New guidance on entity classification rules

On 1 January 2025, new legal entity and partnership classification rules will enter into force. The Dutch Ministry of Finance now published a draft decree (Decree) that provides further guidance on these rules.

This is highly relevant because based on the new rules, various legal forms may switch from non-transparent to transparent and the other way around, per 1 January 2025. This may result in various tax consequences, such as levy of capital gain taxes or changes in withholding tax and interest deduction positions.

The current entity classification rules deviate from international standards. For example, under the current rules an LP is considered transparent for Dutch tax purposes only if the admission and substitution of limited partners is subject to the prior unanimous consent of all (i.e., both limited and general) partners. This deviation from international standards means that foreign LPs are typically non-transparent from a Dutch perspective, resulting in various mismatches between the Netherlands and other countries.
The new rules are introduced to reduce the number of mismatches. Based on the new entity classification rules, it should first be verified whether the foreign entity is sufficiently comparable to a specific Dutch entity (‘Comparability approach’). The Decree provides further guidance on the Comparability approach by stipulating that the following steps should be taken:

1. The Decree includes an annex in which certain foreign legal forms are already classified. If the legal form is on that list, the classification included in that list is in principle leading (subject to a few exceptions). The number of foreign vehicles on the list is relatively limited.
2. If the foreign entity is not on the list, it needs to be verified whether the foreign entity is sufficiently comparable with a Dutch legal form. The relevant test is whether the foreign entity is based on its nature and main characteristics sufficiently comparable with a Dutch vehicle. In the Decree, the main characteristics of each Dutch legal form are included. The foreign civil law is the starting point when comparing the foreign entity characteristics with the Dutch entity characteristics. There is no minimum number of requirements that needs to be met in order to conclude that an entity is sufficiently comparable. It is mentioned in the Decree that each element in principle weighs equally, although we also derive from the Decree that the one requirement seems more important than the other.

If the conclusion is that the foreign entity is sufficiently comparable with one Dutch entity, then the classification of that Dutch entity is in principle also applied on the foreign entity (subject to a few exceptions).

If the conclusion is that the foreign entity is not sufficiently comparable with one specific Dutch entity, the Netherlands in principle follows the tax classification of the other country, unless that entity is established in the Netherlands in which case it will be considered non-transparent, i.e. taxable in the Netherlands.

As the number of entities that are already classified by the Ministry of Finance is limited, for most foreign legal forms a case by case analysis needs to be made. For the sake of clarity, it would be helpful if in the final version of the Decree, more foreign entities are already classified by the Ministry of Finance.

We expect that various foreign entities (owning Dutch entities or Dutch assets) will change from non-transparent to transparent for Dutch tax purposes on 1 January 2025. This may result in capital gains tax for that foreign entity, which may under strict conditions be deferred. It is also noted that changing from non-transparent to transparent may take away Dutch withholding tax and interest deduction issues to a large extent.

Questions?

We are happy to discuss the potential impact for your structure. Please contact Arthur Smeijer for more information.