The participation exemption for Dutch holding companies

The provision, however, is complex. This article provides a general overview of the participation exemption, including its objectives, benefits and information on what participations qualify.

Corporate residence

A company is subject to Dutch corporate income tax (CIT) if it is resident in the Netherlands. Dutch authorities determine if a company is tax resident in the Netherlands based on a number of factors and will consider:

• where important business decisions are made
• where the directors work and meet
• where business records are kept and financial statements are prepared

In short, a company is tax resident in the Netherlands if it is effectively managed in the country.

The Dutch Corporate Income Tax Act (CITA) provides an exception to this principle through the application of the “incorporation fiction.” In essence, the incorporation fiction assumes that companies incorporated under Dutch law are automatically considered residents of the Netherlands for Dutch CIT purposes, even if they are effectively managed outside the Netherlands. The incorporation fiction does not apply to certain tax provisions, however, including the participation exemption.

Dutch corporate income tax rate

A Dutch resident company is generally subject to Dutch CIT on its worldwide income. A reduced rate (19 percent as of this writing) is applicable to taxable income up to EUR 200,000. The standard rate (25.8 percent as of this writing) is applied to taxable income exceeding that amount.

The participation exemption

Despite the general rule that a Dutch resident company is subject to Dutch CIT on its worldwide income, all benefits arising from a qualifying participation (such as dividends and capital gains) are exempt from Dutch CIT at the shareholder level, provided the shareholder qualifies as a Dutch tax resident company. This is known as the participation exemption.

To be clear, a “participation” here refers to an equity interest one company has in another company, for example a Dutch resident company holding 10 percent of the shares of a subsidiary entity.

The Dutch participation exemption serves two purposes. From a Dutch domestic standpoint, it prevents double corporate income taxation on the profits of a single enterprise. That is, it prevents taxation at the level of the qualifying Dutch company and then again at the level of the Dutch shareholder. The participation exemption, then, ensures that the same profits are not subject to Dutch CIT twice within Dutch borders.

The participation exemption also provides relief from international double taxation — or the same income being taxed in more than one jurisdiction — since the exemption applies to holdings in resident and non-resident companies.

Netherlands’ authorities clarify why the participation exemption is a critical element of the country’s tax regime: “Since profits are not taxed twice, subsidiaries located outside the Netherlands can compete with local companies on an equal tax base.”

Qualifying participations: Minimum threshold, motive, asset, and subject-to-tax tests

The participation exemption applies to benefits arising from a qualifying participation held by a Dutch resident company. For a Dutch resident company to claim the participation exemption, the following must apply.

• The Dutch company holds a participation of at least 5 percent of the nominal paid-up share capital of a company (or, in certain circumstances, 5 percent of the voting rights) with a capital divided into shares. This is referred to as the minimum threshold test.
• The Dutch company does not qualify as a Dutch fiscal investment institution (FBI).
• The participation is not held as a portfolio investment. This is determined by the purpose for which the investment is held, and the process of determination is referred to as the motive test. The motive test is based on facts and circumstances and seeks to determine if the Dutch company aims to obtain a return on its participation that exceeds a portfolio investment return. Generally, if the Dutch company takes part in the management of the company in which it holds the participation, or if the Dutch company (or its parent company) fulfils an essential function for the benefit of the business enterprise of the group, then the motive test will be met.
• The participation is not deemed to be a portfolio investment by legal fiction. A participation is deemed to be a portfolio investment by legal fiction if:
  • More than 50 percent of the consolidated assets of the company in which the Dutch company holds the participation consist of shareholdings of less than 5 percent; or
  • The company in which the Dutch company holds the participation, together with its subsidiaries, predominantly (that is, more than 50 percent) functions as a group financing, leasing or licensing company.
• The participation is held as a portfolio investment on the basis of the motive test or legal fiction, but is considered to be a qualifying portfolio investment. This is the case if at least one of the following two tests is met:
  • The asset test. The direct and indirect assets of the company in which the Dutch company holds the participation generally consist of less than 50 percent of low-taxed free passive assets. An asset is a low-taxed free passive asset if it is a passive asset that is not reasonably required in the enterprise carried out by its owner and the income from such asset is effectively taxed at a rate of less than 10 percent.
  • The subject-to-tax test. The company in which the Dutch company holds the participation is subject to an adequate levy according to Dutch tax standards. Generally, a participation is considered to be subject to an adequate levy if it is subject to a tax on profits levied at a rate of at least 10 percent.
• The payment received from the company in which the Dutch company holds the participation is not deductible for CIT purposes in the country where the participation has its residence.

Participations not qualifying for the Dutch participation exemption

If the minimum threshold test is met, but the remaining conditions of the participation exemption are not, then a credit will be granted for the underlying tax paid by the participation at a maximum rate of 5 percent. Qualifying EU participations, however, can be subject to actual tax rates.

This is an updated version of a previously published article.