On July 1, 2022 the Netherlands published its new transfer pricing decree of June 14, 2022. It replaces the transfer pricing decree of April 22, 2018 and section V of the Questions and Answers (Financial Service Entities) Decree of 2014. The new decree includes a completely new section on financial service companies. These are taxpayers that enter into transactions with related companies which primarily, in law or in fact, consist of the direct or indirect receipt and payment of interest, royalties, rental or lease payments.
The decree provides clarification regarding the Dutch tax authorities’ interpretation of the arm’s length principle. The most important changes to the decree are outlined below.
Subsidies, Tax Incentives and Limited Deductibles
According to the decree, Dutch subsidies are to be deducted from the cost base if there is a direct link between the subsidy and the supply of the product or service. It also states that additional levies (for example, charges imposed for the use of environmentally harmful raw materials) can lead to an increase in the cost base used. According to the decree, if tax concessions are granted in the form of a deduction from the taxable profit, such as the Dutch investment deduction, then these cannot be deducted from the taxable cost base.
With regard to the Temporary Emergency Bridging Measure for Sustained Employment (NOW), a Covid-19 subsidy, the question is how that will affect transfer pricing, in particular with regard to cost related remuneration. The decree states that a transfer pricing adjustment must be made at arm’s length and not be aimed at realizing a decrease in turnover that may provide a right, or an additional right, to the NOW subsidy. According to the decree, the taxpayer must make a plausible case that comparable unrelated companies would, in similar circumstances, have agreed a transfer pricing adjustment in a similar manner.
We note that the above policy clarification is very late, considering that companies have already closed their financial years to which the aid measures apply. Also, making a plausible case about how unrelated parties would have acted in similar circumstances will, in practice, be difficult for companies.
Like the 2018 decree, the new decree allows companies to apply the simplified method for low-value added services. The OECD transfer pricing guidelines refer to “low value-adding intra-group service.” If opting for this, companies can apply a profit margin of 5% without having to substantiate it. The 2018 decree included an approved policy for low-value added services so that companies could charge only the relevant actual costs, including financing costs.
We find it striking that this approved policy is no longer part of the text of the new decree. It was replaced by a brief reference to the OECD guidelines. These still include the option for companies to recharge on a cost-only basis. The footnote (number 17) in the new decree explicitly states that the Dutch Tax Authority (DTA) have discretionary power in deciding whether or not to apply this option. We note that omitting the term “approved policy” and adding “discretionary power” seems to indicate a less flexible stance by the DTA on this point.
Characterization of the Intercompany Loan Transaction
The new version of the OECD guidelines, published in 2022, contains a new Chapter X on financial transactions, which is also reflected in the decree. According to the decree, with regard to intra-group loans, the lack of control and/or financial capacity a company has in relation to certain risks may mean that the relevant risks and the associated fee should be allocated to the company that exercises control over those risks and has sufficient financial capacity to bear those risks. If the intercompany finance transaction cannot be undertaken on an arm’s length basis with an adjustment of the price and/or changes to the other intercompany conditions, then according to the decree the DTA may in extreme cases ignore or reclassify (part of) the intercompany loan.
Arm’s Length Interest
The OECD guidelines describe several methods for determining the arm’s length interest rate. The OECD’s preference is for the comparable uncontrolled price (CUP) method. In addition to the CUP method, the OECD guidelines and the new decree also describe the “cost of funds approach.” This is a method in which the lender’s costs to borrow the lent money are increased by coverage for costs, a risk premium and a fee for the required equity. The decree states that if a Dutch taxpayer only performs as an agent or intermediary function, it will only be entitled to remuneration consisting of a surcharge on the costs of its own function (cost-plus).
The decree also states that a company that is not in control of the risks associated with the investment in a financial asset will only be entitled to a risk-free rate of return. The risk-free rate of return is generally determined by using the interest rate on eligible Dutch government bonds. The decree subsequently notes that the borrower is, however, entitled to deduct the arm’s length interest. The difference between the arm’s length interest rate and the risk-free rate of return (the risk premium) accrues to the company that is in control of the risks associated with the investment. The basic assumption here is that the total interest income is subject to a profit tax.
It is striking that the decree allows the DTA to deviate from the explanation given in the decree if part of a group’s profit is not subject to a profit tax, provided that this leads to an outcome based on the arm’s length principle. The above does not fully clarify what can be expected from the DTA.
Financial Services Entities
Under the arm’s length principle, the remuneration of financial service companies (in Dutch “dienstverleningslichamen” or “DVL”) must be assessed on the basis of the DVL’s functions, activities and risks. The OECD guidelines are used to determine the arm’s length fee for a DVL. The decree distinguishes three situations for assessing the transfer pricing system of a DVL. These are where the DVL, directly or indirectly receiving and paying interest in whatever name or form, has:
- Full control over credit risks and has the necessary financial capacity to do so. An appropriate interest rate should be determined on the basis of a comparability study carried out per individual inbound and outbound related loan transaction for the DVL on the basis of the CUP method.
- No control over credit risks and/or insufficient financial capacity: a cost-plus fee is the only appropriate remuneration here for the DVL.
- Shared control, both in a quantitative and qualitative sense, over credit risk and has the necessary financial capacity to do so. The financial consequences should be shared on a pro rata basis, depending on the relative degree of control the participants have in relation to the relevant transactions and associated risks.
In the first and third situation, the company should establish whether, and to what extent, the DVL could independently, without guarantees from related companies, raise borrowings from an unrelated party. If the DVL cannot establish this, the loan is regarded as a loan to the guarantor, which is then assumed to contribute the funds as equity (either through or not through the parent company) in the DVL. The question then is whether the interest income is fully subject to tax in the hands of the DVL.
The decree quite explicitly notes, with regard to the third situation, that “it is unlikely to be common that in similar unrelated transactions under similar circumstances for the risk borne by the DVL to be contractually limited without regard to the relative degree to which the parties exercise control over the relevant risks.”
In our experience, in practice, the risk was contractually limited at most DVLs to the lowest of either 1% of the loan volume or 2 million euros ($2.05 million). The latter figure is laid down in Dutch tax law, albeit there are plans to change this, possibly by the end of September 2022. The above view seems to be a significant change in policy of the DTA. It seems to suggest that the remuneration of the DVL should henceforth be based on a cost-plus instead of on a typical (gross interest) spread.
The decree recognizes that the case law of the Dutch Supreme Court uses other specific criteria for qualifying a loan as equity. This may create tension between the OECD guidelines and Dutch case law. The decree notes here that if a taxpayer asks for advance certainty on the application of the arm’s length principle under an advance pricing agreement, the OECD guidelines will be the starting point. It is especially striking that the DTA thus explicitly states that they will deviate from prior Dutch case law and will take their interpretation of the OECD guidelines as the starting point for their policy.
The section on cash pooling is also new. The decree states that if one or more cash pool participants hold debit or credit positions in the pool for an extended period of time, it is necessary to check whether this is a different type of finance transaction, such as a deposit with a longer term or a loan. This could result in a different and higher remuneration based on the arm’s length principle being appropriate, compared to the remuneration for a short-term position of the participant in the cash pool.
In allocating the cash pool synergy benefits, the decree states that the options realistically available to cash pool participants must be taken into account. According to the decree, the synergy benefits will usually have to be distributed among the participants in the cash pool via the determination of the arm’s length interest rate on the debit and credit positions of the participants in the cash pool.
With regard to “cross-guarantees”, the decree notes that the support of a participant in the event one or more participants are in default should be regarded as an act in the capital domain.
The section on guarantees in the decree is not new, but has been rewritten in more practical terms.
The fee for a guarantee may be determined on the basis of the CUP method. If that is not possible, it can be determined on the basis of the yield approach. Under the yield approach, the guarantee fee cannot exceed the difference between:
- the interest rate that the borrower would have to pay with an explicit guarantee from the group (whereby the credit rating is the same as the group rating), and
- the interest rate the borrower would have to pay without a guarantee.
In determining the credit rating in the latter case, the fact that the borrower is a member of the group must be taken into account. This is referred to in the decree as the derivative rating, where the implicit support of the group has been taken into account. The derivative rating lies somewhere between the borrower’s standalone rating and the overall group rating. The decree contains an approval for determining the guarantee fee at half of the benefit derived by the guarantor. This applies only if, in an individual case, it is not possible to determine a specific arm’s length guarantee fee.
Captive Insurance Companies
This is another section that is not new, but which has been expanded compared to the previous decree.
To characterize captives, the decree has formulated five specific questions. These must all be answered affirmatively in order to arrive at the conclusion that there are in fact actual insurance transactions. In such a situation the related insurance company should receive a fee that is the same as that for similar unrelated insurance companies.
International Consultation Possible
The decree refers to early consultation on potential double taxation resulting from transfer pricing adjustments. Taxpayers may submit a request for a mutual agreement procedure. The decree refers to tax treaties, the EU Arbitration Convention, the EU Arbitration Directive—as implemented in the Netherlands in the Fiscal Arbitration Act—and to the latest MAP Decree of Nov. 15, 2021.
The changes to the decree are mainly a reaction to international developments. In particular, the changes made in 2022 to the OECD guidelines in respect of financial transactions, intra-group services and recent OECD publications on the treatment of government subsidies.
On the one hand, the changes explain how the Netherlands interprets the OECD guidelines and clarifies the position taken by the Dutch tax authorities in practice. On the other, a tightening of policy seems noticeable, which we see, for example, in the position taken on DVLs, where the policy creates tension with existing Dutch case law. The cancellation of the approved policy on remunerating low-value added services on a cost basis is an example of a change where the flexibility in policy seems to have been somewhat diminished.
This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Jaap Reyneveld is a partner and Eduard Sporken is a director at Meijburg & Co.
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