Netherlands: Bill regarding the taxation of “lucrative interests”

Estimated reading time 6 minutes

The bill 'taxation of excessive remuneration', which was sent to Parliament on 13 May 2008, includes a proposal for a new tax regime for so-called 'lucrative interests'.

Executive summary

A new tax regime is proposed for the taxation of certain shares, receivables or rights with similar economic characteristics, the so-called 'lucrative interests'.  The income derived from lucrative interests will either be taxed as ordinary income in box 1 against the progressive rates if the lucrative interest is held directly, or as income of a substantial interest in box 2 against a flat rate of 25% if the lucrative interest is held through an entity in which the taxpayer holds a substantial interest.  The scope of the new legislation does not include shares issued to employees if no specific conditions are attached to such shares. It is the intention that the new regime will apply as from 1 January 2009.

What is a lucrative interest?

Based on the bill, there will be a lucrative interest if the taxpayer has acquired shares, receivables or rights with similar economic characteristics that have to be considered to be granted with, inter alia, the intention to form a remuneration for services (to be) rendered by the taxpayer or certain related persons.  Indications that there is the intention to form remuneration for services rendered are, for example, good leaver/bad leaver arrangements, based on which more or less than the fair market value of the shares is paid, depending on the reason for the termination of the employment.  The bill is not limited to shares and other rights of managers from private equity funds and the like (the so-called carried interest rights) as could be understood from previous announcements, but can also apply to interests of a manager or another employee who invested in the company where currently employed, or was previously employed at (e.g., in respect of a management buy-out).

Shares can only constitute a lucrative interest if (A) there are various classes of shares and (i) the shares held by the taxpayer rank junior to other classes of shares, while (ii) the class of shares held by the taxpayer constitute less than 10% of the share capital; or (B) if the taxpayer owns preference shares with a preferred dividend of at least 15% per annum.  The bill still raises many questions.  For example, what is meant with 10% of the share capital?  The probable answer is that this should be measured by reference to the paid-in capital including share premium.  An example of such a situation is an investment fund of which 99% of the capital is contributed to preference shares and 1% of the capital is contributed to common shares.  If the management acquires common shares, the new regime will apply to these shares (unless it can be demonstrated that these are not intended to form remuneration) since the common shares rank junior to the preferred shares and the common shares represent less than 10% of the aggregate share capital.

Receivables do constitute a lucrative interest if the yield depends on 15% or more of management or shareholder targets such as profit, turnover, EBIT(DA), cost reduction, realisation of an exit and so on.  More or less the same conditions apply to rights with similar economic characteristics.

In addition to the above, the new regime for lucrative interests also applies to loans payable which can be (partly) waived by the creditor if it is assumed that this waiver intends to form a remuneration for services rendered by the taxpayer or certain related persons.  This extension is not meant to increase the taxation (the waiver was normally already taxed in box 1), but to avoid discussions with respect to the date that the waiver should be taken into taxable income.

In principle, the new regime will also apply to foreign taxpayers if the lucrative interest intends to form remuneration for services rendered in the Netherlands, albeit foreign taxpayers will normally be protected against this Dutch domestic tax liability pursuant to tax treaties.

Tax treatment of a lucrative interest

If the regime for lucrative interest applies, the lucrative interest is deemed to form an activity generating ordinary income (box 1).  This means that the benefits derived from the lucrative interest are taxed against the progressive rates amounting to, at maximum, 52% as if the benefits constituted profit from an enterprise.  NB: It is not possible to apply the so-called 30%-ruling (a tax facility for foreign employees assigned to the Netherlands) on the income derived from a lucrative interest.

Taxpayers have the option to elect for taxation against the flat rate of 25% of box 2, if the lucrative interest is held indirectly through a company in which the taxpayer owns a substantial interest and at least 95% of the income from the lucrative interest is distributed by the company to the taxpayer in the year of realisation. It is not clear why this option is not available for lucrative interests that are held directly by the taxpayer and that constitute a substantial interest.

In principle, it is not allowed to claim a loss with respect to lucrative interests that are held indirectly.

It should be noted that the company that issues the lucrative interests will not be entitled to any deduction for corporate income tax purposes relating to the return paid on the lucrative interests.  That means the combined tax rate on can exceed 64% (i.e., 25.5% corporate income tax levied from the company and, upon distribution, 52% personal income tax from the owner of the lucrative interest).

Transitional rules

Based on the bill, the new regime will apply as from 1 January 2009 also with respect to existing lucrative interests.  There is no step-up for existing lucrative interest: the book value of the lucrative interest is equal to it’s original cost price, increased with taxable benefit taken into account in box 1 upon acquisition of the lucrative interest (if any).  As a consequence, the new regime may have retro-active effect: any built-in value of an existing lucrative interest will be fully taxed upon realisation after 1 January 2009.  To the extent the lucrative interest was taxed in box 3 in previous years, there will be no compensation for the tax previously levied in box 3.  Certain rules are included to avoid that taxpayers create a step-up, which rules will also apply in case of contribution of the lucrative interest into a company or the sale of the lucrative interest to a related person.

The foregoing means that if an existing lucrative interest would be taxed in box 1 as from 1 January 2009, it will have to be determined before that date if restructuring is feasible and, for instance, to explore whether it is possible to achieve box 2 treatment.

For more information please contact: Ton Mertens ton.mertens@loyensloeff.com (+31 20 578 56 11)  or Philip Siekman  philip.siekman@loyensloeff.com  (+31 20 578 56 46) at Loyens & Loeff, Amsterdam.  www.loyensloeff.com

Disclaimer

Content is for general information purposes only. The information provided is not intended to be comprehensive and it does not constitute or contain legal or other advice. If you require assistance in relation to any issue, please seek specific advice relevant to your particular circumstances.