Bulgaria signs a new tax treaty with the Netherlands

After few years in the wait, Bulgaria finally announced that it has agreed on a new double tax treaty with the Netherlands, which will replace the previous one dating back to 1990.

The treaty was officially signed on 14 September. It is still to be seen whether the treaty will enter into force by year-end and thus apply from 1 January 2021.

NB! Foreign residents currently benefitting from a withholding tax exemption on technical / consultancy fees may need to submit new treaty relief applications in front of the tax authorities.

Some of the key aspects for inbound investors and entities looking to do business in the country are as follows:

• Bulgaria can now impose its 10% capital gains tax on non-residents, disposing of their shareholdings in domestic private entities, incorporated to hold and exploit investment properties
• As opposed to the old treaty, the new one envisages a 5% withholding tax on interest; certain exemptions may apply for e.g. banks (Impact on Dutch-based group finance centers to be assessed).
• Focus on anti-abuse: The new Dutch treaty text introduces a “principal purpose test” that should be passed in order to derive benefits from it. Treaty exemptions can be denied if one of the principal purposes of the arrangement is found to be the obtainment of a tax advantage. Other paragraphs of the treaty contain case-specific anti-abuse rules.
• PE anti-avoidance rules: Introduction of clauses preventing the avoidance of permanent establishment (PE) status due to the breakdown of a cohesive commercial activity between few associated entities, whereas individually the activity of each would not constitute a PE.
• Construction/installation projects: The term of local presence required to establish the foreign taxpayer is increased from 9 to 12 months.
• Bulgaria switches from the exemption to the credit method for preventing double taxation of PEs situated in the Netherlands (Impact to be assessed for tax exempt income allocated to Dutch establishments).
• Activities in the Bulgarian territorial sea: New specific rules are introduced for PE creation for offshore activities.
• A full exemption from withholding tax on dividends is provided for under certain holding conditions.
• The new treaty provides for assistance in the collection of taxes between the two states.
• An extensive protocol to the treaty contains specific clarifications to the core treaty text that should be examined on a case-by-case basis.

The highlights for individuals, sourcing income or residing in the other state, are the following:

• The definition of a tax resident now fully follows the OECD model and the scope of the treaty now covers any person taxable because of his/ her residence according to the local legislation of either of the contracting states.
• Income from professional services is now taxed as other income only in the country of residence regardless of whether it was derived from a fixed base in the other country (Freelancers should assess their tax residence position and obtain supporting documentation to avoid claims on taxation by the country where they have a formed a fixed base).
• Inland waterways transport is explicitly added to the types of transport from which the derived employment income is taxable only the country of residence of the recipient (Employers in the inland waterways transport should now assess the tax residence position of their employees).
• Tax planning for employment income is now further restricted by changing the period during which the 183-days threshold is measured from fiscal year to any 12 months period starting or ending the relevant fiscal year (Tax effects from duration of working activities should be reassessed).
• A definition on country where pensions and similar payments arise is added which focuses on whether tax relief was used for the contributions made towards the pension income.
• Pensions from voluntary insurance are now within the scope of pensions income. In difference to their treatment under the old treaty, such pensions can now also be taxed in the country where they arose (Individual’s pension structure should be reassessed to determine allocation of taxation rights).
• The exemption method from Bulgarian side, which was applied to all sorts of income, is now replaced by the tax credit method and Bulgarian tax residents will have to present proof of the tax paid in the Netherlands when applying for avoidance of double taxation (Bulgarian tax residents with Dutch sourced income should now reassess their reporting in The Netherlands).