On 2 July 2019, the Dutch State Secretary of Finance published a legislative proposal to implement the EU Anti-Tax Avoidance Directive 2 (ATAD 2) into Dutch domestic legislation. Given the variety of measures taken by ATAD 2, every structure that might be involved with hybrid mismatches, especially CV-BV structures, CV holding structures and imported hybrid mismatches, should be reviewed. ATAD 2 aims to neutralize hybrid mismatches resulting in mismatch outcomes between associated enterprises, head offices and permanent establishments (i.e. situations with a double deduction or a deduction without inclusion). It covers especially financial instrument mismatches; hybrid entity mismatches; reverse hybrid mismatches; permanent establishment mismatches; tax residency mismatches and imported mismatches. The newly proposed legislation will be effective as of 1 January 2020, albeit the rules on reverse hybrid mismatches will be effective as from 1 January 2022.
Financial instrument mismatches
A financial instrument is a debt, equity or derivative instrument. ATAD 2 defines a mismatch as a situation where a payment with respect to the instrument is deducted but does not lead to a corresponding inclusion at the level of the payee. A hybrid financial instrument also includes a hybrid transfer. This contains any arrangement to transfer a financial instrument where the underlying return on the transferred financial instrument is treated simultaneously by more than one of the parties to that arrangement. The deduction of a such a payment shall not be allowed in the Netherlands when the payer is Dutch resident taxpayer. In addition, an optional second rule may apply in case the deduction is not already tackled by the primary rule, under which rule the payment will be included in the taxable income of the Netherlands if the receiver is a Dutch resident (the secondary rule).
Hybrid entity mismatches
An entity qualifies as a hybrid entity if according to one state the entity is non-transparent for tax purposes whereas according to another state the entity is transparent. The mismatch may concern a payment to a hybrid entity which gives rise to a deduction without inclusion. This might be the case when the entity is considered as non-transparent by the jurisdiction in which the persons with a controlling interest in the entity are resident, but is considered transparent in its residence state, as a result of which the payment is not included in the taxable income of the recipient. In such a case, the deduction shall be denied in the Netherlands if the payer is a Dutch resident (primary rule). If the deduction is not denied by the state of which the payer is a resident (i.e. a non-EU Member State), the payment should be included in the taxable income in the Netherlands if the receiver is a Dutch resident (secondary rule). It may also concern a payment made by a hybrid entity which results in a deduction without inclusion. This could be the case when the entity is considered as non-transparent in its residence state and makes a payment to a person that has a controlling interest in the entity and this person is resident in a state that treats the entity as transparent and therefore disregards the payment made by the hybrid entity. In such a situation, the payment will not be deductible at the level of the hybrid entity if the payer is a Dutch resident (primary rule). Otherwise, the payment should be included in the taxable income in the payee jurisdiction (secondary rule). Finally, a hybrid entity mismatch may concern a payment by a hybrid entity resulting in double deduction. This might happen if the hybrid entity is considered as non-transparent in its residence state and considered transparent in the state that controls the hybrid entity, payments made by the hybrid entity are deductible in both the state of which the entity and the state of which the investor is a resident. Under the primary rule, if the investor is a Dutch resident, the Netherlands will deny the deduction if and to the extent the payment is deductible against taxable income. Otherwise, under the secondary rule, the deduction will be denied in the Netherlands if the payer is a Dutch resident taxpayer.
Reverse hybrid mismatches
This concerns the situation where an entity that is incorporated or established in the Netherlands and is treated as transparent, whereas the jurisdiction of one or more associated non-resident entities that hold in aggregate a direct interest of 50% or more of the voting rights, capital interest or profit shares in the entity treats this entity as non-transparent, resulting in a deduction without inclusion. Under the reverse-hybrid entity rule, such hybrid entity will be regarded as a resident taxpayer in the Netherlands. As one might notice, the reverse hybrid entity rule will not neutralize the effect of the hybrid mismatch, but rather tackle the hybrid mismatch at the source by making the hybrid entity entirely subject to tax. Payments made to hybrid entities that result in a deduction without inclusion will in principle be tackled by the primary and secondary rule as from 1 January 2020 (see section B). As from 1 January 2022, these neutralizing rules will however no longer be necessary as there will be no mismatches anymore. The reverse-hybrid rule will mainly affect Dutch transparent CV’s that are used in for example CV-BV structures, whereby the CV is considered as a transparent entity for Dutch tax purposes and non-transparent by the jurisdictions in which associated entities that hold qualifying interests in the CV are incorporated or established. Many of these structures have been set up because of the US check-the-box regime. As a result of the reverse-hybrid rule, such CV’s will be subject to tax in the Netherlands.
Permanent establishment mismatches
Hybrid permanent establishment (PE) mismatches concern situations where the business activities in a jurisdiction are treated as being carried on through a PE by the head office jurisdiction whereby such jurisdiction exempts the income derived from the PE while the other jurisdiction does not recognize a PE. In case the head office resides in the Netherlands, the object exemption for foreign profits will be denied as primary rule. There may also arise mismatches in the allocation of income relating to deductible payments and mismatches in relation to deemed payments between a head office and a PE. In such situations the state of which the payer (PE) is a resident, should disallow the deduction (primary rule). If that state does not allow the deduction, the state where the head office is located, e.g. the Netherlands should deny the object exemption for foreign profits. Finally, a hybrid mismatch may concern a deductible payment in the PE state and the head office state. In such a case, the state where the head office is located should deny the deduction if and to the extent the payment is deductible against taxable income. Where the deduction is denied in the head office jurisdiction, the deduction should be denied in the state of the PE.
Tax residency mismatches
A tax residency mismatch occurs when a taxpayer is a resident for tax purposes in two or more jurisdictions. This could result in deductions of payments, expenses or loses of taxable income in more than one jurisdiction. In such a situation, the deductibility or set-off should be denied by the EU Member State of which the taxpayer is deemed not to be a resident according to the tax treaty between those Member States.
An imported hybrid mismatch shifts the effect off a hybrid mismatch into the jurisdiction of an EU Member State using a non-hybrid instrument within the framework of a structured arrangement. In order to neutralize these imported mismatches, the EU Member State should deny the deduction of interest, expect to the extent that the other states involved have made equivalent adjustments in respect of hybrid mismatches. By Erik de Ruijter and Corney Versteden, HLB NetherlandsClick here to learn more.