In 2007, significant changes in the Dutch corporate income tax came into effect. These changes have positively affected the Dutch investment climate for financial institutions, including private equity.
Among others, the overall corporate income tax rate has been cut to a rate of 25.5 percent. Also, under Dutch domestic tax law, the dividend withholding tax has been reduced from 25 percent to 15 percent effective January 1, 2007. The cut has reduced 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. In addition, under many Dutch tax treaties, dividend withholding tax is further reduced or even eliminated.
Furthermore, the Dutch participation exemption consistently applies to shareholdings of 5 percent or more, unless the shareholder’s interest is a passive 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, generally only the 5 percent threshold applies and, contrary to the regime applicable before 2007, no subject to tax requirement applies anymore. Under the Dutch participation exemption, dividend income and capital gains are tax exempt for corporate income tax purposes. In contrast to some other European countries, the Dutch participation exemption does not contain a minimum holding period and applies in principle directly after obtaining the investment. In this respect, specifically for private equity investors, it is interesting to note that the Dutch participation exemption may also apply to foreign partnerships even if these are not subject to tax in the jurisdiction where they are established.
In addition to the changes per January 1, 2007, as of August 1, 2007 a new regime for financial institutions came into effect, the so-called “tax exempt investment vehicle.” Under this new regime, provided the requirements are met, an investment vehicle is tax exempt. This new regime was introduced to help the Netherlands compete against traditionally attractive jurisdictions such as Luxembourg and Ireland. The primary aim of this new act is to attract financial institutions to the Netherlands that have moved to Luxembourg and Ireland in the past.
Before addressing the new opportunities for private equity created by this new legislation, it is first useful to examine the factors that firms take into account when determining fund location, as well as the characteristics of traditional Dutch fund vehicles.
Creating the optimal tax structure
The best jurisdiction in which to locate a fund vehicle is determined mainly by legal, regulatory and tax considerations. The key considerations faced by private equity practitioners are related to the structuring of the funds to enhance the tax position (for corporate income tax, VAT and withholding tax purposes), create
an optimal financing structure and funds flow and enhance the efficiency and flexibility of future (partial) exits. In addition, one of the key drivers for a fund location is the type of investors the fund has and their location.
The choice of jurisdiction for an acquisition/holding structure is also dictated mainly by legal and tax considerations. From a tax perspective, the structure of acquisition/holding structures is set up with the goal of minimizing tax costs on the acquisition of the target, additional funding, the fund flows and the ultimate exit. In this respect, the absence of dividend withholding tax and a tax free exit option go a long way toward creating an optimal structure.
This can be achieved under some Dutch structures benefiting from the Dutch participation exemption and under which no dividend withholding tax is due. In addition, the absence of capital tax in the Netherlands provides more possibilities for a tax efficient funding. In this context, it should also be noted that the Nether lands has a worldwide network of tax treaties, embracing all EU and OECD member states, Central and Eastern Europe and the Far East, under which double taxation is avoided.
The traditional Dutch fund vehicles
The traditional fund vehicle in the Netherlands is a Commanditaire Vennootschap (CV). This vehicle is similar to a limited partnership, the traditional venture capital/private equity fund-raising and investment vehicle known in the US and the UK. Under Dutch private law, the limited partners in a CV may not perform any acts of management in respect to the CV. This is to avoid endangering their status as limited partners. If they perform management activities they run the risk of being qualified as a general partner and consequently incurring unlimited liability. Because of their unlimited liability, general partners normally use a limited liability company to cap their liability.
The structure of the CV can be either tax transparent or tax non-transparent depending on the mechanics of the CV agreement. Commonly, a CV as fund vehicle is structured as tax transparent to avoid having a taxable entity in the Netherlands, in which case the income of the CV is allocated to the partners for the purposes of Dutch tax. As such, a tax transparent CV is not subject to Dutch corporate income tax or dividend withholding tax. If a Dutch tax transparent CV is used as fund vehicle, it may be necessary to establish an intermediate
holding/acquisition structure that allows access to double taxation treaties and the EU Parent-Subsidiary directive. Furthermore, such an intermediate holding/ acquisition structure between the fund and its investments should create flexibility with respect to funding and cash repatriation from a legal, accounting and tax perspective. In this context, a Dutch BV or Cooperative is a feasible option for an on-shore holding/acquisition vehicle.
In addition to the traditional CV, the Dutch Cooperative has also emerged in recent years as a fund vehicle in the Netherlands and can be used depending on the type of investors and the tax treatment in their jurisdiction. Because the Cooperative, like the BV, can benefit from the Dutch participation exemption, received dividend income and capital gains should be tax exempt in the Netherlands. If structured properly, profits repatriated by a Cooperative to its investors should not be subject to dividend withholding tax. Provided the Cooperative contains sufficient substance in the Netherlands, the Cooperative should be entitled to the benefits of the tax treaties. The Cooperative should therefore be entitled to the lower tax rates applicable under the relevant tax treaties with respect to any withholding tax due on payments of passive income to the Cooperative from another jurisdiction. In addition, the legal form of a Dutch Cooperative is mentioned in the Annex to the EU Parent-Subsidiary Directive and it is therefore entitled to the benefits of the directive. Also no Dutch capital tax is due upon incorporation of a Dutch Coop as well as in relation to future capital uplifts.
From a legal perspective, it should be noted that membership in a Coop is open to any type of private equity investor, i.e. not restricted to individuals and legal entities, also partnerships may 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/full exit proceeds by way of profit/capital distribution without the need for existence of freely distributable reserves (note, however, that legal reserves need to be retained).
New fund formation opportunities
Besides the possibility of using a Dutch fund vehicle mentioned above, the new Dutch tax regime offers new structuring opportunities for feeder and carry vehicles. The tax considerations at stake for private equity practitioners in this respect can be addressed best with specific regard to a general private equity fund structure.
As stated above, per 2007 the Dutch participation exemption may also apply to foreign partnerships even if these are not subject to tax in the jurisdiction where they are established. The main condition is that these partnerships are structured in such a way that they are considered opaque for Dutch tax purposes. Whether a fund LP is considered to be non-transparent for Dutch tax purposes mainly depends on whether the investments in the LP cannot be freely transferred by the investors. This can in practice easily be managed in the fund’s partnership agreement as the transferability of interests is commonly subject to approval of the general partner of the fund only.
Consequently, the new Dutch participation exemption provides for possibilities to repatriate profits from an off-shore fund vehicle on-shore. For investor purposes this can be beneficial as fund proceeds may be treated more beneficially from a tax perspective if investors obtain their profits from an on-shore entity as opposed to an off-shore fund vehicle. Under the new Dutch tax regime, by interposing a Dutch feeder vehicle or carried interest vehicle, fund proceeds may be repatriated tax free on shore. These structures are interposed either between the investors and the fund vehicle (typically being a Channel Islands limited partnership for European private equity funds) or between the PE firm and the fund vehicle. The new regime offers the possibility to structure these Dutch feeder and carried interest vehicles in such a way that profits repatriated to the investors and carried interest holders should not be subject to Dutch corporate income tax and Dutch dividend withholding tax. In this respect, it should be noted that the high quality of the Dutch (services) infrastructure and critical economic and industrial mass provide for less burdensome substance compliance issues than other typical (off shore) locations.
Gijs Fibbe also contributed to this article
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