Changes in Qualification LPs and Foreign Legal Forms

As from 2025, the Dutch classification rules for Dutch and foreign legal entities and partnerships will be amended.The purpose of this legislation is to reduce the number of hybrid mismatches in an international context. The measures aim to minimise hybrid mismatches resulting from differences in the qualification of entities by two countries. Such differences in qualification can lead to either double taxation (i.e., once at the entity level and again at the participant level) or no taxation at all of certain income. Does this sound familiar to you? That may be true, we wrote about this earlier because the legislation follows a consultation that already took place in 2021 and the measures were already part of the 2024 Tax Plan. In principle, they will enter into force on 1 January 2025, and transitional provisions are provided, which can be invoked in 2024.

What does this mean for your organisation?

If your organisation or business has a structure that includes Dutch (business) components, it may be affected by the now submitted bill. This may particularly be the case if your organisation or business has a structure in which there is:

A non-transparent, Dutch limited partnership (CV), or

A foreign legal form that is comparable to a non-transparent, Dutch limited partnership (CV), or

A foreign entity that is not comparable to an existing Dutch legal form.

The changes will also affect partnerships that are used as an investment fund. These partnerships may be classified as a so called FGR and still be considered non-transparent for Dutch tax purposes. This can have major tax consequences.

Not only for businesses but also for private investors, a changed qualification can have consequences.

Introduction

One aspect of the legislation involves the removal of the so-called 'consent requirement' for Dutch CVs (Limited Partnerships). This requirement has been a major cause of hybrid mismatches in the Netherlands. Under this requirement, a Dutch CV is considered non-transparent for Dutch corporate tax purposes if partners can join or be replaced without the consent of all other partners (both managing and limited partners). This is known as an 'open CV'. In simple terms, a non-transparent or open CV results in the CV itself being subject to Dutch (profit) tax, rather than its partners. Based on the new legislation, CVs will now in principle be fiscally transparent and uniformly classified. Also for the qualification of investment funds the ‘consent requirement’ will be abolished to distinguish between non transparent “open” funds and transparent funds.

As a result of these measures, the number of hybrid mismatches should significantly decrease, and more flexibility is expected for organisations aiming for a transparent Dutch CV structure. Nevertheless, it's crucial to analyse existing structures to prevent unexpected consequences of the newly introduced bill.

Dutch CVs and foreign legal forms comparable to Dutch CVs

As previously noted, one of the key components of the measures is the removal of the so-called 'consent requirement.' Currently, this requirement determines whether a Dutch CV should be classified as transparent (underlying partners can be subject to taxation) or non-transparent (the CV itself is subject to taxation). According to the new legislation, a Dutch CV will now in principle be treated as fiscally transparent and will no longer be subject to Dutch corporate tax or Dutch withholding taxes. Instead, starting from 1 January 2025, the partners of a CV will be directly liable for taxation on their participation in the CV (either corporate or personal income tax, depending on whether the participant is a legal entity or a natural person). This rule will also apply to foreign legal forms that are comparable to a Dutch CV.

Please note that if a CV or comparable foreign partnership has the function of an investment fund it may qualfy as a Fund for joint account (FGR) which is not transparent for Dutch tax purposes (see under “Fund for joing account” hereafter).

Transitional provisions

For Dutch CVs and foreign legal forms comparable to Dutch entities that currently qualify as non-transparent for Dutch corporate tax purposes, the shift to fiscal transparency implies that they are considered to have transferred their assets and liabilities to their participants (a fictional disposal followed by cessation). In principle, this results in a final tax settlement on hidden reserves, fiscal reserves, and goodwill. To prevent immediate taxation on these, the legislation includes transitional provisions:

A rollover facility (the tax claim on hidden reserves, fiscal reserves, and goodwill is taken over by the underlying limited partners).
A stock merger facility (the underlying limited partners can transfer the tax claim to a holding company).
A rollover facility in the case of taxable income from the provision of (in Dutch “tbs” situations) (the underlying limited partners can transfer the tax claim on assets they make available).
A deferred payment option, spanning up to ten years if the rollover facility under 1 cannot be applied.

The law is set to come into effect on 1 January 2025. Taxpayers can already invoke the transitional provisions in 2024.

It is possible that an open limited CV that is currently subject to corporate income tax has deductible losses. The termination of the corporate income tax liability of the open limited CV as of 1 January 2025 means that, in principle, the possibility of loss relief will be lost. The Deputy Minister of Finance has indicated that the claim for loss relief may be passed on to the underlying partners if use is made of the carry-over facility referred to under 1. In connection with this, a policy statement was published in early 2024.

Determining transparency for foreign legal entities comparable to Dutch legal entities

Untill 2025, the classification of foreign legal entities as transparent or non-transparent for Dutch tax purposes is based on their similarity to Dutch legal entities, using the so-called 'legal form comparison method'. According to the proposed measures, the 'legal form comparison method' will remain the primary qualification method. This method is applicable in both scenarios where a Dutch legal entity has an interest in a foreign legal entity and when a foreign legal entity or peson has an interest in a Dutch legal entity.

Determining transparency for foreign legal entities not comparable to Dutch legal entities

For foreign legal entities that do not have a comparable counterpart in the Netherlands, the proposed legislation introduces two new approaches:

Fixed approach: If, based on the circumstances, the foreign legal entity is deemed to be effectively located in the Netherlands, it will be considered non-transparent (and therefore subject to Dutch corporate tax).

Symmetrical approach: If, based on the circumstances, the foreign legal entity is deemed to be effectively located outside the Netherlands, the classification will follow the jurisdiction where the entity is located.

Both approaches apply in situations where a Dutch legal entity has an interest in a foreign legal entity and when a foreign legal entity or person has an interest in a Dutch legal entity.

A decree (“Decree") has been published on November 9, 2024 providing the rules to qualify foreign entities (including partnerships) for Dutch tax purposes. If based on the criteria listed in the Decree a foreign entity is comparable with a Dutch partnership (personenvennootschap), such entity will in principle be transparent for Dutch income tax and withholding tax purposes. However, based on the Decree there is an exception for partnerships that qualify as a fund for joint account (fonds voor gemene rekening, FGR). In that case, the qualification as FGR prevails and the fund (partnership) will be non-transparent for Dutch tax purposes.

As an annex to the Decree, a list of foreign legal forms is included that are and are not comparable to a Dutch legal form. However, this list is indicative only.

Relationship with ATAD2

You may be wondering if there was already European legislation addressing hybrid mismatches. Indeed, as of 2020, measures to combat these mismatches were introduced through the implementation of the EU ATAD2 Directive. These measures mitigate the effects of hybrid mismatches. For instance, payments to hybrid entities may not be tax-deductible under specific conditions or may be subject to taxation under certain circumstances.

In contrast, the proposed qualification measures aim to eliminate the root cause of hybrid mismatches, which lies in the differences in qualification between tax systems. The qualification of open CVs and certain foreign legal forms revolves around determining to whom specific income should be attributed: the open CV or the foreign legal form itself, or the underlying participant(s). The answer to this question essentially determines who bears the tax liability.

Another measure introduced by the EU ATAD2 Directive is the corporate income tax liability for so-called 'reverse hybrid entities' which became effective on 1 January 2022. These entities are partnerships established in the Netherlands that are transparent under Dutch law but non-transparent under foreign law. This measure remains in place. For open CVs that become fiscally transparent as of 1 January 2025, but are also classified as (taxable) reverse hybrid entities, there is no final settlement obligation.

Fund for joint accounts (FGR)

As indicated, the purpose of the Act is to reduce international mismatches. However, the legislator has also indicated that, in its opinion, a partnership that has the function of an investment fund can qualify as FGR. In that case the partnership will be non-transparant for Dutch tax purposes and as a result mismaches might still exist. This position is also included in the aforementioned Decree of 9 November 2024. Based on the information known so far, the precise criteria based on which the classification as FGR needs to be done, are still unclear. Depending on the precise criteria a broad range of partnerships may potentially be reclassified and considered a non-transparent FGR for Dutch tax purposes.

As a general rule, as from 1 January 2025 funds are not reclassified as FGR and are therefore tax transparent, unless:

The fund qualifies as an investment fund (AIF) or undertaking for collective investment in transferable securities (UCITS) within the meaning of article 1:1 of the Dutch Financial Supervision Act (Wet op het financieel toezicht, Wft);
The activities of the fund are not considered an active business for Dutch tax purposes; and
The participations in the fund are transferable, whereby participations are not considered transferable if they can only be transferred to the fund itself by way of redemption.

A fund needs to meet all the requirements outlined above in order to be classified as (non-transparent) FGR. Particularly, whether a fund carries out business activities or not, is subject to interpretation and the outcome of this test may be uncertain and subject to debate (with the tax authorities). I order to avoid uncertainty as to the potetial classification as FGR it is possible to seek for a ruling with the Dutch tax authorities.

Alternatives and transitional rules

Investment funds and partnerships that may be faced with the above outlined classification of the fund into a fund for joint account for Dutch tax purposes, could consider the following.

In principle, it should be possible to amend the fund terms in such way that participations in the fund can only be transferred to the fund itself by way of redemption. This limits the possibilities for a direct transfer of participations between investors. However, provided properly implemented in the fund terms and followed in practice, a secondary trade between participants should still be possible. This requires however the transfer between investors takes place by way of issuance and redemption of participations in the fund that is handled by the (manager of the) fund.

Amending fund terms, may take some time, particularly where the approval of investors and other stakeholders is required to change the fund terms at all. Therefore, transitional rules are adopted. Based on this, the participations in a fund are deemed to be not transferable with effect from 1 January 2025 if: (i) the fund for joint account (or a comparable foreign fund) would, without the introduction of the transitional provision, become liable to Dutch tax from 1 January 2025, (ii) the fund was not liable to tax immediately prior 1 January 2025 (i.e. qualified as tax transparent prior to 1 January 2025), (iii) by 31 December 2025 at the latest the participations in the fund can only be transferred to the fund itself and (iv) the intention to meet this condition already existed before 1 January 2025.

It is apparent from the explanatory memorandum that the last condition can be met, for example, by providing minutes or correspondence showing that this intention already exists before 1 January 2025.

So, funds are allowed to amend their fund terms during 2025, without becoming non-transparent funds for joint account per 1 January 2025.

Our view and actions

Although we are of the view that the approach of legislator is undesired and also technically doubtful, funds that may be affected by the above rules are strongly recommended to take action before year end in order to ensure the appropriate tax treatment under Dutch tax laws and potentially avoid taxation of investors on deferred gains due to the change of qualification as per 1 January 2025.

In light of the changes, in order to determine the Dutch tax classification of investment vehicles in the form of partnerships, it is recommended to assess:

Their qualification under article 1:1 of the Financial Supervision Act;
The qualification of the investments as passive investment activities / portfolio management or trade or business activities;
The possibility to amend fund terms to allow transfers of interest only by way of redemption and secondary trades as allowed under Dutch tax regulations.

Investment funds that are not engaged in a trade or business, but are rather performing passive investment activities, should consider changing their fund terms in case a transparent tax treatment as per 1 January 2025 is required.

Should you have any questions in relation to the above, please contact your regular PwC contact.