Global Tax Alert (News from Transfer Pricing) | 26 November 2013
Dutch State Secretary of Finance publishes Decree on transfer pricing and application of arms length principle
On 26 November 2013, the Dutch State Secretary of Finance published a Decree on transfer pricing and application of the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). By means of this Decree, the State Secretary of Finance provides clarifications with respect to the arm's length principle.
The Decree combines and replaces two previous decrees on transfer pricing (i.e., IFZ 2001/295M dated 30 March 2001 and IFZ 2004/680M dated 21 August 2004) and contains a number of new sections in light of specific developments in Dutch case law and the developments with respect to the OECD's project on transfer pricing aspects of intangibles.1
The Decree provides important insights into the Dutch tax administration's position in applying the arm's length principle in general and into specific types of common inter-company transactions.
Compared to the previous two decrees on transfer pricing, the Decree contains important new sections that provide specific guidance for a number of particular inter-company transactions. These new sections among others concern:
- • Transactions involving (in)tangible fixed assets;
- • Centralized purchasing companies;
- • Captive insurance companies; and
- • Financial transactions.
Furthermore, the Decree includes important amended guidance with regard to the remuneration for inter-company services and the determination of shareholder costs.
The specific guidance on these topics can be very helpful for taxpayers when determining or reviewing their transfer pricing policy, or when considering entering into such transactions and/or setting up such companies.
Inter-company services and shareholder costs
Like the previous decree, the Decree contains an important section on the remuneration of inter-company services, which recognizes that inter-company services often are remunerated through a cost-based method. A significant change compared to the previous decree is the statement that it should be established, based on a functional analysis, whether a cost-based remuneration is appropriate. The Decree states that such remuneration generally only can be used for routine services.
Furthermore, it is explicitly stated that activities related to corporate governance will not always constitute shareholder activities, and may (partly) need to be remunerated at arm's length.
It is expected that the Dutch tax administration will scrutinize the transfer pricing for inter-company services, for head office activities in particular.
(In)tangible fixed assets
With respect to transactions involving (in)tangible fixed assets, the Decree emphasizes the importance of the “functionality” of the (legal) owner of such assets. According to the Decree:
- • Independent parties will only enter into such a transaction if both parties expect an increase in profitability as a result of such a transaction;
- • This can only be the case if the buyer has the relevant functionality to add value to the (in)tangible asset; and
- • The mere fact that a buyer is located in a low-tax jurisdiction does not lead to an increase in the overall profit for the parties involved.
If the buyer does not perform the relevant functions with respect to the (in)tangible asset, adjustments for Dutch transfer pricing purposes may be considered appropriate. In that case, the legal owner will only be entitled to a modest reward. The Dutch tax administration will apply a similar treatment in case the legal owner did not acquire the (in)tangible fixed assets from an affiliated company but from a third party.
Centralized purchasing companies
Specific guidance is provided with respect to the remuneration of central purchasing companies. Although the Decree recognizes that independent procurement agents may earn a fee based on the value of products purchased (e.g., a commission), the Dutch tax administration will for pragmatic reasons generally apply a cost-plus method to evaluate the reward allocated to the central purchasing company. The applicable cost base will consist of the purchasing company's operating expenses and will not include the costs of the goods purchased. In case the purchasing activities can be considered to be a core function for the group, the remuneration can be determined on the basis of a profit split.
Furthermore, the Decree states that benefits resulting from the mere aggregation of volumes should in principle be allocated to the companies that enable the central purchasing company to realize these benefits, unless (additional) discounts are realized due to specific know-how or skills of employees of the central purchasing company.
Captive insurance companies
So-called “captive insurance companies” are companies acting as internal (re)insurance company within a multinational enterprise. According to the State Secretary, the use of such companies may lead to a non-arm's length shift of profits if the captive insurance company lacks the functions that would be observed within professional insurance companies and/or in the absence of external diversification of risks. In such cases, the State Secretary considers it appropriate to allocate only a modest reward to the captive company.
The new section on financial transactions mainly concerns the “non-arm's length loan” doctrine (as developed by the Dutch Supreme Court in recent years2) and inter-company guarantee arrangements.
Non-Arm's Length Loans
The Decree elaborates on cases in which non-arm's length arrangements can be adjusted by means of adjusting the interest rate applied, and situations in which it is not possible to make such adjustment of the interest rate applied (i.e. non-arm's length loans). The State Secretary also indicates in which cases the burden of proof lies with the taxpayer to substantiate the arm's length nature of a certain loan transaction. In particular, a third party will generally not provide a loan to a company with a credit rating below investment grade (i.e., a rating below BBB-) and a borrowing company will in general not obtain a loan that lowers its credit rating below investment grade. In these circumstances, the State Secretary is of the view the taxpayer has to prove the loan has been concluded at arm's length conditions.
Furthermore, the State Secretary shares his view on how to determine an interest rate in case of non-arm's length loans.
The Decree states that the credit rating of a company that is part of a group is, from a lender's perspective, in principle not only based on the merits of that company but also on the relevant merits of the group, and on the company's position within that group. Hence the “derived credit rating” of such a company may differ from its “stand-alone credit rating.” Independent lenders will in principle require an interest rate that is based on the derived credit rating of the company. Such an “implicit guarantee” is based on the capital market's assumption that the group will enable the borrower to fulfill its obligations with respect to the loan.
The derived credit rating will primarily depend on the strategic importance of the company within the group: if the company is of high strategic importance to the group, the derived credit rating will tend toward the rating of the group (concern rating). If the company is of lesser strategic importance, the derived credit rating will tend toward the stand-alone credit rating of that company.
The Decree states that inter-company guarantee agreements should comply with the arm's length principle if they can be considered to constitute intra-group services. An explicit inter-company guarantee with respect to a loan is not considered to constitute a compensable intra-group service if the borrower would not have been able to obtain the loan without that guarantee. In such a case, the guarantee would not justify the payment of a guarantee fee. Any payments by the guarantor in case the guarantee will be invoked will also be considered non-deductible.
If the borrower would have been able to obtain the loan without an explicit guarantee, the effects of the “implicit guarantee” as described above should be analyzed. According to the Decree, an implicit guarantee does not constitute an intra-group service and hence does not justify the payment of a guarantee fee. Therefore, this element should be eliminated when determining the guarantee fee.
The Decree and the additional guidance are of great importance to taxpayers engaged in transactions or situations such as those described in this Alert. Please get in touch with your EY contact person for additional information and/or to discuss the potential impact of this new Decree.
1. The most recent work issued by the OECD in this respect is the Revised Discussion Draft on the transfer pricing aspects of intangibles, dated 30 July 2013. Please refer to our EY Global Alert, OECD issues Revised Discussion Draft on the Transfer Pricing Aspects of Intangibles, dated 31 July 2013.
2. Please refer to our most recent EY Global Alert on shareholder loans, Dutch Supreme Court provides new guidance on shareholder loan doctrine, dated 8 May 2013.
For additional information with respect to this Alert, please contact the following:
Ernst & Young Belastingadviseurs LLP, Amsterdam
- • Danny Oosterhoff
+31 88 40 71007
Ernst & Young Belastingadviseurs LLP, Rotterdam
- • Ronald van den Brekel
+31 88 407 9016
EYG no. CM3991