On 1 July 2022, the Dutch State Secretary for Finance issued a new Transfer Pricing Decree (hereafter: “the Decree”).
For those unfamiliar with the Decree: legislation in the Netherlands on Transfer Pricing is relatively limited and the OECD Transfer Pricing Guidelines (“the OECD TP Guidelines”) are followed. For certain aspects, the OECD TP Guidelines allow for an own interpretation / application by the OECD Member States. The Decree is intended to clarify the Dutch application in these matters.
In the below, you will find the key trends from the Decree, as well as an overview of the most important changes.
Four key trends
The Decree reflects certain points of view that are political in nature. The Decree also seems to take into account some of the recommendations made by governmental advisory commissions. The four key trends that we depict from the Decree are the following:
- Transactions with tax havens will be scrutinized more strictly
- It is, simply put, indicated that a transaction that leads to a transfer pricing difference as a result of which profit remains untaxed may be adjusted by a tax inspector to a point that is also arm’s length but more in favour of the Dutch treasury chest.
- The use of flow-through structures is discouraged and will likely gradually be phased-out
- Governmental advisory commissions recently advised to create uncertainty for flow-through structures. The Decree appears to be in line with these developments.
- More details on the relevant changes are included in the below. Our advice is to perform a more detailed analysis on the sustainability if you have such a structure in place.
- Financial transactions will be scrutinized more
- In line with OECD developments a chapter on financial transactions is added.
- The Decree leaves relatively much room for interpretation with the Dutch tax inspector by providing rather extreme examples instead of examples that define the boundaries of the grey area for which you might seek guidance.
- Boosting the APA practice
- It seems that the Dutch Tax Authorities prefer to keep a closer eye on structures that mainly involve financial transactions in related structures. If taxpayers want certainty in advance, they are encouraged to file an APA request.
- During an APA process, the Dutch Tax Authorities can perform a detailed review in a more cooperative setting. It is for example mentioned that for a specific situation there is more room for the taxpayer in an APA setting.
- In recent years we saw a decline in the number of APA requests due to various developments. This would typically limit the insight of the Dutch Tax Authorities and as attention for the TP aspects of financial transactions is relatively new, the emphasis seems to be on this topic.
Details on changes and technical impact
This Decree replaces the Transfer Pricing Decree that was issued in 2018.
In the below, we will highlight the most important changes, as well as the potential impact for your company.
Since the release of the previous Transfer Pricing Decree in 2018, various changes occurred in the global transfer pricing landscape. Important changes on the level of the OECD are the introduction of a specific chapter on financial transactions in the OECD Transfer Pricing Guidelines in 2020 and the release of a new version of the OECD Transfer Pricing Guidelines. On a Dutch domestic level, new legislation was introduced in 2022 in order to eliminate double non-taxation as a result of mismatches in the application of the arm’s length principle.
The most important changes in the new Decree concern a new paragraph on financial transactions. This paragraph includes amongst others new guidance for financial services entities, as well as guidance in respect of cash pooling.
In the below, we will focus on these changes and what they could mean for your company.
- Relationship between the Decree and the OECD TP Guidelines
The State Secretary for Finance mentions that the OECD TP Guidelines can be used as explication and clarification of the arm’s length principle as codified in article 8b of the Dutch Corporate Income Tax Act (“CITA”). For certain aspects, the OECD TP Guidelines allow for an own interpretation / application by the OECD Member States. The Decree is intended to clarify the Dutch application in these matters.
A difference between the new Decree and its predecessor, is that the 2018 Decree explicitly mentioned that the OECD TP Guidelines could be applied directly in the Dutch legal practice. This statement is however no longer included in the 2022 Decree.
What is also different, is that the new Decree mentions that if the application of the OECD TP Guidelines leads to non-taxation of part of the profit of an MNE, the Dutch tax authorities can deviate from the new Decree, provided that this leads to an outcome that is in line with the arm’s length principle.
- Financial transactions
The most important changes in the new Decree concern intercompany financial transactions.
Arm’s length range
The Decree mentions that the OECD TP Guidelines prefer the CUP method to determine an arm’s length interest rate. The Decree also refers to the “cost of funds approach”, in which the lender should be remunerated for the costs made in respect of the funds that are lent, a risk premium and a premium for the equity that is at risk.
Financial service entities
A new element compared to the 2018 Decree is that the 2022 Decree pays specific attention to financial service entities. A financial service entity is defined as an entity with activities that consist predominantly (i.e. more than 70%) of receiving and paying interest or royalties. The new Decree contains strict rules for financial service entities that carry out activities within an MNE group.
Typically, there is a close link between the incoming and outgoing loans in which the financial service entity is involved.
According to the new Decree, these activities will in most cases qualify as routine activities, although the Decree does not exclude that a financial service entity also carries out activities involving a credit risk and market risk.
The Decree states that in order to allocate risks to a financial service entity, it is required that the financial service entity has sufficient control over those risks. Also, it is required that the financial service entity has sufficient financial capacity to absorb any possible negative consequences of the risks involved.
The Decree mentions the following risks:
- Credit risk (debtor risk and f/x risk)
- Market risk
- Operational risk.
If a financial service entity only runs operational risks – in relation to routine support activities -, this will not justify the allocation of credit risk to the financial service entity. If the financial service entity however bears debtor risk and f/x risk in relation to the flow of funds, this may according to the Decree justify a remuneration that relates to the principal amount of the loans involved.
If the financial service entity has insufficient control or financial capacity, the risk cannot be allocated to the financial service entity but should be allocated to the group entity that does have control over the risk and has sufficient financial capacity.
The Decree distinguishes three situations in order to assess the transfer pricing system applied by a financial service entity:
- The financial service entity has full control over the credit risk and has the financial capacity that is required for this control.
- The financial service entity does not have control over the credit risk and/or has insufficient financial capacity.
- The financial service entity shares the control over the credit risk with another group entity and has the financial capacity for this level of control.
- Financial service entity has full control
If the financial service entity has full control over the credit risk, it has to be determined whether the financial service entity has sufficient financial capacity to bear the risks involved.
We note however, that in practice typical financial service entities that perform intermediary financing activities in most cases do not exercise full control over the credit risks of the loans involved. It is in our view therefore unlikely that a typical financial service entity will have full control over the credit risk.
- Financial service entity has no control
In the second situation that is addressed by the Decree, the financial service entity does not have any control over the credit risk of the loans involved, or it does not have sufficient financial capacity. In this case, a remuneration that is related to the amount of the incoming and outgoing loans would according to the Decree not be at arm’s length. In this situation, a remuneration based on the own costs of the financial service entity would be considered to be more appropriate. Operational risks are according to the Decree considered to be immaterial compared to credit risks. Hence, if the financial service entity only runs operational risks, this would not be sufficient to justify a remuneration based on the volume of the incoming and outgoing loans.
- Financial service entity has shared control over credit risks and has sufficient financial capacity
It is also possible that both the financial service entity and the group’s head office (or an other group entity) carry out control activities in respect of the credit risks. In that case, the financial service entity and the other group entity share the control over the credit risks. In order to have shared control the Decree indicates that the control activities carried out by the financial service entity have to be of a certain qualitative and quantitative nature. The Decree does however not indicate when the extent of control performed by a financial service entity is sufficient to establish a situation of shared control.
For taxpayers, a very relevant question would of course be whether a typical financial service entity that is involved in borrowing and on-lending of funds can qualify as an entity that has shared control over credit risks.
Unfortunately, the Decree is not fully clear in this respect.
On the one hand, the Decree mentions that in comparable unrelated cases there will not be many situations in which the risk that is borne by the financial service entity will be contractually limited, without taking into account the extent of control that each party has in respect of the credit risks. If the credit risk materializes in respect of a particular transaction, it would according to the Decree seem appropriate to share the financial consequences in accordance with the extent of control that each of the parties has. The Decree further notes that given the nature and the extent of control activities in relation to financial service entities, shared control within a group will only rarely occur.
The question is of course, how to deal with financial service entities that are involved with intercompany borrowing and on-lending and currently apply the safe harbour rules of article 8c, para. 2 Dutch CITA.
According to this article, a taxpayer is considered to run genuine risks if it has equity at risk which equals at least the lower of
- 1% of the outstanding loan volume or
- EUR 2 million.
In many cases, the credit risk that is borne by the financial service entity is contractually limited in an agreement between the financial service entity and the group entity that lends the funds to the financial service entity.
The potential impact of the 2022 Decree on existing flow through structures may be substantial and MNEs are advised to evaluate their specific situation in detail to learn whether or not action needs to be taken.
If you would like to discuss the consequences of the Decree in more detail, please contact your trusted Quantera Global advisor.