On 26 September 2008, The Netherlands and the UK signed a new double tax treaty (‘DTT’) and protocol, which is intended to replace the current DTT. The new DTT will come into force if and when it has successfully followed the parliamentary approval procedures in both countries. When ratified, the DTT will apply to:
- The Netherlands with effect from 1 January (for withholding taxes paid or credited on or after that date and for all other taxes beginning on or after that date); and
- the UK with effect from 1 April (for corporation tax) or from 6 April (for income tax and capital gains tax) in the calendar year following the date of approval granted by the UK.
In this article we will highlight a number of changes introduced by the new DTT.
Changes to the “tie breaker rule”
The existing DTT includes a “tie breaker rule” which provides that an entity resident of both contracting states is deemed to be a resident of the state in which its place of effective management is located.
The new DTT no longer contains such a residency provision. Instead, it provides that where an entity resides in both the UK and The Netherlands, the competent authorities will have to agree on residency by mutual agreement and not on the basis of determining the place of effective management. Where mutual agreement cannot be reached, the entity will be deemed not to be a resident of either contracting state, and, as a result, will not be entitled to the benefits under the new DTT, except for the double taxation, non-discrimination and mutual agreement clauses of the new DTT.
In addition, the new DTT deals with the residence of an entity that participates in a so-called “dual listed company arrangement.” In such a case, the entity will be deemed to be resident only in the state of its incorporation, provided that it has its primary stock exchange listing in that state. Under the new DTT, a dual listed company arrangement is defined as an arrangement whereby two publicly listed entities (while maintaining their separate legal entity status, shareholdings and listings) align their strategic goals and the economic interests of their shareholders by performing certain pre-defined actions in that respect.
New dividend withholding tax arrangements
New arrangements in respect of “real estate investment vehicles”
The new DTT states that dividend distributions made by so-called “real estate investment vehicles”, which distribute a substantial part of their profits annually, will be subject to a 15% dividend withholding tax (‘WHT’).
Distributions exempt from dividend withholding tax
Under the new DTT, dividend distributions made by an entity to its ultimate beneficial owner residing in the other contracting state should be exempt from dividend WHT, provided that, inter alia, such owner is a pension fund, charitable institution or corporate entity controlling at least 10% of the voting power of the distributing entity.
Withholding tax rate for portfolio dividends
The new DTT provides that the rate for portfolio dividends (i.e. distributions to individuals and to corporate entities controlling less than 10% of the votes of the distributing entity) will be reduced from 15% to 10%.
Qualification of ‘distributions’ in case of liquidation or repurchase of shares
The protocol to the new DTT stipulates that income in relation to the (full or partial) liquidation of an entity or the repurchase of shares by an entity for Dutch tax purposes is to be covered by the dividend article rather than the capital gains article.
Anti abuse arrangements
To prevent abuse of the dividend article (and in addition to the beneficial ownership clause), the new DTT broadly provides that the reduced WHT rates are not available if the main purpose (or one of the main purposes) of any person concerned with the dividends or the shares, is to take advantage of the dividend article of the DTT. A similar provision is included in the interest, royalty, and other income articles.
Interest and royalty payments (in triangular cases)
The new DTT (in line with the current one) provides that interest and royalty payments made by an entity resident of one of the contracting states to an entity residing in the other contracting state, should be exempt from WHT.
An exception however applies to certain payments made in so-called ‘triangular cases’. The protocol to the new DTT contains a clause which denies the relief provided under the interest and royalties articles where:
- the interest or royalty income is paid to a Dutch company;
- the income is attributable to a permanent establishment of that company located in another state with whom The Netherlands has a double tax agreement;
- under that double tax agreement an exemption from double taxation would be available; and
- the tax levied in that third state is less than 60% of the Dutch tax that would have arisen had that income not been attributable to the permanent establishment.
If the above conditions are satisfied, the Dutch company receiving the income would not be entitled to the treaty benefits of the DTT.
(Deemed) capital gains upon emigration or sale of non-listed real estate shares
A typical (new) clause in Dutch tax treaties will also be introduced in the new DTT. Under Dutch tax law, individuals owning 5% or more of the shares in an entity are subject to a 25% income tax on capital gains. The new DTT allows The Netherlands to ‘save’ this taxing right (by means of a protective assessment) even after an individual moves to the UK, albeit in this case the minimum shareholding is increased from 5% to 20%.
Furthermore, the capital gains article in the new DTT provides that under certain conditions the source country rather than the home country of the shareholder has the right to levy taxes on gains realised in connection with the sale of non-listed real estate shares.
Transparent entities for tax purposes
The new DTT provides special provisions which are generally aimed at avoiding both double taxation and non-taxation in case of so-called ‘tax transparent’ entities.
For example, the new DTT does not exclude the taxation of partners in their state of residence on their share of income, profits or gains of a partnership established in the other contracting state.
Also, in the case of a resident deriving income, profits, or gains through a tax transparent entity, where this is regarded as their income, profits, or gains for tax purposes then such amount will be treated as derived by that person for the purposes of applying the new DTT.
In cases where the same income, profits, or gains are considered to be derived by a person in both states, the treaty does not prevent taxation in both states. This could apply to entities which are qualified as non-transparent in one state and transparent in the other.
Where income, profits, or gains are not treated as such for tax purposes, but would have been exempt from tax if they had been, the competent authorities may still grant treaty benefits.
The new DTT contains certain provisions, such as a reduction in or exemption from dividend WHT (as discussed above), which could be regarded as an improvement in comparison to the current DTT in place between the UK and The Netherlands. However, this may not necessarily be justified in light of the EU Parent/Subsidiary Directive which prescribes no WHT where a shareholding of at least 15% is held (to be reduced to 10% from 1 January 2009).
Further, the new DTT also introduces some new measures, in particular for Dutch real estate investment institutions (in view of a 15% Dutch dividend WHT obligation and a potential Dutch substantial interest taxation for capital gains realised by UK shareholders), which may affect cross border transactions and therefore arguably undermines one of the purposes of the new DTT, which was to further improve the economic relationship between the UK and The Netherlands.
Moreover, the new DTT contains some provisions (such as the residency and tax transparency clauses) in which their scope and objective are not yet clear from the treaty text itself. While the explanatory notes to the OECD Model Treaty should provide some assistance in interpretation, this is expected to be limited.