HOLLAND made it harder to use hybrid debt to strip earnings into Holland from another country.

The action is important because many US multinationals make offshore investments through Dutch holding companies.

Hybrid debt is an instrument that is treated as debt for tax purposes in one country but as equity in another. For example, suppose a Dutch holding company advances funds for a project in another country. The advance is drafted so that it looks like a loan for tax purposes in the country where the project is located. The project company deducts the earnings it pays out as interest on the loan. Meanwhile, the Dutch holding company avoids tax on the interest in Holland by reporting the transaction as an equity investment. Returns from many equity investments are not taxed in Holland under a “participation exemption.”

Under new legislation that took effect on January 1, certain debt instruments with equity features will be classified as equity for Dutch tax purposes. This would have helped with earnings stripping into Holland if the legislation did not also deny the participation exemption on such instruments in cases where the interest is tax deductible by the borrower.

Under the new legislation, debt instruments will be classified as equity in three situations. One is where the loan has a term of more than 10 years and the interest is dependent on the profits of the borrower or a related party. Another is in the same circumstances, except the interest is only partly dependent on profits and the interest that will be paid in all events is less than half the market rate. The last situation is where the interest is a seemingly normal fixed or floating rate, but the interest is not paid unless there are profits, the loan is subordinated and it has a term of more than 50 years.

Dutch companies that borrow under these kinds of instruments will not be able to deduct the interest payments in Holland. Moreover, payments to an offshore lender will be subject to withholding taxes as dividends.

The new legislation applies to loans made after January 1, 2002, according to Waldo Kapoen with Loyens & Loeff in The Hague.

Keith Martin