DUTCH PARTICIPATION EXEMPTION

Introduction

Well known is the favorable tax regime in The Netherlands for conduit companies such as holding, financing and licensing companies. The major tax advantage in The Netherlands is the exemption from corporation tax of qualifying dividends and capital gains- Furthermore, The Netherlands does not levy any withholding tax on royalties and interest (except interest on profit sharing loans or bonds). Under an extensive network of tax treaties it is possible to receive capital gains on shareholdings tax free and to channel dividends, interest and royalties from one country to another country at reduced foreign withholding tax rates or without any foreign withholding tax at all.
General Rules of the Participation Exemption

Under the Dutch participation exemption dividends derived from shares in the capital of a subsidiary or capital gains realised upon the alienation of such shares are free from Dutch corporation tax in the hands of a corporate taxpayer in The Netherlands. provided that certain conditions are met. These conditions can be summarised as follows:

• The corporate taxpayer must hold at least 5 percent of the shares in the capital of the subsidiary;
• The shares must not be held as inventory.

For shareholdings in foreign subsidiaries the participation exemption only applies if all three of the following additional conditions are also met:

• The profits of the foreign subsidiary must be subject to an income tax of the State in which the profits have been generated;
• The foreign subsidiary's activities do not relate directly or indirectly for more than 50% to the direct or indirect financing of entities related to the corporate taxpayer or assets of such entities, including making available the use or right of use thereof (unless it can be substantiated that the activities of the foreign subsidiary could be treated as active financing activities according to conditions set by Ministerial Decree);
• The shareholding should not be held as a passive portfolio investment.

The latter condition has been the issue of many discussions with the Dutch Revenue Service during the last 25 years. There are, however, some safe harbour rules in the Dutch Corporation Tax Act 1969 for qualifying shareholdings in EU companies or for other situations based on information of the Revenue Service (see below under). Some of this information has been confirmed in a letter of June 19. 2000 from the Under Minister of Finance.

Safe Harbour Rules

• The Safe Harbour Rules regarding the Non-Portfolio Investment Test for the Participation Exemption can be summarized as follows:
• If a Dutch B.V, or another corporate taxpayer in The Netherlands, (hereinafter referred to as "Dutch holding company"), holds more than 5 percent but not more than 50 percent of the shares in a foreign subsidiary and the other conditions for the participation exemption are met, the Dutch holding company is eligible for the participation exemption for benefits derived from such shareholding. provided that:
• The Dutch holding company has actual influence on or is actively involved with the business operations of the foreign subsidiary. The actual influence/active involvement can be in the financial area, the decision making or the management (the so-called 'business link"), or
*The shareholder of the Dutch holding company caries on a business that is in the line of the business activities of the foreign subsidiary (the so-called "link function test).
• If a Dutch holding company holds more than 50 percent of the shares in a foreign subsidiary and the other conditions for the participation exemption are inst, according to the abovementioned letter of the Under Minister of Finance the Dutch holding company is considered to meet the business link test.
• If a Dutch holding company holds at least 25 percent of the shares in an EU subsidiary (or voting rights) that is a company that satisfies all the requirements of the EU Parent Subsidiary Directive, the participation exemption applies to benefits derived from this shareholding. However in many cases this is different when investments are ultimately structured through an EU subsidiary of a Dutch resident company.

By virtue of anti abuse rules in the Dutch corporation tax law the Dutch participation exemption shall not be deemed to be applicable to a shareholding of at least 25 percent in an EU resident company in case its assets consist indirectly o directly of at least 70 percent of

(I) shareholdings to which the participation exemption would not have been applicable when the Dutch resident company would have held the non-EU shareholdings directly, or
(II) (ii) other assets outside the EU State of residence of the investing company for which assets the Dutch resident company would not be entitled to tax relief when it would have held the assets directly.

These anti abuse rules do not apply if and when the Dutch taxpayer can substantiate that the purpose of interposing the EU resident company is not tax avoidance or tax deferral.

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