“To dip or not to dip, that is the question”

Suppose a Dutch MNE company (BV) borrows 1,000 from a bank (the Bank Loan) at a rate of 5% and BV’s foreign parent (Parent) guarantees said Bank Loan (the Guarantee). Standalone, BV could have borrowed 700.

Parent’s jurisdiction considers the Organisation of Economic Cooperation and Development (“OECD”) Transfer Pricing (“TP”) Guidelines (“OECD Guidelines”) ‘as law’ (including the recent guidance on financial transactions). Following the OECD Guidelines,¹ the Parent delineates for tax purposes the Bank Loan into a part that relates to the BV’s (a) stand-alone borrowing capacity of 700 (the Stand-alone Part) and (a) enhanced borrowing capacity following the Guarantee for 300 (the Enhanced Part). The Enhanced Part is deemed for tax purposes as a loan from the Bank to the Guarantor/Parent (Deemed Loan 1) and that “primary adjustment” is subsequently processed by the Parent as a “secondary transaction” in the form of a deemed equity contribution into BV (the Deemed Contribution). In its tax return, the Parent deducts 15 deemed interest expenses on the Deemed Loan 1.

From a Dutch perspective, the Enhanced Part is also treated as the Deemed Loan 1. However, contrary to the OECD guidelines, Dutch tax law² allows the BV to process the “secondary transaction” in the form of a deemed loan from the Parent to the BV (Deemed Loan 2). In its tax return, the BV deducts 35 interest expenses on the Bank Loan and 15 deemed interest expenses on the Deemed Loan 2. However, the 15 deducted by the BV is not picked up at the level of the Parent as it is considered an exempt deemed dividend accruing on the Deemed Contribution into the BV.

As per the beginning of this year, one may question whether the BV’s deduction of the deemed interest expenses on the Enhanced Part will be denied under the Dutch hybrid mismatch rules (i.e. ATAD II). ATAD II intends to neutralise tax benefits arising from differences between jurisdictions in the tax treatment of entities, financial instruments, permanent establishments or tax residency. Arguably, a different view on the processing of a “secondary transaction”³ should not qualify as a ‘hybrid mismatch’. Moreover, during Dutch parliamentary discussions on the implementation of ATAD II, it was mentioned that differences in tax outcomes that are solely attributable to differences in the application of transfer pricing rules are not considered to be a ‘hybrid mismatch’. Instead, the Dutch government announced that undesired transfer pricing mismatches will be dealt with separately in the scope of a planned assessment of the wider application of the arm’s length principle. But how about DAC6…?

1 OECD Guidelines par 10.161.

2 Dutch Decree, dated 22 April 2018, nr. 2018-6865, section 9.

3 According to the OECD Guidelines (in par. 4.68) a “secondary transaction” can take the form of “constructive dividends” (i.e. company benefitting shareholder), “constructive equity contributions” (i.e. shareholder benefitting company), or “constructive loans” (i.e. either).