In recent years, Dutch private equity practitioners have found themselves in a rapidly changing tax environment. Due to new structuring opportunities, including the possible use of a Dutch Cooperative Association (Dutch Coop) vehicle, the Netherlands has become the prime location for some transatlantic and pan-European private equity funds entering the European market. But the biggest change in recent times will come on FEBRUARY 1, 2007, when the Dutch tax regime will undergo its most significant makeover in the last 30 years. It is hoped that the changes that result from this will positively impact the structuring of private equity funds.
The historic reputation of the Netherlands as a headquarters of choice for fi-nance, holding and distribution companies has, aside from its geographical position and infrastructure, been mainly due to a beneficial tax system. This system appeals to foreign investors because both dividends and capital gains are fully tax-exempt. Other traditional features were, and are, the absence of an interest and royalty withholding tax and a worldwide network of tax treaties, including all EU and OECD member states, most of Central and Eastern Europe and the Far East. These treaties mean that double taxation is avoided.
For private equity funds, which often complete deals in a relatively short period of time, an attractive tax climate is also reliant on a tax administration that is able to be cooperative at short notice. An administration that is accessible and responds quickly helps dealmakers to eliminate tax risk and avoid unecessary and prolonged discussions. In this respect, Dutch private equity practitioners benefit from negotiations with the country's tax inspectors that tend to take place in an informal way, and by way of consultation rather than, as is commonly the case in most Anglo-Saxon countries, in a climate characterised by litigation and penalties.
New year, new taxes
As from FEBRUARY 1, 2007, significant changes in Dutch corporate income tax will enter into force changes that will affect private equity practitioners positively. A competitive cut in the overall corporate income tax rate will be introduced, bringing it down to 25.5 percent. Also at that date, the participation exemption (a feature of Dutch law which avoids double taxation) will consistently apply to shareholdings of 5 percent or more, unless the shareholder's interest is a portfolio investment in a company that is not subject to an effective tax rate of at least 10 percent over a taxable base according to Dutch tax standards. For active companies, only the 5 percent threshold applies and, contrary to the current regime, no ?subject to tax? requirement will apply anymore.
Furthermore, a new regime will be introduced under which inter-company interest is effectively taxed at a rate of 5 percent. Beside the introduction of this interest ?box?, a patent ?box? will also be introduced [the term ?box? is used to signify that interest or income from patents will not be taxed under the general regime applicable to business income]. Under the patent box, profits (revenues including capital gains, minus depreciations and other attributable costs) derived from intangible assets will be taxed at an effective 10 percent tax rate. The introduction of both the interest and patent box is dependent on the approval of the European Commission.
In addition, dividend withholding tax will be reduced from 25 percent to 15 percent with effect from 1 FEBRUARY. This should reduce the administrative burden for companies and shareholders, as many shareholders will no longer be required to apply for a reduction from the general rate of 25 percent to the more common 15 percent tax treaty rate. However, under most tax treaties, of which the Netherlands has around 80, dividend withholding tax is less or even non-existent. In this respect, it should be noted that, in 2006, a policy was introduced in the Netherlands of gradually reducing the dividend withholding tax and eventually abolishing it. Finally, an important change for private equity funds is that, as of 2006, no capital duty is due anymore on capital contributions to Dutch companies.
Besides the above features, new structuring opportunities have made the Netherlands ideal for many private equity funds entering the European market. The key taxation issues include creating an optimal financing structure and ?funds flow? and enhancing the efficiency and flexibility of future exits. From a tax perspective, funds are set up with the aim of minimising tax costs on acquiring the target, obtaining additional funding, fund flows and the ultimate exit. In this respect, the absence of dividend withholding tax and a tax-free exit option are primary concerns when it comes to optimal fund flow. The absence of dividend withholding tax and capital duty under some Dutch private equity structures are attractive features in this respect. The growing number of private equity funds structured through the Netherlands bears witness to this.
The key issues can be best illustrated with reference to one of the main structures currently used for private equity funds structured through the Netherlands. The structure involves interposing a Dutch Cooperative Association (Dutch Coop) between the target company and the fund. The Dutch Coop is a separate legal entity under Dutch law with its own rights and obligations and with the capacity to legally own assets and conclude agreements. The Dutch Coop may act as both holding and fi-nancing vehicle. Although, upon incorporation, the Dutch Coop must have at least two members, the Dutch Civil Code does not preclude the possibility that, after incorporation, the Dutch Coop will have only one member.
Membership is open to any type of private equity vehicle, i.e. it is not restricted to individuals and legal entities partnerships may also be a member. The possibility of issuance of different classes of membership rights, i.e. priority rights, preference rights and alphabet rights, makes the Dutch Coop highly flexible from a legal perspective.
Furthermore, the Coop structure enables the repayment of any partial or full exit proceeds by way of dividend distribution without a requirement for the existence of freely distributable reserves. Also, no Dutch capital tax is due upon incorporation of a Dutch Coop, nor in relation to future capital uplifts.
The structure provides for a tax-free means of acquiring new portfolio companies and the repatriation of funds from target companies through to the fund. The high quality of the Dutch services infrastructure, together with economic and industrial critical mass, provide for less burdensome substance compliance issues than other typical (off shore) holding locations.
The 2007 Dutch tax regime contains some features beneficial specifically to private equity funds. The most significant changes include a cut in the overall corporate income tax rate and the introduction of both a special interest box and patent box. In addition, the reduction, and eventually the potential abolition, of dividend withholding tax and the removal of capital duty are equally important. In addition, the flexibility from a legal perspective, and efficiency from a tax perspective, of the Dutch Coop provide interesting possibilities for private equity funds in the Netherlands.
Oscar Kinders is an M&A tax partner at PricewaterhouseCoopers in the Netherlands (email@example.com. com)
Gijs Fibbe is an advisor in the technical office of Pricewaterhouse Coopers in the Netherlands and lecturer in international tax law at Erasmus University in Rotterdam (firstname.lastname@example.org)