News Update Transfer Pricing
First thoughts on the new Dutch Transfer Pricing Decree
6 July 2022
On 1 July 2022, the Dutch State Secretary published the long-awaited updated Dutch Transfer Pricing Decree (the "New Decree").The main changes compared with the previous Decree of 22 April 2018 include reference to the impact of government’s COVID-19 relief measures (known as "NOW"), minor changes to the guidance on intercompany services, a new paragraph on intermediate financial services companies, new guidance on financial transactions and general alignment with the wording of the new OECD Transfer Pricing Guidelines ("Guidelines") that were issued in January 2022. In this News Update, our transfer pricing experts reflect on the most important changes that the New Decree contains.
Government relief and NOWGeneral
Where the arm's length price consists of a remuneration based on cost, the question can arise whether subsidies should be excluded from the cost base. According to the New Decree, subsidies should be excluded from the cost base if there is a direct relationship between the subsidy and the supply of the good or service and where the subsidy was granted through an allowance for the costs. The New Decree provides an example that refers to a subsidy for using more expensive but sustainable raw materials. If a company incurs higher production expenses for using more sustainable raw materials and receives a subsidy for the additional cost, no mark-up should be applied on the subsidised costs. Allowing a lower cost base for remunerating activities in the Netherlands could potentially result in a higher tax base in the foreign counterparty country.
The Dutch government introduced the NOW as a Covid relief measure in 2020. The NOW was intended to help employers to continue paying their workers’ wages. According to the New Decree, relief measures such as this could impact the terms that parties agree on in their intercompany transactions, including the price. If the taxpayers have received NOW relief and wish to modify the terms of their intercompany transactions accordingly, they must demonstrate that comparable unrelated entities would agree on a comparable change under comparable circumstances. This addition to the New Decree is not groundbreaking, because taxpayers must always be able to demonstrate that the terms of their intercompany transactions are similar to what comparable unrelated entities would agree on under comparable circumstances. The challenge for taxpayers lies in finding relevant third-party data to substantiate their position. It would have been helpful if the New Decree had provided concrete guidance on the most common challenges.
Intercompany servicesAccording to the Guidelines, an intercompany service has been rendered when an activity is performed for one or more group members by another group member and the activity provides a respective group member with economic or commercial value, for which the latter group member would normally be willing to pay. Intercompany services do not include activities that are performed in the capacity of a shareholder. The New Decree contains a few changes regarding intercompany services. Firstly, it extends the provisions that applied to “contract research activities” from the previous version of the Decree to include “contract manufacturing activities”.
Secondly, the State Secretary has removed the paragraph that explicitly referred to taxpayers having the option to obtain advance certainty regarding whether an activity should be regarded as an intercompany service or as an activity performed in the capacity of a shareholder. For services, advance certainty is typically requested for confirming a profit mark-up; it is rarer to ask whether an activity should be considered a service or a shareholder activity. It is unclear whether this paragraph was removed because it was so difficult to provide certainty for the characterisation of the activity or because it was so rarely used by taxpayers.
Most of the other changes regarding intercompany services are textual, without affecting the substance.
Intermediate financial services companiesEnterprises that predominantly receive and pay interest, royalties or rental or lease payments are defined as intermediate financial services companies (dienstverleningslichamen, "DVLs"). Before the New Decree was issued, intercompany transactions involving these DVLs were principally governed by the Dutch Financial Services Companies Decree of 12 June 2014, no. DGB 2014/3101. The New Decree now also contains explicit guidance on intercompany transactions that involve DVLs, including guarantees.
The New Decree acknowledges that DVLs are characterised by a close relationship between incoming and outgoing cash flows. Such enterprises typically engage in routine activities, but in some cases they might be exposed to credit and market risks. For determining the arm's length remuneration that the DVL should receive for its functions, assets and risks, the New Decree refers to Chapter X of the Guidelines. For risks to be allocated to a DVL in accordance with the arm's length principle, the DVL must exert sufficient control over those risks and have sufficient financial capacity to assume the risks.
The risks that are associated with financial transactions are credit risks, market risks and operational risks. If the credit risks can be considered to be allocated to the DVL at arm's length, the DVL's remuneration should be determined based on the principal amount of the intercompany transaction under review (i.e. a spread on the principal amount). Exposure to operational risks alone cannot result in the credit risks being allocated to the DVL.
The New Decree distinguishes between three situations in relation to the intercompany transactions of DVLs and the associated risks.
- The DVL has full control over the credit risks and has the necessary financial capacity If the DVL has full control over the risks and possesses the necessary financial capacity to assume those risks, an appropriate interest rate should be determined based on a comparability study. The comparable uncontrolled price (“CUP”) method is considered the most appropriate transfer pricing method for the intercompany transactions in this case.
- The DVL has no control over the credit risks and/or has insufficient financial capacity If the DVL does not control the credit risks and/or if the DVL has insufficient financial capacity to bear the credit risks, those risks cannot be allocated to the DVL in accordance with the arm's length principle. An appropriate remuneration then consists of a profit mark-up based on the DVL's own operational expenses (i.e. cost-plus).
- The DVL has shared control over the credit risks and has the necessary financial capacity The third situation is where both the DVL and the head office or another related party exert control over the credit risks.
In situations with both shared control of the credit risks and the necessary financial capacity, an appropriate remuneration should be determined based on the facts and circumstances of the case. To determine the arm's length remuneration, it is necessary to take appropriate account of the other related party exerting control over the risks.
The specific guidance on DVLs and the examples for the three situations distinguished above are a welcome additional guidance for taxpayers and transfer pricing practitioners. Nevertheless, assessing what full control, no control or shared control over the credit risks means in practice, and how that translates to people functions, remains a challenge.
Financial transactionsOn 11 February 2020, the OECD released its transfer pricing guidance on financial transactions, which is included as Chapter X of the new Guidelines. The New Decree is intended in part to reflect that guidance.
The New Decree gives consideration to the use of credit ratings to determine the borrower’s creditworthiness. As in the previous version of the Decree, the State Secretary emphasises that an independent borrower will generally not obtain a loan if doing so will push its credit rating below “BBB-”. If an intercompany loan transaction results in a situation where the borrower’s credit rating drops below “BBB-”, the taxpayer is expected to provide plausible evidence of a comparable loan agreed between comparable unrelated parties under comparable circumstances.
Furthermore, the CUP method remains the most appropriate method for determining the arm's length interest rate, as per the Guidelines. Special attention is given to situations where an independent lender issues a loan and the borrowed amount eventually passes to the ultimate affiliated borrower, through one or more related entities. If the intermediate related entity acts solely as an agent or an intermediary, the only benefit that the intermediary enterprise may charge is a mark-up on the costs of the actual agency function, rather than a mark-up on the costs of the services. This approach matches the rules for intermediate financial services companies.
Enterprises usually have current receivables and payables with third-party financial institutions. Within a group, it can be beneficial to pool all the various receivables and payables through a “cash pool”, where group enterprises can deposit current receivables or take out current payables.
The advantages of a cash pool include lower interest rates, lower administrative costs and synergy benefits. According to the New Decree, these benefits should be allocated based on a calculation of the arm's length interest rate on the debit and credit positions of the participants in the cash pool, taking into account an appropriate remuneration for the cash pool leader. For notional cash pooling, the New Decree seems to consider the cash pool leader to be a routine entity, which needs to be taken into account for determining the cash pool leader’s remuneration. For zero-balancing, on the other hand, the New Decree seems to be more lenient towards allowing a value-based remuneration for the cash pool leader, if this is supported by that leader’s functional and risk profile.
Under the New Decree, guarantees are treated in largely the same way as they were under the previous version. The main addition is that the CUP method is considered the most appropriate method. However, if that method cannot be applied, the New Decree prefers the “yield approach” instead.
The section in the New Decree that deals with captives (i.e. entities whose business is to provide insurance policies for the risks of related entities) has been expanded slightly. To assess whether a captive actually performs insurance activities, the New Decree lists the following relevant questions, as per Chapter X of the Guidelines:
- Is there diversification and pooling of risk in the captive?
- Has the economic capital position of the group entities improved as a result of the diversification?
- Is the captive a regulated entity, subject to rules regarding the actual assumption of risks and the required capital?
- Would the insured risk otherwise be insurable outside the group?
- Does the captive have the required expertise and experience for the insurance business and for investing the premiums received?
- Is there a real possibility that the captive will incur losses?
To conclude that actual insurance activities are performed within the group, essentially all these questions should be answered in the affirmative.
Other changesIn the "Introduction" to the New Decree, the State Secretary explicitly refers to cases where the interpretation or application of the Guidelines leads to the possibility of transfer pricing differences within a multinational group across different jurisdictions, so that part of the profits goes untaxed. In such situations, the State Secretary states, the Dutch Tax Authorities are not obliged to adhere to the New Decree, as long as the outcome is in accordance with the arm's length principle. It is not quite clear what the State Secretary is implying here, as the main and explicit purpose of the New Decree is to provide further interpretation of the arm's length principle. Rather, the State Secretary seems to be looking for another way to prevent double non-taxation.
ConclusionThe New Decree contains welcome guidance for taxpayers and transfer pricing practitioners. Most of the changes have been made to align the Dutch rules with the 2022 version of the Guidelines. The guidance and examples on DVLs and government relief will add useful clarification to the existing Dutch guidance.
If you have any questions about the New Decree, please contact Houthoff’s Transfer Pricing Team.