Dutch earnings stripping legislation and its impact on the real estate (development) sector
On 1 January 2019, earnings stripping legislation entered into force in the Netherlands.
The earnings stripping rule is a general interest deduction limitation applicable to interest expenses in relation to loans from affiliated parties and third parties. This rule applies to all Dutch taxpayers subject to Dutch corporate income tax. The new tax rule will likely lead to different ways of structuring development projects in the Netherlands, affecting the number of entities used, financing and the moment of legal transfer.
The earnings stripping rule is part of the implementation of the EU Anti-Tax Avoidance Directive and must therefore also be implemented in all other European member states. The member states had certain discretion to implement this rule, as a result of which the impact of the interest deduction limitation differs per member state.
Limitation on deduction of net borrowing costs
The Dutch earnings stripping rule limits the deduction of net borrowing costs (i.e. the amount by which deductible borrowing costs exceed the interest income) to the highest of:
- 30% of the tax EBITDA; or
- EUR 1,000,000.
The tax EBITDA is the taxable amount plus net borrowing costs plus depreciation on assets and impairments on assets. All parameters are tax parameters; i.e. net borrowing costs and tax EBITDA excludes income / expenses that are otherwise not taxable / deductible. As interest deduction may be limited as a result of a lower tax EBITDA, this could have an impact on the preferred timing of incurring certain costs.
Net borrowing costs include all costs / receivables originating from a loan agreement, such as handling fees, registration fees and penalty interest. Costs incurred in relation to and income derived from swap instruments (such as interest rate swaps or currency swaps) are also included in the net borrowing costs. As real estate developers finance their projects mostly with large amounts of debt and have a low EBITDA during the construction period, they will be confronted with this interest deduction limitation.
The earnings stripping rule provision applies per taxpayer. This means that if an entity has opted for a ‘fiscal unity’ for corporate income tax purposes (a consolidation regime), the EUR 1,000,000 threshold solely applies once. The introduction of this legislation could therefore be a reason to reconsider the way development projects are usually set up.
Carry forward principle
Interest that is non-deductible by virtue of the earnings stripping rule can be carried forward unlimitedly. If in a subsequent year there is any room to deduct carried forward interest, this carried forward interest may be deducted.
On 1 January 2020, legislation will enter into force based on which carry forward interest will be forfeited if the beneficial owner of the taxpayer has changed substantially (i.e. 30% or more).
As carry forward interest might be forfeited after a share transaction, this could affect the choice between a share deal and an asset deal. This may especially be so as an asset deal might increase the tax EBITDA and consequently, interest may be deductible (unless a reinvestment reserve has been formed, as this reduces the tax EBITDA). Further, the pricing could be affected as interest may be no longer deductible as a result of a share deal. In addition, it could be considered to ‘re-use’ a property company after it has sold its assets via an asset deal to set-off carry forward interest to future profits.
In short, the earnings stripping rule could have an impact on the way a development project is set up, during the period that a project is held and in relation to an exit.
For more information on project development and construction practice in the Netherlands, please be referred to our page on Lexology 'Construction in The Netherlands' and the Loyens & Loeff publication ‘Building in the Netherlands’. Development projects require a multidisciplinary approach, which Loyens & Loeff provides by combining the in depth knowledge and expertise of its tax advisers, lawyers and civil law notaries.