Dutch tax innovation

In 2006, the Netherlands started truly innovating its tax system. The most famous Dutch tax innovation – the exemption of dividend income and capital gains from subsidiaries – had long been copied by other countries, and the 2001 reform of the Dutch tax ruling practice by the Barbapapa group was basically continuation of the old system in a different shape, not real innovation. However, the Netherlands had do think of something new to preserve its tax haven features for multinationals after it had closed the low-tax regime for interest and royalty income. In 2005, Belgium further increased the pressure by announcing a system of notional interest deductions, designed to facilitate tax dodging structures using intra-group loans.

That’s where the real innovation came in. The Netherlands didn’t copy the Belgian system, that would be below its standing – we’re a country of innovators, not copycats! Instead, the government proposed a patent box and a group interest box. The patent box provided a preferential 10% tax rate on income from patents, with certain restrictions that limited tax avoidance opportunities. The interest box was much more aggressive and provided a 5% tax rate for intra-group interest income. This was very different from the previous Group Financing Activities regime, much simpler and without ring-fencing. No other country had anything like it. Truly innovative!

The simple rules and rock-bottom tax rate made the group interest box enormously atractive for multinationals that wanted to set up tax dodging structures. Within a year, hundreds of foreign multinationals established Dutch special purpose entities to benefit from it. The total balance of intra-group interest income of such entities, to which the 5% tax rate applied, exploded from 18 billion euro in 2007 to 63 billion euro in 2008.

At least, that is what could have happened if the group interest box had entered into force. Fortunately, it didn’t. The European Commission argued that it was still discriminatory because it was an optional regime that did not apply to all companies, unlike the Belgian notional interest deduction. After several years of negotiations, the Netherlands gave up, in part because extending the box to all domestic companies would leave a huge gap in tax revenues. The government just wanted to provide a selective tax advantage for foreign income of multinationals, undermining the revenues of other countries – it didn’t want to pay for the tax break itself.

Realising that true innovation is risky, the Netherlands didn’t put all its eggs in one basket. As of 2007, it deliberately exempted the revenues from special types of financing to foreign subsidiaries, even if the payments to the Netherlands were deductible abroad and thus reduce taxable profits of the subsidiaries. Tax advisors and the Netherlands Foreign Investment Agency were quick to promote tax avoidance opportunities via these so-called hybrid financing structures.

The EU was not blind, though. The same group that had identified the 66 harmful tax regimes of member states back in 1999 kept an eye on subsequent developments. In April 2006, the group noted:  “Of course, differences in tax systems (…) can lead to (…) double non-taxation (…) without anybody being to blame. (…) However, in cases where one Member State actively promotes tax planning schemes based on those differences or even introduces legislation to create such a difference” – as the Netherlands was doing at that very moment – “(…) the Member State concerned should be requested to change the practice or legislation.”

Yet it took until 2014 before the the problem of deliberately introduced legislation enabling double non-taxation was finally solved at the EU-level. In March 2016, when the EU was forced to disclose minutes of the group, it became clear why it had taken so long. For years, the Netherlands had successfully blocked decisions of the group about the matter.

Read how Dutch tax innovation continues in the last blog of this small series, Will this time be different?