New box 3 mixes asset accumulation tax and capital gains tax

15/09/23

This item was last updated on 1 February 2024

The outgoing cabinet has designed a new box 3 system with the draft legislative proposal 'Wet werkelijk rendement box 3’ ('Actual Return Box 3 Act'), which was published for consultation on 8 September 2023. In response to the consultation, the government announced some changes to the draft proposal in its Parliamentary letter of 25 January 2024 with accompanying annexes. As a main rule, the new box 3 system assumes taxation of actual returns according to an asset accumulation tax. This system taxes realised and unrealised income from assets and allows related expenses to be deductible.

For real estate and for shares in family businesses and start-up companies, a capital gains tax applies as an exception to the main rule. Thereby, the development of value for these assets is taxed upon realisation, such as upon sale. For the so-called 'first home in box 3', involving mainly owner-occupation, a flat rate return applied in the draft proposal but in response to consultation reactions, this is taken out. All real estate properties now taxed in box 3 will be subject to the capital gains tax.

This new box 3 system should enter into force on 1 January 2027. Due to the caretaker status of the cabinet, it will be up to a new cabinet to actually submit the draft proposal to Dutch parliament - whether in amended or new form.

What does this mean for you?

Depending on the composition of your box 3 assets, this new box 3 system could have a solid impact. The proposal that has now been published may still change significantly, a new cabinet may have different ideas about the design. At the same time, it is important to follow these developments in order to be able to assess the consequences for your personal situation so that you can take timely action if needed.

Our initial assessment is that the new system in the amended proposal tackles a lot of criticism of the current box 3 system. For the most part, this system would no longer tax assets on a flat-rate basis, but would be based on actual returns. Taxing actual returns would satisfy fundamental court rullings. It also includes relief for assets that are ‘tied up’ and less liquid. Capital gains from that type of capital are in principle only taxed upon realisation of those gains. A major drawback, it seems to us, is the complexity that this new system introduces. On the other hand, a flat-rate system has also become complex due to court rulings and can deviate enormously from the returns actually realised. The question is whether the current design strikes a proper balance in this respect.

The system in outline

In the new Box 3 system, as a main rule, the actual return on savings and investments will be taxed on the basis of a so-calledasset accumulation tax, i.e. both income from assets and realised and unrealised capital gains will be taxed annually. This requires, as now, the annual valuation of assets and liabilities to fair market value. Because an asset accumulation tax taxes capital realised and unrealised capital gains annually, it prevents lengthy tax deferral. It also prevents taxpayers and chain partners, such as banks and insurers, from having to keep long-term records of historical cost prices and investments. However, a disadvantage of an asset accumulation tax is that taxpayers also have to pay tax on capital gains that they have not yet realised.

To avoid paying tax on less (or non-)liquid assets, those assets are only taxed when you have actually realised a profit. To this end, real estate property and participations in family-owned and start-up companies are valued at the acquisition price, and when you sell them, for example, you have to pay tax on the difference between this acquisition price and the proceeds: the capital gain. In the draft proposal, a step-up at the start of the new regime was lacking. This has been corrected in the amended proposal. Since the flat-rate returns in the current system include capital growth, the assets already held by the taxpayer at the start of the new system, would be valued at market value (WEV) at the start of calendar year 2027 (the intended entry into force date of the new regime). Otherwise, pre-2027 capital gains or losses would be unfairly included in future taxation. Income from these assets, such as dividends, is already taxed in the year of realisation. For residential properties, the market value at the beginning of the calendar year 2027 will be set at the WOZ value with a valuation date of 1 January 2027. The WOZ value (the value under the Dutch Valuation of Immovable Property Act (WOZ) is usually below market value.

The wealth taken into account under the new Box 3 system remains the same as under the current system and can be divided into two components:

real estate property and shares/profit certificates in family businesses or start-ups: here, actual income and capital gains are taxed; and
other assets and liabilities, including bank balances: here, actual income and asset accumulation is taxed.

The amended proposal provides that foreign exchange gains on bank deposits will be taxed, unlike in the draft proposal, where bank balances formed a separate category. Take for instance bank deposits held in foreign currency. This change does increase the administrative burden for taxpayers with foreign currency payment accounts. However, this is expected to be a relatively small group.

The current levy-free net assets will be replaced by a levy-free income.

The draft proposal does not yet include a specific rate for box 3 income. Based on financial estimates accompanying the consultation proposal, it could be a rate of between 33 and 37 per cent. This remains open to a new cabinet, as does the level of tax-free income.

Deductible expenses

In determining actual income, expenses may be deducted. The basic principle is that only costs related to the collection, preservation and acquisition of earnings may be deducted. Consider bank and management fees, transaction costs for buying and selling investments or costs for interest paid. To avoid discussions, the legal text will designate costs that are not deductible.

Total benefit idea and taxation of own use

The new Box 3 system taxes the total return (all benefits minus costs) from assets: the total benefit rationale. This principle is designed on the basis of the total profit principle that applies to entrepreneurs. With this, doctrines such as good business practice apply mutatis mutandis, taking into account the difference between a business and assets, the legal exceptions and derogations in Box 3. An important difference between the total benefit concept and the total profit concept is that box 3, as mentioned above, also taxes asset accumulation as a main rule. This is done by valuing the relevant assets annually at their economic value (in principle WEV). Another important difference is that for box 3, it is determined by law which assets belong in box 3 and therefore no asset labelling applies.

The box 3 benefit is determined by asset comparison. The starting point here is the nominal value of the starting and ending capital of the total box 3 assets. Inflation is therefore not taken into account. In the equity comparison, a correction applies for deposits and withdrawals (against WEV) not related to the box 3 assets. With this, only taxable changes in assets in box 3 are taxed.

As part of the total benefit concept, the arm's length principle applies. When determining the total benefit, the starting point is business as usual. This is to prevent box 3 planning by, for example, acting at arm's length between parent and child, creating losses or by constructions with impractical fees in relation to box 1 and box 2. To avoid complicating the system unnecessarily, an efficiency margin for e.g. interest on receivables/debt applies as a practical concession. The amount or percentage of this efficiency margin is not yet known. For immovable property, the economic rental value for own use, less related costs, will form part of the Box 3 tax base on a flat-rate basis. Movable property for own use, such as cars, caravans and boats, will remain outside taxation, as under the current Box 3 system, unless held mainly for investment.

There will be a remission benefit exemption, somewhat similar to those in income and corporate tax. The debtor's remission benefit will be exempt if there is a remission of a financially impaired claim and to the extent that income exceeds deductible losses.

Box 3 homes

In the initial draft proposal, a flat rate return applied to one of the Box 3 homes (at your one-off choice). Under the amended proposal, all real estate property currently taxed in Box 3 will be subject to the capital gains tax. The monetized benefit of having an immovable property available for own use will be determined with a flat rate.

Family businesses and start-ups

The definition of a family enterprise in the amended proposal has two elements. First, the entity must carry on an enterprise or hold a joint right. In addition, the family must hold an interest of at least 25 per cent in the body carrying on an enterprise or holding a joint right. The 'family' includes the first person who holds an equity interest in the body, his partner and all his relatives by blood and marriage in the descending line. The shareholder who is not part of the family can also benefit from this arrangement. If a shareholder - family or non-family - wants to be taxed through the capital gains tax regime, it must be able to convincingly demonstrate that the aforementioned conditions are met.

In a holding company structure, even if the holding company does not itself run a business, the holding company may still qualify as a family enterprise if the operating company in which the holding company holds an interest does itself run a business. However, the taxpayer must be able to convincingly demonstrate that the 'family' holds an interest of at least 25 per cent in the holding company and in the operating company that runs the enterprise.

The amended proposal defines a start-up as follows. This is an unlisted body that runs an enterprise, was established no more than 15 years ago, has an annual turnover of less than EUR 30 million and whose shares are ultimately held no more than 25 per cent by an entity that is not a start-up company. The amended proposal includes the possibility of excluding companies in sectors yet to be designated from qualifying as a start-up company.

Green investments and savings

The new system no longer includes an exemption for green savings and investments, but does include an increase in the tax credit for green investments and savings.

Loss set-off

Loss set-off becomes possible with other Box 3 income, but not across boxes. The loss carry-forward is unrestricted. The initial backward carry-forward of losses with the previous year will be dropped in the amended proposal. For efficiency reasons, there will be a loss relief threshold (amount still unknown) so that relief for very small losses will not be possible.

Miscellaneous

The general part of the draft explanatory memorandum contains the necessary background information, such as numerical information on the current box 3, the considerations surrounding alternative box 3 systems and the knock-on effects to income-dependent schemes.

A system based on actual returns requires more data than the current flat-rate system. Data from chain partners will remain relevant, so as much data as possible will be pre-completed in the tax return. But more data will often be relevant. As a result, there will also be an administration obligation for taxpayers with box 3 assets, which is still being looked at how to set this up as efficiently as possible.

Next steps

Whether the targeted introduction on 1 January 2027 is feasible depends on several factors. A legislative process usually takes a year and a half, followed by another year and a half for implementation. This means that a new cabinet must be formed as early as spring 2024. The next question is whether this new cabinet will adopt, amend or reject the draft proposal in its entirety. Furthermore, to meet the targeted date of introduction, the legislation should be published in the Dutch Government Gazette by 31 December 2025. After all, the year 2026 is needed for the chain partners to build the software and test the new data deliveries with the Dutch Tax Administration. All this means that the proposal must be submitted to the Dutch parliament by summer 2024 at the latest.

If 2027 is not feasible, the current bridging legislation will in principle be in force for another year. In the meantime, however, the Dutch Supreme Court may declare the current bridging legislation (partially) unlawful and force the legislator to make the necessary adjustments. For instance, the Dutch Supreme Court may rule that if a fixed return on investments of 6.17 percent (figure 2023; 6.04 percent in 2024) is much higher than the actual return, the taxpayer should (could) be taxed for the lower actual return. The legislator should then come up with a solution, for instance by introducing a rebuttal regime. This will make the current Box 3 system a lot more complex.