New Dutch transfer pricing decree: incorporating case law, bringing clarity

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The Dutch Ministry of Finance has released a new transfer pricing Decree that is already in effect.

The New Decree, announced in late November, supersedes two earlier Decrees, that of 30 March 2001 (IFZ 2001/295) and that of 21 August 2004 (IFZ2004/680M). Other transfer pricing Decrees are not modified by this New Decree.

The New Decree incorporates recent Dutch case law on transfer pricing, makes official certain points that were already being used in practice by the Dutch Tax Authorities during APAs or audits and includes interpretation of certain parts of the 2010 OECD Guidelines.

The most important clarifications of the New Decree are the following:

Intercompany financing

  • The New Decree clarifies the nature of non-arm's length loans. It uses examples referring to loans that are (or could be) arm's length but where the interest is not arm's length, and loans that are non-arm's length because a third party would have not been willing to grant the loan to the (potential) borrower. If a company has a credit rating below investment grade, it would generally not be able to obtain financing. If a company's credit rating drops below investment grade by obtaining a loan, then the loan would generally not be arm's length. If the loan is non-arm's length, the part of the loan beyond the arm's length amount is treated as equity and the corresponding interest is not deductible. These new paragraphs were introduced to prevent perceived situations of abuse when a Dutch group company is highly leveraged.
  • Credit rating. The credit rating of a company part of a group is not the credit score stand-alone of that company. Consideration needs to be given to the fact that the company is part of a group and receives its implicit support (OECD Guidelines par. 7.13). If the group subsidiary is strategic to the group, its credit "rating" (or score) will tend towards the group rating. If the subsidiary is not strategic to the group, its credit score will be closer to the stand-alone score. This approach is consistent with what was already best practice in the Netherlands and what is being used in Advance Pricing Agreements and tax audits.
  • Intercompany guarantees. When a group company issues an external guarantee to a third-party lender in a situation in which the Dutch group borrower would have not been able to borrow a similar amount on a stand-alone basis (i.e., the loan or part of the loan is non-arm's length), then the group borrower cannot pay any guarantee fee to the guarantor (or the payment is non-deductible in the Netherlands), not even for the part of the loan that is arm's length. Similarly, if the guarantor is a Dutch company and the guarantee is invoked by the third-party lender, the cost is not deductible for the guarantor. If the explicit guarantee provides only better terms and conditions that would have been achieved on a stand-alone basis, a guarantee fee can be paid to the guarantor (for part of the advantage, not all, between the stand-alone situation and the guaranteed situation). There many possible combinations of the situations described in the New Decree and it is not very clear for now how the examples mentioned can be used in practical terms, especially if the guarantor is outside the Netherlands and takes a different approach to explicit guarantees.
  • Captive insurances. The clarification on captive insurances follows a well-known doctrine in the Netherlands and is consistent with the OECD Guidelines. If the group captive insurer does not perform most of the functions of a third-party re-insurer (product development, marketing and sales, acceptance of contracts, asset/liability management, development of the reinsurance policy and active diversification of risks), then the reinsurer is only considered an administrator that will only earn a small routine return.
  • Central purchasing: As with captive insurances, if a group central purchasing company is only achieving savings due to the combination of volumes (volume discounts), then those savings need to be passed by the central purchaser to the providers of the volume (for example, sales or manufacturing companies). When the cost-plus method is applicable to the central purchasing function, then the cost of raw materials cannot be included in the cost base. If the central purchasing company is strategic to the group and performs strategic functions, then a profit split method will be applied. This section of the New Decree is consistent with example F in Chapter 9 of the OECD Guidelines. Case law in the Netherlands already addressed these points as well.

Intangible assets and contract R&D: With respect to transactions involving intangible assets, if the owner of the asset (the legal or economic owner) does not have the functional capability to manage the intangible, then transfer pricing adjustments could be appropriate. The intercompany transaction with the intangible needs to make economic sense (i.e., expect increased profitability) to both parties to the transaction, buyer and seller of the intangible. If the legal owner of the intangible does not perform the relevant management functions, the owner is  only entitled to a limited return. These principles were already included in the (now superseded) transfer pricing Decree of 2004 (IFZ2004/680M). Some of these concepts are also included in the revised discussion draft on the transfer pricing aspects of intangibles (OECD, 31 July 2013).

Shareholder services and intercompany services: The New Decree adds some clarifications and modifies the list of shareholder services that were included in the Decree of 2004. The New Decree emphasizes that the cost plus method can only be used for routine services and that the appropriate answer may be different per sector.

The most important points of the New Decree are the clarifications about the treatment of certain intercompany financing transactions. This subject had become somehow unclear during the last two years due to different interpretations of recent case law. The New Decree, though, could lead to double taxation in some cases when the guarantor of a third-party loan is outside the Netherlands.  The examples about captive insurances, central purchasing, contract R&D and intangible assets sales are generally consistent with the OECD Guidelines and what was already being done in practice in the Netherlands before the publication of this New Decree.