On 3 September 2021, the Appeals Court at ‘s-Hertogenbosch ruled in a case of a German real estate investment fund in contractual legal form (Immobilien-Sondervermoegen) – ‘the Fund’, with respect to its foreign tax payer status for its income from Dutch real estate in the years 1997/1998 until 2009/2010. Due to the fact that the Fund had multiple investors, possible tax transparent status for Dutch purposes is apparently not considered, making the Fund in principle eligible to be regarded as a foreign tax payer for its Dutch source income if it would meet the requirements. The Fund tried two main arguments to escape Dutch taxation on its Dutch real estate income, but both failed. Nevertheless, certain points in the ruling are worthwhile to note and comment on.
In the years at hand, Dutch corporate income tax (CIT) is due on income from Dutch real estate realized by foreign tax payers, meaning certain defined entities existing under foreign law that are not considered to be resident in the Netherlands. With respect to a German Sondervermoegen, it would only be considered a foreign tax payer if it would be qualified as a so-called ‘doelvermogen’, which the Dutch Supreme Court defines as an amount of capital (‘vermogen’) that is separated for a certain purpose, which has no legal personality and which does not belong to a (legal) person either. Such a separate amount of capital is treated as an independent entity for tax purposes. According to the Supreme Court, an amount of capital cannot be regarded as a ‘doelvermogen’ if it belongs to one or more (legal) persons, for example because they have a claim on the capital by means of participation certificates.
This latter remark could be interpreted in such a way that if the ‘vermogen’ issued participation rights or certificates, the ‘vermogen’ belongs to the participants, even if these participation certificates could be regarded in the same way as shares issued by a legal entity, meaning that the participants are only regarded to have an indirect claim on the capital the participations represent. As a consequence, such wide interpretation would mean that any amount of capital that would be separated for a specific purpose and that has issued ‘shares’ or certificates to its participants would not be regarded as a ‘doelvermogen’ and therefore not be regarded as a foreign tax payer and escape taxation on its Dutch source income. This interpretation seemed to be the position of the Fund.
The Court, however, came to a narrower interpretation, which appears to be that the ‘vermogen’ is not a ‘doelvermogen’ only in case the participants have a direct claim on the capital of the ‘vermogen’, because – according to the Court – there would be no separation between the capital and the participants. As the Fund had issued participation certificates that were freely transferable, no such direct claim was deemed to exist. Consequently, the Fund qualified as a ‘doelvermogen’ under Dutch tax rules.
The weak point in the argumentation of the Appeals Court: the Supreme Court clarified that a specific characteristic of a ‘doelvermogen’ is that it is an amount of capital separated for a certain purpose, that it has no separate legal personality itself, but also does not belong to another entity. The Supreme Court mentions three separate elements which positively define the status of ‘doelvermogen’ where separation of the capital is one element and the fact whether the capital belongs to (another) person is another element. The Appeals Court argues the other way around, based on the definition of the Supreme Court: it says that only in case the capital belongs to the participants, in which case there is no separate capital, can the capital not be considered a ‘doelvermogen’. From the wording of the definition of the Supreme Court, it could be inferred that both direct and indirect ownership of an amount of capital that is separated (in a fund) for a certain purpose could mean that such fund is not a ‘doelvermogen’.
The strong point in the reasoning of the Appeals Court is that it prohibits the possibility that a fund could be regarded as an entity for Dutch tax purposes, but being disregarded as a foreign tax payer on its Dutch source income. Should such possibility exist, then a loophole in Dutch tax legislation would be opened up where foreign, non-resident, contractual funds without separate legal personality could invest tax free in Dutch real estate. The solution of the Appeals Court seems to ensure that there is always an entity that is liable for the Dutch source income: either the fund as ‘doelvermogen’, or the participants in the fund.
Anyway, this first attempt to escape Dutch taxation failed, which means that the second line of defense was triggered: the claim that effectively no tax was due because of application of the Dutch ‘FBI’-regime (the special regime for investment funds that taxes the profit of the fund with a rate of 0% CIT and is in fact an exemption regime). This FBI-regime applies to Dutch funds it they meet certain shareholder requirements (shareholder test), if they annually pay out their profits within 8 months from book year end (distribution test) and if they satisfy certain investment requirements that are meant to prohibit ‘business’ activities, though it allows certain investments with ‘active’ investment features (passive investment test). Furthermore, the fund must have a certain legal form. From the year 2008, the FBI-regime also applied to foreign, non-resident funds that met the requirements.
In the end, all these tests were deemed to be met according to the Appeals Court. The shareholder, distribution and legal form tests were not contested. Notable is that regarding the passive investment test the Court concluded that it was met on a very interesting finding. The Fund had stated with some substantiation that with respect to Dutch resident FBI funds the Dutch tax authorities in reality did not test whether such Dutch funds indeed meet the passive investment requirement. The Court found that the burden of proof to disprove the Fund’s argument was on the tax inspector. But, as the tax authority was not able to meet the burden of proof, the Court found that the Fund won that argument.
Interesting further is that the Court mentioned that the tax authority could have met this burden of proof by submitting anonymized tax audit reports or questionnaires. In our view – if the argument can be introduced with at least a beginning of substantiation – this could also be of value with respect to the shareholder and distribution tests. If the tax authority is not able to show - via tax audit reports or questionnaires regarding those requirements of the FBI-regime - that the tax authorities are actively checking if those tests are met, this could be an easy way to win that round.
For the period before 2008/2009, the Court dismissed the claim for the FBI-regime based on the reasoning that the Dutch Supreme Court ruling in the Deka case (23 October 2020), that regarded the refund of Dutch dividend WHT to a German UCITS fund (Sondervermoegen), also applied to the case at hand. Consequently, the Court demanded that the Fund would agree to a ‘replacing payment’ to compensate for the dividend tax that could not be levied on the profit distribution of the foreign fund. As the Fund refused this, it lost the case for those years.
For the later years, the Fund lost as well, as it refused to pay the ‘exit’ tax that is due when entering the FBI-regime from a taxable status: in short the Fund would have to revalue its Dutch properties to fair market value and pay tax on the gain before it could enter the FBI-regime the next year (2008/2009). This the fund refused as well, being of the opinion that the statute of limitations regarding the ‘exit’ taxation would prohibit the tax inspector to levy the tax. However, the Court did not accept the argument, stating that paying the ‘exit’ tax is a precondition for getting the FBI-status, it is not a consequence.
For the later years, the tax inspector argued that an implicit condition to receive FBI-status for a non-resident fund was that it must meet the requirement that the taxation at fund level is replaced with a taxation at investor level (which would be impossible as a foreign fund cannot withhold Dutch WHT). The Court disagreed with this argument on the basis that the legislator had implemented the shift of taxation from fund to investor level through the requirement of the annual profit distribution. Therefore, the fact that a foreign fund does not and cannot withhold Dutch WHT on the profits it distributes is irrelevant for meeting the requirements to apply the FBI-regime.
For the earlier years until 2008/2009, it is remarkable that the Court applied the ‘replacing payment’-solution to refuse the application of the FBI-regime for the Fund. In the Deka case, the comparability of the German fund with a Dutch ‘FBI’ fund was the central theme to force the refund of Dutch dividend WHT. In the current case, the application of the FBI-regime to the German Fund itself is at stake, as it is regarded as a foreign tax payer for Dutch CIT purposes. It makes sense to assume that if the FBI-regime would have been open to foreign funds also in earlier years, there would have been no requirement to levy any Dutch ‘replacing payments’, as such a requirement has not even been considered when extending the FBI-regime to foreign funds starting in 2008.
We are looking forward to further developments in this case, as we understand that the case has been brought before the Dutch Supreme Court.
On 5 August 2021, the Lower Court at Breda (Rechtbank Zeeland-West-Brabant) ruled in a case that concerned a UK company (claimant) that was held by a UK listed company. The claimant was registered in the UK as an insurance company that had concluded insurance agreements concerning unit linked policies with UK institutional investors. These investors could invest in Pooled Pension Funds via the unit linked policies. With respect to these investments, the claimant had received dividends from Dutch portfolio dividends in the years 2005-2007 and 2009-2010 on which Dutch dividend WHT was levied. The claimant filed corporate income tax returns for the years 2005-2007 and refund requests for 2009- 2010 with the aim to recover the dividend WHT paid.
The claimant presented two positions to plead its case. One position was that the claimant was comparable to a Dutch pension fund that qualified for the Dutch corporate income tax exemption and therefore as well for a refund of dividend WHT. The other position concerned the argument that compared to a Dutch company that was subject to Dutch CIT, the claimant should not bear a heavier tax burden. This argument refers to the Société Général case (CJEU 17 September 2015, C-17/14). This case could in practice only lead to success for a claimant if the (corporate income) tax burden of a Dutch domestic investor would be lower than the dividend WHT paid by a foreign investor on the same dividend. In practice, this really never happens, due to the fact that the CIT rate is higher than the dividend WHT rate and the relevant CIT base for the comparison would consist of the dividend income reduced only by the expenses that are directly linked to the actual payment of the dividend. The claimant argued that to restrict the deductible expenses in such a way is a wrong notion, which can be deemed wrong or obsolete in the light of other CJEU case law. In the claimant’s case, the dividend income was apparently neutralized by a similar increase in its obligations to policy holders. Consequently, the dividend income did on balance not result in a profit position and therefore not to a corporate income tax burden in a comparable Dutch domestic situation. Unfortunately, the Lower Court held to the strict line of the Société Général case and denied the argument. Consequently, the claimant lost on all counts.
However, interestingly the Court stated that - on a conceptual level - there could be questions raised regarding the relationship between some of the CJEU cases the claimant had presented to support its view and the Société Général case. As a tentative explanation for the strict view on eligible expenses, the Court offered that this may be due to the special nature of dividends. Apparently, the Lower Court had some doubt about the correct interpretation of EU law on this aspect, but not enough to ask a preliminary question to a higher Dutch court or to the CJEU. Remarkably, the case law mentioned in the published judgement includes the Sofina case (CJEU 22 November 2018, C-575/17, Sofina SA and others) but does not include the CPP case (CJEU 13 November 2019, C-641/17, College Pension Plan of British Columbia), though the latter seems to fit perfectly in the argumentation of the claimant.
Needless to say that the market is looking forward to a possible continuation of this legal battle at the Appeals Court.
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