Hybrid mismatches with third countries

On 21 February 2017, the EU Member States reached an agreement on the proposed amendments to the Anti-Tax Avoidance Directive (“ATAD”). One of objectives of this new Directive (“ATAD 2”) is to neutralise the effects of hybrid mismatches between EU Members States and third countries. For the Netherlands, the new provisions might have an impact on many tax planning structures such as the CV/BV structures with the US.

In general terms, a ‘hybrid mismatch’ structure is a structure where a financial instrument, an entity or a permanent establishment is treated differently for tax purposes in two different jurisdictions. The use of such hybrid mismatches could lead to situations in which a payment is deducted in two jurisdictions, a payment is deductible in one jurisdiction and is not taxed correspondingly in the other jurisdiction or to a situation where income is not taxed at all.

In case of a typical CV/BV structure, interest or royalty payments are deducted in the jurisdiction of the operations and paid on the CV located in an offshore jurisdiction. Due to a mismatch of the entity classification and the US deferral system the corresponding income is only taxed in the US if the proceeds are repatriated.

Also, in the case of a hybrid mismatch with a third country, ATAD 2 places the responsibility to neutralise undesired effects of hybrid mismatches on the EU Members States. For example: as long as the US does not tax the interest and royalty income (yet), it is up to the EU Member States to deny the deduction of the payments (primary rule) or to include the income that is not taxed (yet) in the US (secondary rule).

The Netherlands tried to postpone the effective date to 1 January 2024, to give third countries, like the US, sufficient time to amend their legislation to neutralise the effects of a hybrid mismatch in the country of the payment recipient. However, as part of the compromise, the EU Member States agreed that ATAD 2’s new provisions apply already from 1 January 2020 (with some exceptions). The Dutch Ministry of Finance has indicated there will be draft legislation to implement ATAD 2 in the second half of 2017.

Many CV/BV structures involve IP that has been transferred from the US to the offshore jurisdiction of the CV. The Dutch tax authorities have already indicated they are willing to discuss the option of transferring the IP to the Netherlands with a step-up in value. With the amortisation of the IP and perhaps the ‘innovation box’, the Netherlands intends to maintain its position as attractive jurisdiction for US multinationals.