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Economic Substance –The Reality and Practical Issues in the Netherlands

11 December 2020

IQ-EQ is pleased to share a recording of our first webinar within a new global series that aims to shed light on the reality and practical issues of economic substance in all key investment hubs.

For the inaugural session, hosted by IQ-EQ’s Group Investment Structuring Leader, Pascal Rapallino, our spotlight was on the Netherlands. Pascal was joined by two expert speakers: Anton Akimov, senior tax adviser at Loyens & Loeff in the Netherlands, and Emma Causevic, corporate director at IQ-EQ Netherlands.

During the session, Anton provided an overview of the latest regulatory updates that are expected to affect economic substance and how they will impact local corporate structures. IQ-EQ’s Emma Causevic then shared some practical ‘best practice’ insights to help corporates meet the current and future substance requirements.

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Transcript

Speaker name
Pascal Rapallino
Spoken content

Good afternoon everyone and welcome to this IQ-EQ webinar, which focuses on the important issue of economic substance in the Netherlands. This is a first webinar, part of a global series, which has an objective of shedding the light of the reality and particular issues of economic substance in all key investment hubs, including the Netherlands, of course. The economic substance agenda is one in which we have become increasingly familiar with, driven from the highest levels of international cooperation at the level of OECD, including BEPS action plan and ATAD I and ATAD II for European countries. In this context, the Netherlands has recognised the importance of ensuring economic substance and has been taking a number of steps, which we'll be exploring in your webinar today. As you may know, the Netherlands already has established minimum substance requirement in a range of areas, for example, concerning the residency of statutory and decision-making directors, the location of Board decisions and the level of equity that corresponds to higher risks. The law in the Netherlands also takes a substance as a form of approach to ensure that's where decision making is happening in this country. Looking ahead for financial services companies registered in the Netherlands, the new year is expected to usher in additional requirements as from 1 January, relating to annual salary cost and office space and might discuss the likely impact of these new rules today. As you know, at IQ-EQ, we are very much committed to playing our part in helping corporates to meet the current and future substance requirements, whether through setting up and administering a Dutch payroll or seconding employees to your Dutch company, for example, in line with the company's specific profiles and needs. We will surely be looking into some of these issues in greater depth today. If you look at the picture in a wider context in the light of this pandemic we are currently facing, and related travel and quarantine restrictuions, it will also be interesting to consider whether there might be some negative impact on the ability for companies to demonstrate their economic substance as they will normally do. And we might think about how these can be dealt with, that’s the key element of substance requirement. For now it gives me a great pleasure to kick off the discussion and introduce you to Anton Akimov, Senior Associate at Loyens & Loeff.who will give an update on Dutch substance requirements.

Speaker name
Anton Akimov
Spoken content

In this part of the webinar, I will update you on the substance requirements for Dutch service company that they currently need to meet. So in 2020, I will elaborate on the additional substance requirements as per 2021. Then we will take a step into the future to 2022. When the Dutch government wants to introduce substance requirements for Dutch holding companies. Let's go to the next slide. Let me start with the Dutch substance requirements for Dutch service companies. The Dutch minimum substance requirements already exists for quite some years, and probably you're all familiar with them. In short certain companies that make use of the Dutch tax treaty network have to comply with these requirements, otherwise information gets exchanged with source countries involved. So the substance requirements help source countries determining whether the Dutch service company should be entitled to treaty benefits. Let's go into a bit into more detail. Substance requirements in principle applied to so-called service companies. What are service companies? Dutch based companies whose activities in a year, predominantly for 70% or more consists of receiving and on paying interest royalties, rent, or lease amounts to and from group companies based outside the Netherlands are considered as so-called service companies. If the service company can apply the Dutch tax treaty network, or the EU directive or the domestic implementation of source countries involved, certain requirements will need to be met with respect to their substance in the Netherlands to determine the activities, or to determine whether the activities for at least 70% or more consists of receiving and non-paying interests, royalties, rent, lease amounts. The following factors can play a role and these are types of assets and liabilities, the turnout for profits, activities from which the profits are derived and the time spent by employees. Any holding activity of the taxpayer must be excluded for this test. Therefore, holding companies that for example, for marginal financing activities also need to meet the minimum substance requirements if they aren't engaged for at least 30% in other activities. If the taxpayer is a fiscal unity, which is an optional regime in the Netherlands, the activities of all companies included in that fiscal unity must be taken into account. If a company qualifies as a service company and the Dutch tax treaty network or an EU directive or a domestic implementation thereof is used, the following substance requirements must be continuously met. Probably, most of you have already seen these requirements. The first one is thata 50% of the board is Dutch resident. The Dutch board members have required professional knowledge to perform the functions, qualify them, employees for proper handling of transaction management, decision taken in the Netherlands, main bank accounts held in the Netherlands, bookkeeping conducted in the Netherlands, registered office in the Netherlands. Companies not considered resident for tax purposes elsewhere and then specifically for service companies. The company runs real risks in connection with the intergroup activities, and it must have a proper amount of equity at risk. And this risk requirement is similar to the one of Article 8 C of the Dutch corporate income tax act that is the minimum amount of equity at risk must be the lower of the 1% of the funds lent or to 2 million Euro. Let us go back to the previous slide again, companies with an advanced pricing agreement or tax rulings under the old ruling practice, which was before July 2019, also have to meet the Dutch substance requirements. The set of requirements differs a bit from the one that I just mentioned. For example, a company must also have properly fulfilled its tax compliance obligations, and this condition applies to corporate tax wage tax, VAT, etcetera. Good to note in practice these requirements are also used by the Dutch tax administration as a guideline to determine the place of effective management of a holding company. Let's take a look at the new substance requirements as of the 1st January, 2021, two additional substance requirements will need to only be met by service companies. The first one is the service company incurs an annual salary cost of at least 100,000 Euro in relation to the service company functions. The second one is the entity has for at least 24 months, their own office space at its disposal in the Netherlands, which office space is again used for its relevant functions. These substance requirements are new and in practice we already see a lot of questions arising, especially about the 100 K requirements. Bear in mind that the guidance provided is very limited and much needs to be cleared up in the near future. However, the 100K requirements must be applied to salary costs of employees at the level of the company and must relate only to the financing, the Dutch parliamentary proceedings. We understand that the salary costs and salary expenses must also be considered as realistic. Well, what happens if the requirements are not met? The service company must explicitly state in its annual corporate income tax return whether it meets the Dutch minimum substance requirements. If the service company meets all substance requirements and declares as such in the tax return, then no spontaneous exchange of information will take place. If the service company cannot confirm that all substance requirements are met, it should first declare in its tax return which requirements are not met, provide information to the tax authorities to determine which of the substance requirements are met, provide an overview of interests, royalty, rent, and lease amounts received for which a reduction of withholding tax, has or could be claimed on the right tax treaty or any EU directive or a domestic implementation thereof. And, it must provide details on these foreign paying group entities. On this basis spontaneous exchange of information will in principle take place. In case a service company by error declares in his tax return that it complies with the substance requirements while in fact, this has not been the case, this will count as a violation and could result in an administrative fine of up to 22,000 Euros. It is important here to keep in mind that service companies could keep in mind that if the service company could not and did not apply to the tax treaty network or an EU directive or a domestic implementation, thereof, it is not obliged to provide the information mentioned above and no exchange of information with other authorities can take place. All right, then let's go to the next slide. Well substance requirements for Dutch holding companies and here we look a bit more into the future. In September 2020, on the Dutch budget day, the Dutch government announced that it contemplates to introduce spontaneous exchange of information on low substance Dutch holding companies starting from 2022. These ideas are not completely new because in February 2018, the Dutch government announced a study into the application of the Dutch participation exemption to Dutch resident holding companies with low substance. One of the options considered was disallowing the participation exemption to low substance holdings. However, the study concluded that it would raise too many objections and instead the government will contemplate the option of exchanging information with respect to low substance holdings as of 2022. As mentioned earlier, the Netherlands exchanges information with EU member States and tax treaty partners on Dutch intra-group financing licensing and leasing companies that benefit from tax treaties or EU directives. Only of course, if these companies do not meet the substance requirements, as already mentioned, the Dutch government has stated that it intends to introduce a similar provision for low substance holdings, but currently we have no further details. This moment we expect that holdings would need to declare in their annual corporate income tax return that they meet the substance requirements. If these requirements are not met, the Netherlands would spontaneously exchange information with the relevant EU Member States or a tax treaty partners, just like for the service companies that we just discussed. It's currently not clear whether this exchange of information will be subject to the holding company receiving income from its participations and on paying it to its shareholder or not. We expect to know more in the first half of 2021. There are some interesting and very relevant developments to come in the near future. Well, thank you for your attention. I would like to give the floor to Emma.

Speaker name
Emma Causevic
Spoken content

Thank you Anton. Within IQ-EQ Netherlands, we offer our clients corporate governance solutions that are fully in line with the latest local and international law and regulatory requirements. In the next slides we will provide some case studies of best practices which we see amongst our clients. The two examples are of two clients, which are being serviced by us for approximately 10 years. Next slide please. The first case study, some client background: A UK private equity firm from London with several billions assets under management has set up 20 holding companies in the Netherlands within a time span of 10 years. The holding companies hold the various investments and assets. The client implemented the current substance requirements by IQ EQ-Netherlands. The current substance solutions IQ-EQ Netherlands provides registered office to the client. At least the half of the total number of statutory board members reside in the Netherlands. The client is serviced by IQ-EQ’s private equity pool, so the board directors are qualified directors and have professional knowledge of the segment in which the client operates. There are around six board meetings per year, which are held at the office of the Dutch holding company. This was pre COVID situation. Next slide please. They also had their main bank accounts controlled from the Netherlands and the bookkeeping was also done in the Netherlands. In addition to the current substance requirements, the client implemented some additional substance requirements. The client got IQ-EQ personnel on the split payroll. What is split payroll? When you use the split payroll solution, IQ-EQ Netherlands employs IQ-EQ personnel for a certain amount of hours, a maximum of 36 hours of the 40 hours. Usually the employees already work on the file of the client and have in-depth knowledge. For split payroll employees the employer risk is at the end fully with IQ-EQ. In this case, the overall salary costs and employer expenses are in line with the threshold as stipulated in the new substance requirements being a 100,000 euros. Next slide please. The following case study is a real good example of taking substance step-by-step to the next level and implementing economic nexus in the Netherlands. Some client background: In 2011, a large production company from Asia had set up a holding company, a BV, in the Netherlands. In the same year, the BV purchased a company in Germany. in the last nine years the BV purchased more companies and currently has companies in 45 countries worldwide with a turnover of 6 billion Euro. The consolidation of the group was done at BV level. In 2016, the German subsidiary requested a tax ruling with the German tax authorities. Key part of the facts and circumstances for the application of the ruling was for the BV to prove and confirm that it had sufficient substance in the Netherlands. The German tax authorities granted the tax ruling, meaning that all dividends from the German subsidiary to the Dutch BV are exempt from withholding tax. So what did this client implement that the German and the Dutch tax authority ruled that they had sufficient substance? Well, the BV had at least half of the total number of the statutory board members, which were residents in the Netherlands. The staff working on the file had professional knowledge of the segment the client operated in. All the decision making on the transactions entered into by the BV and the management decisions are being taken during board meetings at the Dutch office of the BV. The board of directors meet every quarter and discuss the forecast budget strategy for the Dutch BV and the worldwide group. The main bank accounts of the client are being held from the Netherlands and the authorization is done via co-authorization, meaning one external director and one IQ-EQ director and the bookkeeping is also done in the Netherlands. In addition to the current substance requirements, the client implemented some additional substance requirements. The BV rented office space from IQ-EQ, and they got IQ-EQ personnel on the split payroll. These employees were already working on the file of the clients. In addition, accounting employees from the client's group were sent to the Netherlands, whereby the personnel increased. The HR and payroll administration is handled by IQ-EQ, via IQ-EQ Pro HR, and in addition to that, we have assisted the client with the visa application, the 30% ruling and the relocation. The client created and relocated the group’s finance departments to the Netherlands, and all the employees were directly employed by the BV. By implementing this strategy, the client created real economical substance in the Netherlands. Next slide please. Some key takeaways: Substance is the degree to which companies have economic nexus in a country. The more local reporting infrastructure, transactions and legal presence a company has the greater its economic substance. Over the years, IQ-EQ has developed a set of services to support our clients to be compliant with economic substance. Our current substance solution mitigates the growing financial and reputational risks that challenge multinational companies and international investment managers operating from the Netherlands. IQ-EQ can help you realise all operational elements needed such as directorships and office space, supplemented with ongoing accounting, treasury and corporate secretarial and HR payroll services. Next up will be the Q&A session.

Speaker name
Pascal Rapallino
Spoken content

Thanks Emma and Anton. Very useful, clear and straight to the point. Thanks for that. We see the kind of questions. So if I may, can I start with Anton? The first question that we received is about the deadline. Is 1st January 2022 a hard deadline for increased substance requirements for holding companies, or maybe we can let's say manage this deadline or it's our deadline?

Speaker name
Anton Akimov
Spoken content

Well, right now we only have the information that was given on budget day and that was only more like some information given on the plans of the Dutch government. So that means that they have the intention to increase or to introduce substance requirements for holding companies. But there's no proposal of law yet and they will try to have it on the 1st January, 2022. But for this moment, nothing is yet formalised and there's even not a draft bill or anything like so that should probably be something that we will know in the first half of next year.

Speaker name
Pascal Rapallino
Spoken content

Okay. Clear, thanks for that. Maybe Emma thanks for your comment on IQ-EQ services, but could you elaborate a bit more on two topics? The first one you mentioned, office space and the second one for HR. So for office space, the question is does IQ-EQ Netherlands provide office space, the first question, and the second one, you mentioned Pro HR, so what is the scope of IQ-EQ Pro HR? Could you please elaborate a bit more on that?

Speaker name
Emma Causevic
Spoken content

Yes Pascal. At IQ EQ, you can lease office space starting from 12 square metres up to 25, or if you want to have another office space in Amsterdam, we work with well established real estate agents. Apart from the office space, which you can lease, we can also help you with HR and payroll. We have a system called IQ-EQ Pro HR, which is the complete web-based system for HR processes and payroll. So as you recruit your Dutch workforce, we can help you through each step of the process from recruitment, selection and employment, to handling payroll and compliance with Dutch HR rules and regulations.

Speaker name
Pascal Rapallino
Spoken content

OK clear. Thanks for that. Maybe Anton another technical question. You mentioned a salary cost, but does employer cost fall in the scope of salary cost or is it two different things?

Speaker name
Anton Akimov
Spoken content

Sorry I did not understand the question. Does what? The salary cost?

Speaker name
Pascal Rapallino
Spoken content

No the employer cost. You mentioned the salary cost, but does employer cost fall within the scope of the salary cost?

Speaker name
Anton Akimov
Spoken content

This is something that hasn't been cleared out in the Dutch parliamentary history or in the law, but the law is clear on that there has to be at least 100,000 euros of salary costs that relates directly to the remuneration of the employees. I would also argue that employer costs also relate directly to the salary and should therefore also have to be taken in this threshold of the 100 K.

Speaker name
Pascal Rapallino
Spoken content

OK clear. Thanks for that. Let’s take a last question before we close the webinar. One question from my side. Emma if could you elaborate a bit more on how does split payroll work just to make sure we all understand that.

Speaker name
Emma Causevic
Spoken content

Part of IQ-EQ Pro HR is the split payroll solution for clients. IQ-EQ Netherlands employs IQ-EQ personnel for a maximum of 90% to our clients. Usually, these employees already work on the files of the client. For split payroll employees the employer risk is at the end fully with IQ-EQ. That's a big benefit for the client. They will save many recruitment costs and in case of an employee leaving, IQ-EQ will facilitate for another trained and professional colleague. The employees can also easily utilize IQ-EQ network for day-to-day questions, which is a complimentary benefit. In case of an employment conflict IQ-EQ will also deal with this. The client can be reassured that the employment is fully aligned with Dutch employment legislations.

Speaker name
Pascal Rapallino
Spoken content

Clear. It is now to close the webinar. Thanks Emma. Thanks Anton. Thanks all for attending this webinar. Hopefully it has been useful. Speak soon. Bye bye.