The Netherlands: Consultation legislative proposal reverse hybrid entities (ATAD2)
Following the second EU anti-tax avoidance directive (ATAD2), a consultation was released on 4 March 2021 that addresses the further implementation of the reverse hybrid rule entering into force as of 2022. The draft legislative proposal aims to ensure that this rule is embedded in the Dividend Withholding Tax Act (DWTA) and the Conditional Withholding Tax Act on Interest and Royalties (CWTA).
Furthermore, some changes from a technical nature are made to the Corporate Income Tax Act (CITA). Reactions on the draft legislative proposal can be provided until 2 April 2021. The government aims to include this proposal in the Dutch Tax Plan 2022 on the Budget Day 2021 (Prinsjesdag).
Background reverse hybrid entities
A reverse hybrid entity is an entity that is tax transparent in its resident state, but regarded as opaque, and thus as a regular foreign taxpayer, from the perspective of the state of a related participant in such entity. Due to the different treatment of such reverse hybrid entity by the resident state and the investor state, the income of the reverse hybrid entity is not subject to corporate income tax.
A typical example of a reverse hybrid structure was the so-called CV/BV structure in which payments were made to a Dutch transparent limited partnership, a CV, that was held by a US investor for which the CV is checked as opaque in the US.
Reverse hybrid entity structures through which tax planning is achieved are already rare nowadays. The other measures from ATAD2 that are effective as from 1 January 2020 in the Netherlands and other countries in the EU, already deny deduction of payments to such reverse hybrid entities. Hence, such structures should already have been revisited and changed accordingly.
Proposed changes to the DWTA
It is proposed that distributions, made by a reverse hybrid entity that becomes a taxpayer for Dutch corporate income tax, will also be subject to Dutch dividend withholding tax (DWT). In similar sense as for Dutch corporate income tax purposes, this will only apply to distributions to participants that classify the reverse hybrid entity as opaque under their domestic laws. Other participants, for which the reverse hybrid is regarded as transparent, would not face such DWT under the proposed rules.
Furthermore, it is proposed that dividend distributions from Dutch entities to a Dutch reverse hybrid entity may qualify for a domestic dividend withholding tax exemption. However, such exemption will not be granted insofar participants in the Dutch reverse hybrid entity would not be able to apply a withholding tax exemption under the currently existing rules. This exemption generally applies in case of corporate participants with an interest of at least 5% in the Dutch entity and resident either in a country with which the Netherlands concluded a tax treaty containing a provision on dividends distributions or in an EU/EEA state.
Proposed changes to the CWTA
Also for the CWTA, payments by a reverse hybrid entity, that becomes subject to Dutch corporate income tax, may be subject to the conditional withholding tax. This will be the case if these payments are made directly or indirectly to related entities in certain low tax or blacklisted jurisdictions (see our Tax Flash dated 22 February 2021).
Moreover, also payments to reverse hybrid entities may be subject to the conditional withholding tax. The conditions for such taxation are very similar to the conditions for denying the withholding tax exemption as proposed for the DWTA.
Structures in which dividends are paid to a reverse hybrid should be re-examined based on the now consulted measures. Application of the consulted measures could result in double taxation that can be avoided. The same is true for structures in which interest and royalties are paid to a reverse hybrid entity.
Of course, we can assist you with further analysis on the impact of the consulted measures. Also in case you wish to react on the published consultation, we are happy to help you in this respect.
Announced consultation Dutch classification rules
Finally, we note that one of the reasons that hybrid entities exist lies in different entity classification rules. The current Dutch rules for entity classification deviate from common international standards. The Dutch government also announced that it will publish new classification rules subject to consultation in the next few weeks; such new rules should also prevent the existence of many hybrid entities.