to fiscal years starting on or after 1 January 2022. The legislation is still subject to parliamentary discussions. However, the implementation of the reverse hybrid entity provisions under ATAD II is obligatory for Member States, so the proposed legislation is expected to be enacted without significant modifications. Simultaneously, the discussions with respect to the qualification of foreign partnerships are still ongoing.2 Initially, the proposed amendments to the qualification of foreign partnerships were expected to be implemented as of 1 January 2022. However, due to the complexity and initial feedback during the consultation, the draft legislation on the qualification of foreign partnerships is now expected in the coming winter months. _________________________________________ For additional information with respect to this Alert, please contact the following: Ernst & Young Belastingadviseurs LLP, International Tax and Transaction Services, Amsterdam
Ernst & Young Belastingadviseurs LLP, International Tax and Transaction Services, Rotterdam
Ernst & Young LLP (United States), Netherlands Tax Desk, New York
Ernst & Young LLP (United States), Netherlands Tax Desk, Chicago
Ernst & Young LLP (United States), Netherlands Tax Desk, San Jose/San Francisco
Ernst & Young LLP (China), Netherlands/EMEA Tax Desk, Shanghai
Ernst & Young LLP (Hong Kong), Netherlands Tax Desk, Hong Kong
Ernst & Young LLP (United Kingdom), Netherlands Tax Desk, London
_________________________________________ Endnotes
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