Investing or Trading Abroad

How Treaties can be used in Tax Planning

DOUBLE TAXATION TREATIES SPECIFIC JURISDICTIONS

The purpose of this chapter is to provide real examples of how tax treaties are employed in contemporary tax planning. Hopefully, it will be demonstrated that these are invaluable 'tools', but that any use must be tempered by a careful analysis of the applicable treaties. In particular, many treaty partners from high tax jurisdictions, especially the United States, have sought to close as many 'loopholes' as possible. Certainly, there is a growing propensity to abrogate, sometimes unilaterally, treaties which appear to afford unwarranted advantages. In addition, anti-avoidance provisions, in many developed countries, now demand some genuine business purpose over and above the saving of tax. Nevertheless, with suitable flexibility and knowledge, many advantages can still be enjoyed.

THE NETHERLANDS & THE NETHERLANDS ANTILLES

SYNOPSIS: Traditionally, the double taxation treaty between the Netherlands and the Netherlands Antilles provided direct access by companies located in the latter jurisdiction to the very extensive Dutch treaty network. However, the well known status of the Netherlands amongst 'treaty shoppers', has resulted in specific caveats being introduced into many recently negotiated treaties. In particular, the new United States/Netherlands Treaty, effective from the 1st. of January 1994, has introduced 5 new tests specifically aimed at denying treaty rights to those without a significant and genuine Dutch presence. Nevertheless, real benefits can still exist for those located in many other jurisdictions, although the newer and hence lesser known 'treaty havens', such as Malta, may provide stiff competition in the future. In particular, some of the aforementioned do not have the same restrictions in respect to payor and payee companies (See below):

THE NETHERLANDS

ADVANTAGES:

• Unrivalled tax treaty network with direct access to low tax regime of the Netherlands Antilles.
• Generally, very favourable treaties due to the country's prestigious reputation and status as a major industrial power. In particular, the treaties with Switzerland, Luxembourg and Malta can afford benefits.
• Unlike smaller tax planning jurisdictions, treaty partners are very unlikely to unilaterally rescind or vary previously negotiated instruments.
• Full membership of the European Union can have beneficial consequences on dividend distributions to other member states. For example, the E.U. Parent/Subsidiaries Directive (90/435), means that once a Dutch parent company holds at least 25% of the paid up capital of a subsidiary company located in another E.U. member state, then the participation exemption will apply, even if the investments are of a portfolio nature.
• Highly qualified professionals and regulatory bodies.
• Excellent communications.

DISADVANTAGES:

• The Netherlands high profile use in tax planning has resulted in the introduction of anti-avoidance provisions by certain countries, including the United States, and less seriously, the United Kingdom.
• In many cases, it is necessary to establish a 'Qualifying Participation Exemption' (Q.P.E.) if a significant reduction in withholding taxes is to be afforded. In fact, in many cases such establishment can result in no or little tax liability ( See Tax Chart ). The requirements of a Q.P.E. are as follows:

(a) The Dutch resident company has a 5% or more direct equity stake in the paid up capital of the payor company. Alternatively, it must be shown that the dividend payments have been received in the normal course of the Dutch company's business.

(b) The non-resident dividend payor must be subject to a variable tax rate depending on gross profits. In other words, territories such as Cyprus would be fine as this is subject to a 10 % tax rate on its world-wide profits. However, traditional offshore havens, such as Jersey or the Isle of Man, could not benefit as they are only subject to flat rate duties.

(c) Non-resident payors must be seen to be part of a company's, or group of companies, business structure. Dutch law specifically prohibits the use of the participation exemption in circumstances where the payor can be seen to be making general and/or passive portfolio investments. Therefore, the Netherlands would not be suitable for those purchasing general stock from international stock exchanges or other similar bodies.

• The Dutch authorities have shown a tendency in recent years to dilute the efficiency of the treaty with the Netherlands Antilles. It has been suggested by senior government personnel that non-resident dividend payors should only be able to avail of the participation exemption if a tax on gross profits of 15% or more has been paid in the payor jurisdiction (See proposals by State Secretary for Finance, 16th. July, 1993).
• The advantages gained by E.U. membership are counter-balanced by directives requiring cross-border information disclosure.

NETHERLANDS COMPANIES

TYPES:

(i) The naamloze vennootschap ( N.V.) is the Dutch equivalent to a British public limited company or an American open stock corporation. They require relatively high paid-up share capital and are subject to full accountancy disclosure and an independent audit. Rarely used for reasons of expense.

(ii) The besloten vennootschap met beperkte aansprakelijkheid ( B.V.) is the Dutch equivalent to a British or Irish private limited company or an American close stock corporation. This type of undertaking is almost universally used in tax planning. If it's assets are approximately US$1,800,000.00 or less, there is no need to file fill financial statements or even apooint an auditor. Minimum capitalisation is approximately US$23,500.00 provided nominal share capital does not exceed NethFl 200,000.00. If nominal share capital does exceed this sum then the applicable minimum capitalisation can be found by dividing the authorised capital by a 5:1 ratio.

LEGAL SYSTEM: Dutch civil law
 
TIME FRAME TO ESTABLISH: 3 months

EXCHANGE CONTROLS: Generally there are no exchange control restrictions in the Netherlands.

THE INDIGENOUS TAX SYSTEM: Dutch companies are only subject to tax on their world-wide income and not on their world-wide assets. The standard corporate tax rate is 35% and is payable by all companies deemed Dutch resident. Whether a company is resident for tax purposes depends on where effective management and control are exercised. In particular, it is important to note that the Dutch, in common with most western European tax authorities, will seek to tax any entity which is locally managed and controlled. Therefore, the full 35% tax rate will be payable, even if there exists a foreign entity already subject to tax. In other words, a possible double taxation position could exist especially where no, or unfavourable, tax treaties exist.

ANTI-AVOIDANCE LEGISLATION: The Netherlands does not have specific anti-avoidance legislation, unlike the United Kingdom or the United States. It is also true that it does not, as is normally the case, place a reverse burden of proof on the potential tax payor. It is incumbent on the Dutch courts to come to an objective decision based upon the facts laid before them. However, Dutch law does inculpate tax payors if they introduce an artificial legal transaction without a bona fide business reason and generally adheres to similar tax principles, even if not codified, to other sophisticated western countries.

DUTCH STRUCTURES COMMONLY USED IN TAX PLANNING

(1) THE HOLDING COMPANY: This is perhaps the principle use of Dutch companies. However, it should be noted that they are not special companies and can perform all other objects specified in their Articles. As already discussed, to be effective, it is normally required to claim a 'Qualifying Participation Exemption' (For requirements please see above). Obviously, once the dividends have been received, further benefits can derive from the applicable tax treaties of the parent company. A simple example being as follows:

Example: A U.K. company receives dividends from manufacturing companies located in Germany, Ireland, the United States and Switzerland. Direct payment to U.K. is less tax efficient than using a Dutch catalyst.

	'D'	'IRL'	'US'	'CH'
GROSS PROFIT US$	1,000.000.00	1,000,000.00	1,000.000.00	1,000.000.00
CORP. TAX (APPR)	450,000.00	125,000.00	400,000.00	300,000.00
EQUALISING TAX TO EQUAL UK 33%, IF ANY	0	0	30,000.00	35,000.00
EQUALISING TAX TO EQUAL UK 33%, IF ANY	0	+205,000.00	0	0

 
NOTES

(i) The Irish tax rate is based on the preferential manufacturing rate of 12.5% 

(ii) Switzerland and the United States both 'withhold' money on the distribution of dividends to the United Kingdom. It will be noted that the Netherlands has managed to negotiate more favourable treaties in many instances than the U.K.

(iii) In the U.K., credit is only given for the total amount of taxes, including withholding taxes, paid that are equivalent to the U.K. rate. Any taxes above this level cannot be used as a credit.

USING A DUTCH HOLDING COMPANY

 

	'D'	'IRL'	'US'	'CH'
GROSS PROFIT US$	1,000.000.00	1,000,000.00	1,000.000.00	1,000.000.00
CORP. TAX (APPR)	450,000.00	125,000.00	400,000.00	300,000.00
WITHOLDING TAX	0	0	30,000.00	0

TOTAL TAX PAID = US$ 1,280,000.00, THEREFORE EFFECTIVE TAX RATE FOR ALL FIVE COMPANIES IS 32% . THE PAYMENTS BY THE DUTCH COMPANY ARE NOT SUBJECT TO ANY WITHOLDING TAXES BECAUSE OF THE E.U. PARENT/SUBSIDIARY DIRECTIVE. THEREFORE, THE EQUALISING TAX IN THE U.K. WILL BE 1% OR US$ 40,000.00 GROSS SUM =$4.000.000.00 NET SUM $2,665,000.00 AFTER PAYMENT OF (PAID OUT IN DIVIDENDS) ALL TAXES  SAVING +$200,000.00 

(2) FINANCE COMPANIES: The establishment of a finance/lending company is one of the most common tax planning methods. Most importantly, interest payments made by British, American and many other countries, to a Dutch financing company are not subject to withholding taxes. Where withholding taxes do apply they are normally at a significantly discounted level.

THE TAXATION OF FINANCE COMPANIES

(i) Non-related loans: Where loans are made by a Dutch company to non-residents of Holland, then the Dutch company will be taxed on the profits made as a result of the transaction minus overheads at the normal rate of 35%. Of course, the real benefits of a Dutch structure can be enjoyed when the sums have originally been lent by a third party company, normally from a tax free or low tax jurisdiction. It is always wise to get tax clearance to confirm that the Dutch tax authorities accept the 'non-related' status.

(ii) Related Loans: Where loans are for the benefit of subsidiaries and/or connected companies, the Dutch authorities require a 'turn',normally based on 1/8 of a percent of the loan amount. An example being given below:

INTER-COMPANY FINANCING

DUTCH TAX OBLIGATIONS:
1/8th.% of $1,000,000.00 = $1,250.00 (taxable base)
Imposition of standard Dutch Tax rate of 35% = $ 437.50 ( Tax to be paid to NL Authorities ).
 

(3) INTELLECTUAL PROPERTY COMPANIES: The Netherlands can afFord significant benefits to those licensing intellectual property rights. As with finance companies, it provides both an unrivalled treaty network and favourable tax treatment.

THE TAXATION OF INTELLECTUAL PROPERTY COMPANIES

(i) Non-related licensing: Where royalty payments are made by a Dutch company to non-residents of Holland, then the it will be taxed on the profits made as a result of the transaction, minus overheads at the normal rate of 35%. It is important to note that the spread between the company's inputs and outputs must correlate with those expected from a similar firm operating in Holland.

(ii) Related Licensing: Once again the Dutch authorities expect to receive a 'turn' on the licensing transaction involving non-residents which will vary from 7% to 2% depending on the amount of royalties received. The Dutch corporation tax rate of 35% will apply to the 'turn' amount.

RELATED 'INTELLECTUAL' PROPERTY COMPANY 

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» Double Taxation Treaties - Why they Developed

» How Treaties can be used in Tax Planning

» Examples - Investing in Private or Commercial Property

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