The Netherlands: Impact of ATAD2 to U.S. multinationals

Executive summary

New Dutch ATAD2 decree provides beneficial guidance in specific cost-plus situations

The Dutch State Secretary of Finance published a new decree on the interpretation of the Dutch anti-hybrid rules, known as the Anti-Tax Avoidance Directive II (ATAD2) rules, on Nov. 3, 2022. The decree addresses specific adverse situations resulting from the Dutch implementation of ATAD2, which impacts specific U.S. multinational enterprise (MNE) groups with cost-plus structures including companies in the Netherlands. The decree has a retroactive effect back to 2020.

ATAD2 overview

As of Jan. 1, 2020, anti-hybrid mismatch rules, known as ATAD2, have entered into force throughout all Member States of the European Union (EU). These rules generally apply to deductible payments between related parties that are not included in the tax base of the recipient or are also deductible elsewhere and where the mismatch (except in a double deduction (DD) scenario) originates from a different tax treatment of an entity or an instrument under the laws of two or more jurisdictions. The measures aim to neutralize the effects of such (hybrid) payments by either:

1. denying the deduction of the payment in the EU payor jurisdiction or
2. by including the payment in the taxable income of the EU recipient.

ATAD2 is particularly prevalent in U.S. MNE structures with EU entities due to the U.S. check-the-box provisions.

In principle, ATAD2 only applies to hybrid mismatch arrangements between related parties. A related party can include individuals and/or entities. Parties will generally be considered related if there is some element of control involving at least 25% voting rights, profit entitlement or capital ownership or in specific cases where they are part of a ‘collaborating group.’ ATAD2 also applies in specific ‘structured arrangement’ cases.

ATAD2 measures do not apply to certain categories of payments resulting in a deduction no inclusion (D/NI) or DD outcome to the extent that the payment can be set off against dual inclusion income, also known as the dual inclusion income escape. The dual inclusion income escape is available for:

1. Payments by a hybrid entity (i.e., an entity that one jurisdiction considers non-transparent, whereas another jurisdiction considers as transparent) resulting in a D/NI
2. Deemed payments between head office and permanent establishment (PE) or between two or more PEs resulting in a D/NI
3. Remunerations, payments, expenses or losses that result in a DD outcome

Dual inclusion income must be income taxed in the same two jurisdictions between which the mismatch has arisen (i.e., profit tax or a foreign personal income tax on business profits). The interpretation of what qualifies as dual inclusion income does however vary across the Member States of the EU. This contribution illustrates, by way of two simplified examples, the application of the Dutch dual inclusion income escape in relation to structures with U.S. shareholders that are holding an interest in a related Dutch group entity.

Example 1: Cost-plus remuneration provided to Dutch entity treated as a disregarded entity for U.S. tax purposes

From a Dutch transfer pricing perspective, NL OpCo is performing a support function for US Inc. and is remunerated on a cost-plus basis, amounting to $110. NL OpCo itself is not generating (external) revenue, as the actual sales are carried out through US Inc., resulting in income of $130.

Application of ATAD2 and dual inclusion income escape

The third-party expenses of NL OpCo are typically tax deductible for Dutch CIT purposes and as NL OpCo is treated as a DRE for U.S. tax purposes, these expenses would also be deductible for U.S. tax purposes. As such, these expenses would be deductible in both the U.S. and the Netherlands and thus, typically qualify as a DD outcome due to a mismatch in the qualification of an entity (i.e., NL OpCo). This DD outcome is in scope of the Dutch ATAD2 legislation.

As a result, the third-party expenses of $100 are in principle non-deductible at the level of NL OpCo, unless the dual inclusion income escape applies for Dutch CIT purposes. Should NL OpCo have generated external revenue, which would also be taxable in the U.S. at the level of US Inc., the dual inclusion income escape could have applied insofar the revenue of NL OpCo would have exceeded the expenses of NL OpCo. However, in this example, the $110 income of NL OpCo only exists of the intra-group cost-plus remuneration. This cost-plus remuneration is taxable for Dutch CIT purposes, but for U.S. tax purposes, this cost-plus income is not taken into account as income due to NL OpCo’s election to be treated as a DRE. In conclusion, this would in principle result in an ATAD2 correction at the level of NL OpCo and the $100 would not be deductible.

In practice, the above situation resulted in uncertainty on how to interpret this legislation. As a result, the Dutch State Secretary of Finance published a decree on Nov. 3, 2022, on the interpretation of the Dutch ATAD2 rules. This decree addresses three specific situations involving U.S. group companies that resulted in adverse consequences due to the Dutch implementation of ATAD2, and it has retroactive effect to 2020.

This specific cost-plus situation is one of the three situations addressed by the decree. The State Secretary of Finance now reasons that the cost-plus remuneration in this case may be considered as double inclusion income provided that:

• The third-party expenses of NL OpCo ($100) are double deducted (i.e., both in the Netherlands and U.S.).
• The limitation of the $100 deduction leads to double taxation. Namely there is a one-time deduction of the $100 at the level of US Inc., while there is a two-time taxable income pickup ($130 external sales income at the level of US Inc., and the $110 cost-plus remuneration at the level of NL OpCo).
• The cost-plus remuneration ($110) paid by US Inc. is not deductible for U.S. tax purposes and this cost-plus remuneration is taxable in the Netherlands at NL OpCo level.

The burden of proof for the dual inclusion income escape sits with the taxpayer. Consequently, the taxpayer must prove the situation included in the decree is similar to their specific case. This typically needs to be substantiated in an ATAD2 documentation file, which should be kept in the administration.

Example 2: Cost-plus remuneration provided to Dutch entity treated as a partnership for U.S. tax purposes

Application of ATAD2 and dual inclusion income escape

The third-party expenses of NL OpCo are typically tax deductible for Dutch CIT purposes. The expenses are also fully included as deductible expenses on US Inc. 1's U.S. tax return. In the context of ATAD2, these third-party expenses therefore result in a qualifying DD outcome. This would in principle result in an ATAD2 correction at the level of NL OpCo and the $100 would not be deductible.

This specific cost-plus situation is also addressed in the decree. The State Secretary of Finance now reasons that the cost-plus remuneration in this case may lead to ‘double inclusion’ income provided that:

• The transactions (including the cost-plus remuneration of $110) between the shareholders (US Inc. 1 and 2) and the foreign partnership (NL OpCo) are fiscally visible in the U.S., and are taken into account in the U.S. tax base and cumulatively.
• In respect of the cost-plus remuneration, no tax exemption or reduction of tax rate may apply, nor a settlement or refund of taxes, other than a credit for withholding taxes. A potential FTC in the U.S. for the Dutch CIT levied on the cost-plus profit at NL OpCo level, does not change this double inclusion income treatment.

The burden of proof for the dual inclusion income escape sits with the taxpayer. Consequently, the taxpayer must prove the situation included in the decree is similar to its specific case. This typically needs to be substantiated in the ATAD2 documentation file, which should be kept in the administration.

Conclusion

The consequences of ATAD2 in the Netherlands in relation to U.S. MNEs can be complicated. When transactions are carefully structured, tax consequences can be mitigated through application of the dual inclusion income escape of the decree.

The ATAD2 analysis, along with the dual inclusion income escape, requires careful structuring and involvement of Dutch and U.S. tax experts. U.S. legal entity tax structures are set up in many different ways and actual facts and circumstances (e.g., source of revenue, intercompany transactions, treatment for Dutch tax purposes of the U.S. entity) may lead to differing results for specific cases. The dual inclusion income escape may not be available for every situation.

All Dutch taxpayers are required by law to substantiate their ATAD2 position, as applied in their Dutch CIT returns. This obligation could typically be met via the preparation of an ATAD2 documentation file, which should be updated annually. Noncompliance may result in challenges (or discussions) from the Dutch tax authorities, shift of the burden of proof to the taxpayer, penalties, additional CIT due, interest on CIT due and advisory costs.

RSM has established an efficient and coordinated approach towards meeting the Dutch ATAD2 documentation requirements. Taxpayers should contact their tax advisors to better understand how the decree may affect their tax obligations.