July 4, 2022
The Netherlands issues new transfer pricing decree
On 1 July 2022, the Dutch State Secretary of Finance (Finance Secretary) published a new decree related to transfer pricing and the interpretation of the arm’s-length principle in the Netherlands (Decree). The Decree replaces the previous transfer pricing decree dated 11 May 2018 and reflects the most recent changes in the Organisation for Economic Co-operation and Development’s (OECD’s) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines), most notably the inclusion of the guidance on financial transactions.1 The Decree also includes further details on the transfer pricing considerations with respect to governmental support, which have been particularly relevant as a result of the COVID-19 pandemic. The Decree provides the formal position of the Dutch Tax Administration, but it does not legally bind taxpayers.
The Decree provides information regarding the position of the Dutch Tax Administration with respect to the application of the arm’s-length principle and the OECD Guidelines in the Netherlands. The Decree provides further interpretation of the arm’s-length principle where the OECD Guidelines leave room for own interpretation or where there is a need for clarifications in practice. The insights from the Decree can help taxpayers in assessing the view that may be taken by the Dutch Tax Administration in similar cases.
The Decree covers, among others, topics such as characterization and recognition of intercompany transactions, comparability analysis (including relevance of options realistically available), aggregation of transactions, use of arm’s-length ranges and multi-year data, impact of government policies, transfer pricing methods, valuations, secondary adjustments, intangible assets (including hard-to-value intangibles), business restructurings, intra-group services, cost contribution arrangements, group procurement functions, financial transactions (loans, guarantees, and cash pooling), group financing entities, captive insurance, transfer pricing documentation requirements, advance certainty, and early consultation with foreign authorities on prevention of possible double taxation.
For certain transfer pricing issues, especially with respect to intercompany financial transactions and the characterization of funds as debt or equity, there may be tension between the guidance set forth in the OECD Guidelines and Dutch case law. The Decree acknowledges this and stipulates that the OECD Guidelines will be taken as the starting point in cases where taxpayers request certainty in advance to ensure that unilaterally given advance certainty is also internationally defensible. However, no guidance is provided in the Decree as to which position (OECD or Dutch jurisprudence, in the case of conflicting guidance) should apply to situations where taxpayers do not seek advance certainty. It is also noted that if the application of the OECD Guidelines leads to a transfer pricing mismatch as a result of which part of the profits remain untaxed, the Dutch Tax Administration can deviate from the content of the Decree.
Similar to the previous decree, the Decree confirms that insofar as the recent changes to OECD Guidelines provide further clarification with regard to the application of the arm’s-length principle, these changes also apply to years in which these changes were not yet published.
The Finance Secretary reiterates that the OECD Guidelines are considered a suitable interpretation and clarification of the arm’s-length principle. The Decree provides the formal position of the Dutch Tax Administration on the interpretation of the arm’s-length principle in certain specific cases.
One of the objectives of the Decree is to align the wording and guidance with the changes in the OECD Guidelines. Similar to the prior decree, the Finance Secretary is of the opinion that, insofar as the changes in the OECD Guidelines are a further clarification of the application of the arm’s-length principle, such changes are also applicable to years in which the changes were not yet published. The Decree does not specify which changes are considered a mere clarification, and to what extent this applies to the section on financial transactions.
The Decree confirms that taxpayers are able to obtain advance certainty in the Netherlands on their transfer pricing positions through advance pricing agreements. The requirements as outlined in the ruling decree dated 9 August 2021 (nr. 2021 – 16465) are relevant in this respect.2
Application of the arm’s-length principle
Consistent with the OECD Guidelines, the Decree stipulates that any analysis should start with the accurate delineation of the transaction, taking into account the economically significant factors and an analysis of the functional and risk profile of the companies involved. Specific attention is paid to the analysis of the risks assumed, managed and controlled.
Consistent with the previous decree, the Decree confirms that if multiple parties exercise control over a risk, and have the financial capacity to bear the risk, while only one party has contractually assumed the risk, the contractual risk allocation should be respected (par. 1.94 OECD Guidelines). However, care should be taken in such cases that each party receives an arm’s-length reward for its (contribution to the) control function. The OECD Guidelines (par. 1.105) state this compensation may take the form of a share in the positive or negative consequences of the risks. The Finance Secretary adds that the transactional profit split method may therefore be appropriate in this situation. The Decree articulates that it does not seem arm’s-length that a party which contractually assumes the risks, but in fact only partially contributes to the control of such risks, should be allocated all the consequences of such risks whereas the other parties receive a limited routine reward. The conclusion may be different though if the applied risk allocation can also be found between unrelated parties in comparable circumstances.
The Decree confirms that there are situations in which intercompany transactions can be analyzed in an aggregated manner. However, according to new guidance included in the Decree, taxpayers are required to reconcile the profits realized with their respective counter-parties, to trace which profits are derived from each individual transaction. This requirement is stipulated in light of ensuring the avoidance of double (non-)taxation. This requirement is also particularly relevant in the application of the new Dutch legislation against international transfer pricing mismatches, which contains a similar requirement to trace the profitability per transaction in order to allow for the deduction of a unilateral downward correction of the commercially applied transfer prices between related parties.3
With respect to the application of an arm’s-length range, the Finance Secretary acknowledges that transfer pricing is not an exact science and the application of a range for transfer pricing purposes can be considered appropriate. If the comparables in the comparability analysis are highly reliable, the use of a full range can be considered. If comparability limitations exist, the use of statistical methods, such as an interquartile range, can be used to improve the reliability of the comparables. On a similar note, if a transfer pricing adjustment should be imposed by the Dutch Tax Administration, the Decree considers that an adjustment to any point in the range can be imposed in the first situation. A transfer pricing adjustment will be made to the median by the Dutch Tax Administration in the situation that comparability limitations remain. Similar to the previous decree, the Decree also provides further guidance on the use of multi-year data.
The guidance on governmental policies has been expanded in the Decree. In relation to the application of cost-based transfer pricing methods, the following is noted. Subsidies or additional levies should be taken into account in such methods if there is a direct connection with the provision of the underlying product or service. If the subsidy or tax benefit is connected to the entity itself and there is no causal connection with the activity that receives the cost-based remuneration, these should not be considered in determining the cost base. Similarly, should the tax benefit take the form of a deduction of the taxable profit, this should not reduce the cost base. Costs that are only partially deductible according to the Dutch Corporate Income Tax Act (CITA) should still be fully included in the cost base on which the profit mark-up is calculated.
The other new topic on governmental policies covers government assistance programs, which are also addressed in the OECD’s guidance on the transfer pricing implications of the COVID-19 pandemic.4 One particular example in the Netherlands is the Temporary Emergency Measure Bridging for Employment Preservation (referred to as the NOW).5 The Decree stipulates that it can be assumed that third parties would renegotiate their terms (including price) in the case of a substantial drop in turnover and/or a temporary stop in production as a result of extraordinary circumstances. In such renegotiations, the effects of the NOW can be considered if such behavior is consistent with the behavior of unrelated parties operating under comparable circumstances. Should a taxpayer wish to change the existing terms as a result of received or expected governmental assistance, it would be required to substantiate the arm’s-length nature of such an amendment. The aim of the transfer pricing policy amendment should in any case not be the realization of a turnover reduction in order to become eligible for a support measure.
Transfer pricing methods
Whereas the Decree, in line with the previous decree, indicates that the Comparable Uncontrolled Price (CUP) method in practice is difficult to apply, an exception to that statement was added. The Decree indicates that financial transactions form the exception, as comparable transactions between unrelated parties with respect to financing transactions do exist.
The Decree furthermore substantiates that when applying a cost-based method and determining the cost base, costs over which no relevant functions are being performed should be excluded from the cost base regardless of how these cost elements are being treated for administrative purposes. In doing so, the Decree puts further emphasis on the actual conduct rather than the contractual framework.
With respect to the application of valuation methods, the Decree, similarly to the previous decree, stresses the importance of considering the perspective of all parties involved in order to determine an arm’s-length price. Taxpayers should take into account the tax consequences for both parties (i.e., any tax costs for the seller, and tax depreciation and/or amortization benefits for the buyer). Furthermore, in line with the OECD Guidelines, other transaction-specific considerations should be taken into account in selecting the appropriate discount factor, which include the risk profile of the parties involved as well as the asset and/or the activities that are being valued. The Decree states that if it is determined that the value of an asset is higher for the seller than it is for the buyer, the transfer of such an asset would not occur between third parties, since not entering into the transaction would then be a more attractive alternative to both parties. The considerations relating to the (non-) recognition of transactions apply in this situation.
In line with the previous Decree, the Finance Secretary refers to paragraph 4.68 and 4.78 of the OECD Guidelines regarding the consequences of secondary transactions. A secondary transaction is required from a Dutch perspective for purposes of processing the transfer pricing correction. The secondary transaction may trigger a secondary adjustment (e.g., taking into account interest on the debt receivable or a subsequent dividend tax assessment on a profit distribution).
The Decree clarifies that dividend withholding tax will still be levied if the other state, in the year in which the secondary adjustment is applied, is on the list of countries included in the “Regulation of low-tax states and non-cooperative jurisdictions for tax purposes.”
In general, with respect to intangible assets, the Decree follows the guidance already included in the previous decree.
In relation to hard-to-value intangibles (HTVIs), the OECD Guidelines are reflected in the Decree with some further clarifications. If an HTVI is transferred and subsequently the actual results deviate significantly from the projections used in valuing the HTVI, and such deviations cannot be explained by facts that have occurred after the valuation date, the Dutch Tax Administration may challenge the value as determined at the moment of the transaction by referencing the actual results. A significant deviation in this context is a deviation of more than 20% between the projections and the actual result (not a 20% deviation in the price of the HTVI itself). An intangible will not be considered an HTVI if the significant deviations start to occur after a period of five years has passed from the moment third-party revenue in relation to the intangible was realized.
The Decree also covers situations related to the purchase of shares followed by business restructuring, where a multinational enterprise purchased shares in an unrelated entity, followed by a business restructuring as a result of which the intangibles of that acquired entity are being transferred. The Finance Secretary is of the opinion that in this scenario, the share purchase documentation is an essential part of the taxpayer’s transfer pricing documentation. It is required to support the arm’s-length value of any transferred intangible. The value of such an intangible, as established by the acquirer in its share purchase documentation, is a good indication of the minimum price which the acquirer would like to receive when subsequently transferring the intangible. This implies that the actual value for the acquirer, and therefore the minimum price he would like to receive when selling the intangible, could be higher when the specific positions of the parties involved are considered (e.g., synergy benefits expected by the buyer). Moreover, the seller will generally take into account the tax costs related to the transfer of the asset when determining the minimum price. When the entrepreneurial function and the related intangibles are transferred to an associated enterprise and a mere routine function remains, the transfer price is sometimes determined as the difference between the discounted cash flow of the current functionality and the future, remaining routine functionality, applying a perpetual cash flow to the remaining routine function. In determining an arm’s-length value for such a transfer of functions and intangibles, the Dutch tax administration will generally take the position, in particular if only one (exclusive) intercompany contract remains in the entity, that the cash flow of the (remaining) routine function should not be perpetually discounted as such routine functions are easily replaced in the market and the underlying contracts often have a relatively short tenor. As a result, the transfer price of the transferred intangibles will be higher.
Finally, with respect to determining the compensation for the use of intangibles, the Finance Secretary questions whether public databases contain sufficiently detailed information to perform a proper comparability analysis in order to determine the compensation for the use of intangibles. The Dutch Tax Administration will therefore take a critical view in assessing the use of such databases. The OECD Guidelines state that the use of one-sided methods are often not reliable methods to directly determine the value of an intangible. The Decree mentions that these methods can be used, however, to determine the residual profit that should be allocated to these intangibles by first determining an arm’s-length reward for the routine entity (i.e., the tested party). The subsequent residual profit can be considered the reward for (the functions performed in relation to) the intangibles, under the condition that all other functions, assets and risks are sufficiently rewarded. Therefore, in these cases, where comparable uncontrolled transactions do not exist, the Finance Secretary states that it could be acceptable for taxpayers to determine the reward for intangibles following this methodology.
The Decree indicates that when applying the arm’s-length principle with respect to intercompany services this typically results in the application of a cost-based remuneration based on the Transactional Net Margin Method (TNMM). With regard to the charge out of intercompany services, there is a preference for applying the direct method. In practice however, the indirect method is often applied as application of the direct method leads to practical challenges.
The Decree confirms that taxpayers can opt for application of the simplified approach for low-value-adding-services as described in the OECD Guidelines, whereby the Dutch tax authorities will apply a more practical approach in assessing whether compensation is appropriate. The Decree furthermore confirms that no benchmark study is required in substantiating the profit mark-up, and that charge out of all relevant costs with a 5% profit mark-up will lead to an arm’s-length outcome. The revised wording further acknowledges the elective and simplified procedure for applying and documenting intra-group charges for low-value adding services.
In the event that a taxpayer opts for an alternative method in line with paragraph 7.37 of the OECD Guidelines (a charge-out of all relevant costs without a profit mark-up), the Finance Secretary clarifies that all conditions of paragraph 7.37 should be met whereby also the financing related costs should be taken into account. It furthermore indicates that the application of paragraph 7.37 of the OECD Guidelines remains at the discretion of the Dutch tax authorities.
While none of the parts of the Decree explicitly addresses transfer pricing considerations in relation to environmental, social, and governance aspects, it is worth noting that, in comparison to the previous decree, activities associated with the group’s environmental policy, social policy, and corporate sustainability policy, being pursued or to be pursued by the group, were excluded from the list of shareholder activities in the Decree.
Cost contribution arrangements
As compared to the previous decree, no significant changes were made to the section covering cost contribution arrangements (CCAs). In line with the guidance on CCAs in the OECD Guidelines, it is mentioned that companies which only provide financing and perform control functions in relation to their financing and not in relation to the other activities performed within the CCA, can only be allocated an arm’s-length return for its financing.
Group procurement activities
The Decree provides specific guidance with respect to the remuneration of central purchasing companies, which is in line with the previous decree. The Decree recognizes that independent procurement agents may earn a fee based on the value of products purchased (e.g., a commission). The applicable cost base will consist of the purchasing company’s operating expenses and will not include the costs of the goods purchased. If the purchasing activities can be considered a core function for the group, the arm’s-length remuneration can be determined on the basis of a profit split method. Furthermore, the Decree states that benefits resulting from the mere aggregation of volumes should in principle be allocated to the companies that enable the central purchasing company to realize these benefits, unless (additional) discounts are realized due to specific know-how or skills of employees of the central purchasing company.
As previously indicated, the Decree includes a revised section on financial transactions, including completely new content, related to the 2020 amendments to the OECD Guidelines in the area of financial transactions.
Characterization of a transaction
With respect to the characterization of the loans, the Finance Secretary specifically refers to the characterization process as outlined in Chapter X of the OECD Guidelines. The Decree furthermore indicates that the risk control and financial capacity concepts also apply to financial transactions, potentially resulting in a conclusion that certain risks and corresponding returns should be allocated to the party actually having the risk control functionality and financial capacity.
Furthermore, the Decree stipulates that not only the price, but all other relevant terms and conditions should be assessed in line with the arm’s-length principle. If a transaction cannot be made at arm’s-length through an adjustment of the price and/or other terms and conditions, this can result in disregarding or requalifying (part of the) loan in extreme cases.
The Decree emphasizes the importance of a two-sides analysis when analyzing whether a loan would have been entered into between unrelated parties. In doing so, it is also important to look at the options realistically available to the parties as part of the transaction.
Credit rating, investment grade and implicit support
Similar to the previous decree, the Decree refers to credit ratings and investment grade ratings. Intragroup loans entered into with a borrower that has a credit rating below BBB- are considered to be non-investment grade. If a loan is provided to an affiliated borrower which is non-investment grade, the Decree further emphasizes the necessity to substantiate the loan was entered into under arm’s-length conditions.
The Decree also includes a new section on implicit support, which should be taken into account when determining a (derived) credit rating for the borrowing entity. The Finance Secretary also clarifies that implicit support can, for example, have an effect on the interest rate or the size of the loan.
Arm’s-length interest rate
The Decree includes completely new guidance in relation to determining arm’s-length interest rates. As previously mentioned, the Decree indicates that the OECD Guidelines seem to have a preference for the application of the CUP method when determining arm’s-length interest rates. It also refers to the “cost of funds” method, in which the actual borrowing costs of the lender will be increased with coverage of costs, a risk premium, and a return for the required equity capital.
If group lending entities operate as “agents” or “intermediaries” (without performing risk control functions), the Decree stipulates that the remuneration for those entities should be limited to a cost plus mark-up on the costs related to its own function.
An entity that is not in control with respect to the risks that correspond to the investment of a financial asset is solely entitled to a risk-free rate of return. In assessing what the risk-free rate of return should be, it is best practice to align this with the interest on the corresponding governmental bonds. The risk premium should be allocated to the party that is in control with respect to the risks that correspond to the investment related to the financial asset.
Non-business like loans
Similarly to the previous decree, the Decree provides further views on non-business like loans, reflecting Dutch jurisprudence by the Supreme Court on this matter. In the case of a non-businesslike loan (i.e., a loan with credit risk that no third party would be willing to accept), the interest rate to be taken into account for tax purposes is the lower of: (i) the guarantee rule of thumb,6 and (ii) the economic value of the (imputed or accrued) interest at the moment this interest becomes due.
Dutch jurisprudence on loans versus equity
It is worth noting that in the following section of the Decree, the Finance Secretary acknowledges that the Dutch jurisprudence in relation to recognition and qualification of intercompany loans as equity follows somewhat different criteria and approach as compared to the OECD Guidelines, whereby the two views (Dutch case law and OECD) may be conflicting. Where taxpayers request tax certainty in advance, the OECD Guidelines will be taken as a starting point (to ensure that advance certainty is internationally defensible). Based on the Decree, it is unclear which view should prevail in other cases.
Group financial services entities
Entities predominantly involved in the activities, either directly or indirectly, of receipt and payment of interest, royalties, rental and lease instalments are classified as group financial service entities (in Dutch: Dienstverleningslichamen, abbreviated as DVLs).
In determining the arm’s-length remuneration for group financial service entities, alignment with Chapter X of the OECD Guidelines is sought. More specifically, in allocating the risks to the service entity, it is required that the service entity performs sufficient control with respect to the risks and has sufficient financial capacity to bear potential negative consequences of the risks being incurred.
The risks that may result from financial transactions consist in particular of credit risk (debtor risk and foreign exchange risk), market risk and operational risks. To the extent credit risk has a strong relation with the financial flows, this may justify a remuneration that is related to the principal amount. If the service entity solely bears operational risk, this will not result in the allocation of credit risk to the service entity.
In determining whether the service entity has sufficient financial capacity to bear the consequences in case the risks materialize, it needs to be assessed to what extent the service entity would be able to attract debt from a third party on a standalone basis (i.e., without guarantees from affiliated entities). Funding that could only be obtained by the service entity due to guarantees by related parties would in line with par. 10.161 of the OECD Transfer Pricing Guidelines be regarded as effectively a loan to the guarantor followed by an equity contribution by the guarantor to the borrower. Solely for the part of the loan that qualifies as a loan to the guaranteed party, an arm’s-length guarantee fee could potentially be charged. Similarly to intercompany loans, it is also recognized by the Finance Secretary that in the case of guarantees, it is uncertain whether the OECD position regarding guarantees recognition (where part of the guaranteed amount can be considered as capital contribution) would be recognized by the court, in light of the applicable Dutch jurisprudence.
In general, the Decree makes a distinction between three different situations of DVLs, which would lead to different transfer pricing outcomes: (i) DVLs that have both the full control over the credit risk and the adequate financial capacity; (ii) DVLs that have no control over credit risk and/or insufficient financial capacity; and (iii) DVLs that have control shared with other group companies over the credit risk, but have the adequate financial capacity. These three aforementioned cases are further clarified in the Decree by means of illustrative examples.
The Decree includes specific guidance with respect to cash pooling in line with Chapter X of the OECD Guidelines. The Decree explains that positions that have been held for a longer term should be reviewed carefully in order to avoid being recharacterized (e.g., into long-term credit or debt positions instead of short-term cash pool positions). Furthermore, participation in the cash pool should be assessed by looking at the options realistically available to the participants. Benefits to the participants do not solely consist of lower interest rates, but may also consist of less administrative burden and more efficient management of the liquidity position. Also, the Decree mentions that notional cash pool leaders have limited functionality and add less value than cash pool leaders in a zero balancing (physical) cash pool. This should be reflected in reward for the cash pool leader.
The guarantees section from the previous decree was revised, and it is more closely aligned with Chapter X of the OECD Guidelines. Similarly to loans, intercompany guarantees, including also cross guarantees, should be first accurately delineated, i.e., as a shareholder activity or an intra-group service. Only in case of a service, an arm’s-length guarantee fee would be due. This fee should be determined using one of the five methods described in the OECD Guidelines, but preferably the CUP method or, if the CUP method cannot be applied, the so-called “yield approach.”
The captive insurance section of the Decree is generally consistent with the prior decree’s guidance. Specifically, the so-called “captive insurance companies” are companies acting as internal (re)insurance company within a multinational enterprise. According to the Finance Secretary, the use of such companies may lead to a non-arm’s-length shift of profits if the captive insurance company lacks the functions that would be observed within professional insurance companies and/or in the absence of external diversification of risks. In such cases, the Finance Secretary considers it appropriate to allocate only a limited remuneration to the captive company.
Transfer pricing documentation
The Decree elaborates on the two types of transfer pricing documentation requirements in the Netherlands. The first is the general documentation requirement applicable since 1 January 2002, which does have not a prescribed format on how to document controlled transactions (general documentation requirements as codified in article 8b-3 of the CITA). The second is the country-by-country reporting (CbCR), master file and local file requirement that is applicable for fiscal years starting on or after 1 January 2016 (as codified in the articles 29b-29h of the CITA). The Finance Secretary approves that documentation prepared in line with the requirements for the master file and local file also meets the documentation requirements under article 8b-3 of the CITA with respect to cross-border transactions. Insofar the documentation prepared in line with the requirements for the master file and local file also includes domestic transactions, the Decree considers it also meets the requirements of article 8b-3 of the CITA.
The Decree and the additional guidance provided herein are of great importance to multinational enterprises (MNEs) with operations in the Netherlands. The Decree provides extensive new guidance on intra-group financial transactions, recognizing that there is some discrepancy between the Dutch jurisprudence and the OECD Guidelines.
MNEs should evaluate whether their transfer pricing policies and transfer pricing documentation should be updated to be aligned with the guidance in the OECD Guidelines and this Decree.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP (Netherlands), Transfer Pricing, Rotterdam
Ernst & Young Belastingadviseurs LLP (Netherlands), Transfer Pricing, Amsterdam
Ernst & Young Belastingadviseurs LLP (Netherlands), Transfer Pricing, Eindhoven
Ernst & Young LLP (United States), Netherlands Tax Desk, New York