In the second quarter of 2023, a legislative proposal is expected to be published to amend the Dutch tax entity classification rules. This proposal will, most notably, include the abolishment of the so-called unanimous consent requirement for Dutch and foreign limited partnerships (LPs) to qualify as transparent for Dutch direct tax purposes. As a result, LPs will in principle qualify as transparent going forward. The abolishment is expected to be implemented together with a deemed disposal rule for tax opaque LPs and limited partners that are subject to Dutch corporate income tax. This could possibly lead to exit taxation unless certain tax facilities are made available. Timely impact assessments are recommended, as the abolishment could be effective as soon as 1 January 2024. This publication outlines the potential impact for the real estate funds industry.
Background
The Netherlands has very specific tax classification rules for Dutch and foreign entities, which deviate from international standards. Especially for contractual entities – such as limited partnerships, funds for joint account and trusts – this often leads to hybrid qualifications (i.e., tax opaque from a Dutch tax perspective, but tax transparent for other jurisdictions). For this reason, a legislative proposal will be published in the second quarter of 2023 to partly solve this. Partly, as changes to the tax classification of funds for joint account are still being evaluated and will be included in a separate legislative proposal.
The announced changes to the tax classification of funds for joint account are described in our publication 'Dutch Tax Entity Classification Rules: Changes Announced for Funds for Joint Account' and will not be discussed in this publication.
Based on a Public Consultation in 2021 and a recent announcement, we expect that the legislative proposal that will be published in the second quarter of 2023 will broadly contain the following items:
- Legal form comparison method – A codification of the current tax classification method for foreign entities, which is based on a comparison of legal form characteristics. The legal characteristics of a foreign entity are compared against those of entities incorporated and established under Dutch law (e.g., Dutch BVs, cooperatives and limited partnerships). The foreign entity is subsequently treated the same as its Dutch equivalent (i.e., tax transparent or tax opaque).
- Fixed method: incomparable resident entities – Foreign entities tax resident in the Netherlands with a legal form that is incomparable to a Dutch legal form will default to tax opaque (i.e., irrespective of the classification in their jurisdiction of incorporation or establishment). As a result, such entities will be subject to Dutch corporate income tax. An example of an incomparable legal form is the UK LLP.
- Symmetric method: incomparable non-resident entities – Foreign entities resident outside the Netherlands with an incomparable legal form will follow the classification applied by their jurisdiction of incorporation or establishment (i.e., tax transparent or tax opaque).
- Limited partnerships: abolishment unanimous consent requirement – Dutch and foreign LPs (e.g., the Dutch CV, Luxembourg SCSp and Cayman LP) are currently considered opaque for Dutch tax purposes, unless the unanimous consent requirement is met. This means that the admission and substitution of limited partners can only take place after prior consent from all partners (i.e., general and limited partners). Admission and substitution are interpreted broadly, covering all forms of economic transfers by limited partners. This requirement will be abolished, meaning all Dutch and foreign LPs will in principle qualify as transparent for Dutch tax purposes.
- Transitional law: shapeshifting limited partnerships –The abolishment of the unanimous consent requirement will lead to a deemed disposal of all assets and liabilities held by tax opaque LPs to their limited partners. Limited partners in turn will be deemed to dispose their interests held in tax opaque LPs at fair value, as well as any shareholder loans granted to such LPs. For limited partners and LPs that are currently subject to Dutch corporate income tax this will lead to exit taxation. We expect that relief facilities will be included in the legislative proposal, such as forms of roll-over relief and an installment facility allowing limited partners and LPs to pay exit taxes in instalments over a number of years.
Impact for real estate funds and investors
The Dutch tax consequences connected the abolishment of the
unanimous consent requirement will be the key focus area for the
real estate funds industry. In other words, the moment tax opaque
LPs convert into tax transparent LPs. This will trigger a deemed
disposal for both the LP and its limited partners. LPs and limited
partners subject to Dutch corporate income tax can therefore be
impacted with an exit taxation. LPs include the Dutch CV,
Luxembourg SCS(p), the German KG, the Danish KS, UK LP, Cayman LP,
Guernsey LP and so on. Such LPs can, for example, function as fund
or feeder vehicles, as fund of funds, property-owning vehicles and
as pooling / investment vehicles for institutional investors.
If the legislative proposal is adopted, it could become effective
as soon as 1 January 2024. To help investors and real estate fund
managers get started with their impact assessment, we have compiled
the below overview. This overview is based on the limited
information currently available. Ultimately all situations will
need to be assessed on a case-by-case basis against the final
adopted legislation.
- Dutch taxable investors in tax opaque LPs – Dutch taxable investors (e.g., insurance companies and family offices) in tax opaque LPs will need to assess how the abolishment of the unanimous consent requirement affects their expected return on investment and tax (compliance) position. Items to consider are (1) whether the Dutch participation exemption or relief facilities can be applied on capital gains as a result of the deemed disposal of their limited partner interests, (2) the tax treatment of the income that will be allocated to the investor going forward as a result of the tax transparency of the LP (e.g., interest income on loans granted by the LP and/or income from real estate), and (3) whether the fund manager is able to supply financial data of sufficient quality to allow the investor to fulfil its Dutch corporate income tax compliance obligations (e.g., financials allowing the investor to include the LP's income and expenses in its fiscal profit and loss account, and the LP's assets and liabilities on its fiscal balance sheet).
- Dutch and foreign tax opaque LPs directly holding Dutch real estate – In case a tax opaque LP is subject to Dutch corporate income tax (e.g., a Dutch CV or foreign LP that directly holds Dutch real estate), the abolishment will lead to a deemed disposal of all assets and liabilities held by that LP, and therefore exit taxation. Assessing whether a capital gain is expected upon such deemed disposal, and if so, whether roll-over facilities can be applied will be important. Moreover, the taxable income of the LP will in principle shift to the limited partners going forward due to the tax transparency of the LP. This includes the related corporate income tax compliance obligations. In case this needs to be mitigated, compliance blockers or tax neutral conversions of an LP into another legal form can be considered.
- Entities taxable in the Netherlands (indirectly) held by Dutch and foreign tax opaque LPs – Holding and property companies that are ultimately held by an LP (e.g., a fund vehicle) and that are subject to Dutch corporate income tax (e.g., Dutch BVs and cooperatives, or Luxembourg Sarls that directly own Dutch real estate) will need to re-assess their ATAD2 and Dutch conditional withholding tax positions. No adverse effects are expected as a hybrid mismatch will in principle be eliminated following the abolishment of the unanimous consent requirement. As the LP would become transparent for Dutch tax purposes, this may also affect the Dutch dividend tax position for distributions made by holding and property companies tax resident in the Netherlands to such an LP (e.g., a look-through to the investors in the LP can be applied more broadly for Dutch dividend withholding tax purposes).
- Dutch and foreign tax opaque carried interest LPs – Carried interest vehicles in the form of a tax opaque LP can allow Dutch private individuals to be taxed according to a lower personal income tax rate. For this facility to apply, one of the requirements is that the carried vehicle qualifies as opaque for Dutch tax purposes. The abolishment can therefore adversely impact existing carried interest structures as such LP could become tax transparent for Dutch tax purposes. To mitigate adverse effects, restructuring steps should be evaluated.
- More commercial flexibility – Fund managers that have incorporated the unanimous consent requirement into Dutch and foreign LP agreements will in principle be able to remove such clauses once the abolishment is effective. This will allow for more commercial flexibility, as prior (written) consent from all partners will no longer be required. The abolishment of the unanimous consent requirement does not only allow for more commercial flexibility, but it also improves the overall tax framework for real estate funds that want to operate out of the Netherlands. Due to the transparency of Dutch and foreign LPs, Dutch tax resident companies held by such LPs (e.g., Dutch BVs and cooperatives) can more broadly apply dividend withholding tax exemptions and reductions looking-through the LP to the investors.
How can A&M help?
Given the announced effective date of 1 January 2024, it is important to identify a possible impact as early as possible to allow for sufficient time to act.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.