The importance of the dividend tax repurchase facility

20/03/24

Dutch listed companies are currently allowed to repurchase their own shares without being subject to dividend tax, under certain conditions. However, this share buyback facility for dividend tax will be abolished starting from 1 January 2025, unless new legislative measures are introduced. This provides a good opportunity to explain the importance of the share buyback facility and the potential consequences of its abolition.

Introduction: Why a share buyback facility?

The Netherlands levies dividend tax on profit distributions. Dividend tax is essentially a tax on shareholders: the company that pays out dividends withholds dividend tax from the dividend and pays the dividend tax to the Tax Authorities. Shareholders can, under certain conditions, reclaim or offset the dividend tax against other taxes, such as income tax or corporate tax.

Dividend tax is not only levied on regular dividend distributions, but also on share buybacks. In a share buyback, the company purchases shares from the shareholder. There are various business reasons for setting up share buyback programs, including maintaining a consistent dividend policy and ensuring the value development of shares. However, a practical problem arises when publicly traded companies engage in share buybacks. The purchasing company does not know whose shares are being bought. Similarly, the selling shareholder is also unaware of who is buying the shares. This does not matter to the selling shareholder as long as they receive a price for their shares that is equal to the market price. The purchasing company must not only pay this price, but also the dividend tax that cannot be recovered from the (unknown) selling shareholder.

When purchasing shares, dividend tax is due on the difference between the purchase price and the average capital paid up on the shares. This amount, also known as the 'proceeds' for dividend tax purposes, is charged to the retained earnings and is treated as a dividend payment. The average capital paid up on the shares varies per company and is mainly determined by what the shareholders have previously paid up on the shares.

If a company bears the dividend tax itself, the proceeds must be multiplied by 100/85 to calculate the tax due. This means that the purchasing company must pay dividend tax on a grossed-up amount, resulting in an effective rate of 17.65% on the difference between the purchase price and the average capital paid up on the shares. This dividend tax is not offsettable for the shareholder and therefore constitutes an additional burden for the purchasing company. To prevent this disadvantage, the share buyback facility for dividend tax applies. It is also common in many other countries, including Germany, France, Spain, and the United Kingdom, for an exemption or facility to apply to the repurchase of shares by listed companies.

The dividend tax in the case of share buybacks by listed companies can be illustrated using the following example:

Assumptions

The market price of a company's share is €120 per share. The average capital paid on the shares is €20. The dividend tax rate is 15%.

Share buyback with buyback facility

If a listed company meets the conditions for the buyback facility, it can buy back shares without paying dividend tax. The company pays the shareholder an amount equal to the market price of €120 per share and does not have to pay dividend tax. The total price per repurchased share is €120.

Share buyback from an unknown shareholder without the buyback facility

Even without the buyback facility, the company pays the shareholder an amount equal to the market price of €120 per share. However, the company also has to pay 15% dividend tax on the gross proceeds before the dividend tax.

 Result

The gross proceeds before the dividend tax is the price per share (€120) minus the average capital paid on the shares (€20), which amounts to €100 in this example. Since the company has to bear the dividend tax, the proceeds are multiplied by 100/85 (grossing up). The dividend tax payable is thus 15% x €100 x 100/85 = €17.65. This corresponds to an effective tax rate of 17.65% on the proceeds. Without the buyback facility, the total price that the listed company has to pay per repurchased share is not €120 but €137.65.

The Dutch buyback facility will be abolished as of 1 January 2025, following a motion in the Dutch House of Representatives. For more information, please refer to a previous PwC Tax News article: Dividend tax repurchase facility own shares abolished.

The caretaker cabinet, however, advised against the motion to abolish that facility. It also indicated that it does not expect any positive effects from the abolition of the buyback facility. The Senate also expressed serious concerns but ultimately agreed, after the State Secretary of Finance promised to make maximum efforts to present alternative measures during the spring decision-making process. This commitment applies not only to the buyback facility but also to the reduction of the 30% ruling, the increase in the box 2 rate, and the increase in the bank tax.

Consequences of the abolition of the buyback facility as stated by the caretaker cabinet

The caretaker cabinet has recognized that it is difficult to estimate the revenue that will be generated by the abolition of the buyback facility. The most recent estimate is that the abolition of the buyback facility will yield approximately €814 million per year. This estimate takes into account a first-order behavioral effect of 70%, including the replacement of share buybacks with regular dividend payments and a possible departure of listed companies from the Netherlands. It is also acknowledged that the revenue could be zero. This underscores the significant uncertainty surrounding the estimate.

The broader impact of the abolition of the buyback facility and other legislative developments

The abolition of the buyback facility leads to an increase in costs for Dutch listed companies. Because most other competing countries do not impose or impose less tax on share buybacks, the Netherlands places itself outside the level playing field that currently still exists for share buybacks.

The potential behavioral effect of Dutch listed companies leaving, as also noted by the caretaker cabinet, does not seem to be a purely theoretical risk. Various studies, including the PwC CEO Survey, the National Survey on Business Climate 2024 by VNO-NCW and MKB-Nederland, recent public statements by directors of Dutch listed companies, and concerns expressed by the Minister of Economic Affairs and Climate after discussions with some of these companies, indicate a widely shared concern about the state of the Dutch business climate, which of course is not only about the buyback facility. In addition to the abolition of the buyback facility, other fiscal policy developments also play a role, such as the recent reduction of the 30% ruling, a significant limitation of the deduction of interest costs (earnings stripping) compared to other countries, the (recent) limitation of the liquidation loss regime, an increase instead of a decrease in the corporate tax rate, and a gradual increase in the innovation box rate. These cumulative measures, changing policies, and other non-fiscal reasons are mentioned by companies as elements of a deteriorating business climate. See also the earlier PwC Tax News article CEO Survey: concerns about the Dutch business climate. This poses the risk of potential departures of companies from the Netherlands. This risk is further exacerbated by the attractive nature of subsidies and similar incentive measures offered by some other countries to companies in certain (high-tech) sectors.

If companies actually leave the Netherlands, the consequences will not be limited to the buyback facility. For example, the departure of headquarters from the Netherlands will also have an effect on the amount that the State can annually collect in dividend tax (currently net €2.9 billion, mostly paid by foreign (portfolio) investors in large Dutch listed companies). In the event of such a departure, the Netherlands will no longer be able to levy dividend tax on regular dividend payments. Additionally, in certain cases, the Netherlands will have to provide foreign tax credit for foreign dividend tax, resulting in further loss of Dutch tax revenue.

Furthermore, such a departure can lead to a loss of corporate tax revenue and the departure of employees can result in reduced income tax and payroll tax revenue. There are also potential secondary and tertiary effects, such as the impact on ecosystems with many small and medium-sized enterprises (SMEs).

In short, depending on the extent to which departure and other behavioral effects occur, the damage from the abolition of the buyback facility may be (significantly) greater than the estimated revenue. Especially in the long term, and as part of a stack of reduced or abolished (tax) measures. Therefore, we are eagerly awaiting possible alternative measures in the Spring Memorandum.