Changes in qualification open LPs and foreign legal forms

This article was last updated on 31 October 2024.

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 legal 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. For the time being, the final decree containing the details of the legal form comparison method has not yet been published.

The 2025 Tax Plan already includes some technical changes in connection with the introduction of this Act.

What does this mean for your organisation?

If your organisation or business has an international 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 an international 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.

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.

As a result of thesemeasures, 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 Entities

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.

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 goods (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.

The law is set to come into effect on 1 January 2025. Taxpayers can already invoke the transitional provisions in 2024. This provides taxpayers with a few months to prepare for the proposed measures and potentially utilise the transitional facilities.

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

Currently, 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 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 has an interest in a Dutch legal entity.

The elaboration of the legal form comparison method has been delegated to a general administrative order. This means that the detailed rules will be included in a Decree. In February 2024, draft Decree was submitted for consultation. This draft Decree shows that the question of whether a foreign legal form is comparable to a Dutch legal form must be based on certain so-called essential characteristics. The Decree specifies the most important characteristics of the Dutch legal forms. The basic principle is that equal weight is given to the various essential characteristics. This means that one characteristic does not outweigh the other. In the assessment of the foreign legal form, however, more or less weight can ultimately be attached to a single or a few essential characteristics: An analysis of the civil law laws and regulations of the foreign country in question with regard to the legal form to be assessed therefore serves as the starting point for the classification.

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. In principle, this list is leading, but it does contain a reservation for a relevant change in the foreign law of a state that governs the legal form compared to the time of classification. The Decree currently in force is indicative only.

As a result of the consultation, various parties provided input on the decision. We now have to wait for the final Decree.

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.

Follow-up tax qualification foreign legal entities

As of 1 January 2025, the legal definition of a fund for joint account (FGR) will be adjusted. Neither under current law, nor under future law, the definition of a FGR does requires a legal form. According to the Secretary of State, both under current law, as in future, a CV can be liable to tax (and as such non-transparent), because it will be considered a FGR.

In response to questions during the parliamentary debate on the Tax Plan 2025 Bill, it appears that the Dutch cabinet has received signals from practice that the possible qualification of a CV as a FGR may be undesirable. On the other hand, there are also signals that practice actually finds it desirable for a CV that qualifies as an FGR to be liable to tax as such. The Dutch cabinet has considered several alternatives (such as including a consent requirement or exempting investment CVs whose participants can identify each other), but it has concluded that these options are undesirable for various reasons.

Although requested, the Dutch cabinet sees no reason to provide for transitional law if a CV or foreign CV-like entity that is currently fiscally transparent becomes independently taxable as of 1 January 2025, because it meets the conditions for a FGR. The cabinet does not find this necessary because the creation of tax liability does not, in principle, lead to taxation. The cabinet also sees insufficient reason to postpone the entry into force of specific parts of the Bill.

However, the Secretary of State has announced that there will be transitional law for repurchase funds

From practice, it appears that certain investment funds intend to become repurchase funds as of 1 January 2025, but for practical reasons, it is not always feasible to achieve this before 1 January 2025. If a repurchase fund is involved, the fund does not qualify as a FGR and is therefore not liable to tax as such.

The Dutch cabinet will therefore soon introduce an amendment note for an additional transitional provision, which under certain conditions provides more time for the restructuring of an investment fund into a repurchase fund. With this provision, under certain conditions funds will have more time to restructure into a repurchase fund. One of these conditions is that the fund already intended in 2024 to meet the conditions of a repurchase fund during 2025.

A CV or CV-like entity that wishes to obtain certainty about whether it will be subject to corporate income tax as of 1 January 2025, can submit a request for a preliminary ruling by the Dutch tax authorities.