The study concludes that adjustments to the tax treatment of equity and/or debt is preferably achieved within an international context, for example through the so-called DEBRA initiative recently communicated by the European Commission. In case of unilateral measures, an allowance on equity is undesirable, but suggestions are made to tighten the earnings stripping rules in combination with a reduction of the headline rate of the corporate income tax. It is currently unclear whether the Netherlands is considering changes to the earnings stripping rules. Next week’s Budget Day could shed more light on this.
Research on reducing the corporate debt bias
As part of the 2021 Budget Plans it was announced to prepare a study on a more equal tax treatment of debt and equity on a budget neutral basis. Like many other tax systems, the Dutch corporate income tax act allows in principle the deduction of interest costs contrary to dividend distributions. Hence, financing through debt instead of equity generally is more cost-efficient, which leads to relatively more debt financing. According to various studies referred to in the aforementioned research paper, this so-called corporate debt bias is not desirable from a macro-economic perspective and can lead to more instability, both for companies themselves as for the financial sector.
In analysing the various possibilities to achieve a more equal treatment of debt and equity, the study focuses mostly on either (i) an equity incentive through an incremental allowance on equity for corporate income tax purposes, or (ii) a debt disincentive by tightening the earnings stripping measure in combination with a reduction of the headline rate of the corporate income tax.
Incremental Allowance on Equity
An incremental allowance on equity is based on the increase of equity. The study indicates that the introduction of a unilateral incremental allowance on equity will potentially provide new opportunities for tax avoidance. In addition, such unilateral allowance on equity needs to take EU law into account (e.g. stand-alone entity application rather than at the level of a fiscal unity). The study concludes that the unilateral introduction of an incremental allowance on equity is not desirable. According to the study, it is preferable to introduce such measure on an international level. In this context, reference is made to the recent communication of the European Commission on “Business Taxation for 21st Century”, including the consultation on a proposal for a Debt Equity Bias Reduction Allowance, which is intended to result in an EU Directive proposal early 2022 .
Tightening of the earnings stripping measure and reduction of the corporate income tax rate
In the Netherlands, the earnings stripping rules limit the interest deduction, insofar as the balance of interest exceeds the higher of the 1-million-euro threshold or 30% of the fiscal EBITDA. It is suggested to curb the earnings stripping further by lowering the threshold amount and/or by lowering the deductible percentage of EBITDA. The latter has been mentioned as an additional measure, albeit without consensus, by the Advisory Committee on taxation of multinationals (see also our Tax Flash) and is mentioned in several election programs of Dutch political parties. The study acknowledges that a further restriction of the deductibility of interest could have a negative impact on investments in the Netherlands and could result in economic double taxation. It is proposed to use the budgetary proceeds for a generic reduction of the headline rate of the corporate income tax to mitigate these disadvantages.
Based on this research paper, a unilateral allowance on equity is not expected. The European Commission intends, however, to publish early 2022 an EU Directive proposal which could contain an allowance on equity. It remains to be seen whether the Netherlands meanwhile tightens the earnings stripping measure. It might be that next week’s Budget Day will create more clarity.