Timing is of the essence and restructuring may be needed prior to 1 January 2009
The issue of excessive pay for top executives has been subject of extensive political and media discussion in The Netherlands over the past year or so. This has led to draft tax legislation being introduced in early 2008 with the aim of entering into force as of 1 January 2009. The Bill has been approved by the Lower House of Dutch Parliament and is scheduled to be either approved or rejected by the Upper House of Dutch Parliament in its current form.
The aim of the draft tax legislation is to increase the overall tax burden on ‘lucrative interests’ (such as carried interest schemes), on ‘excessive’ redundancy payments and on ‘excessive’ pension payments.
This article focuses on the impact of the changes in respect of lucrative interests, which are primarily aimed at interests held by private equity (or hedge fund) managers.
A lucrative interest is in general a participation held by an individual (employee or otherwise) which generates an irregular high return. Whether a particular interest is taxed as a lucrative interest depends on the nature, mixture and conditions of the issued shares and whether the interest was granted as a reward for employment duties performed by the recipient.
At present, carried interest schemes and similar types of remuneration paid to private equity managers are either subject to income tax in Box III (effective tax rate of 1.2%) or, depending on the percentage of the lucrative interest, in Box II (flat tax rate of 25%).
The proposed legislation will re-classify private equity managers as “entrepreneurs” for Dutch personal income tax purposes with respect to income and gains derived from their lucrative interests. This re-classification will subject the recipient to income under Box I (maximum progressive rate of 52%) to the extent the income and gains were not already subject to Dutch payroll taxes.
Under the proposed legislation, there will be no transitional rules available for existing carried interest schemes and the new rules will therefore apply with retrospective effect. This will result in double taxation (first Box III then Box I).
However, if the lucrative interest is held via an intermediary company, and various conditions are met, the lucrative interest could still be taxed in Box II (25%).
The proposed legislation is very wide-ranging (a ‘lucrative interest’ can take one of four forms) and it is unlikely the wording of the proposed legislation will be adjusted prior to 1 January 2009.
It is therefore of the utmost importance to review and adjust (if needed) existing carried interest schemes and other ‘lucrative interest’ schemes prior to 1 January 2009 in order to minimise the negative consequences of the proposed legislation, for example, by interposing an intermediary BV company for holders of lucrative interests as soon as possible before 31 December 2008.