Participation exemption is an important component of corporation tax. This exemption avoids double taxation on a participating interest. Participation exemption plays a role when income is received from a shareholding. But – unfortunately – also when losses are incurred.
Participation exemption applies to companies paying Dutch corporation tax. A company is liable to pay Dutch corporation tax if it meets the following conditions:
- the company is a legal entity, for example a bv, nv or a stichting (foundation);
- the company has its registered office in the Netherlands.
Avoiding double taxation
The participation exemption avoids double taxation in a company group. Based on the participation exemption, the parent company is exempted from being taxed for the subsidiaries’ profits.
After all, the subsidiaries have already paid tax on their own profits. Such profits include, for example, dividend received and profit made on the sales of a shareholding.
Participation exemption not applicable
The participation exemption cannot be claimed by:
- entrepreneurs who are subject to personal income tax;
- fiscal investment institutions (liable to corporation tax but zero-rated);
- professional partnerships and other partnerships that are not independently subject to Dutch corporation tax;
- companies forming a tax group with another company and therefore not independently liable to pay corporation tax;
- entities exempt from corporation tax, such as government bodies and foundations under Dutch law, not running an actual business;
- foreign entities not running a business in the Netherlands.
Loss not tax-deductible
However, the participation exemption not only covers profits, but also loss of value of the shareholding. So you cannot deduct the loss incurred on a shareholding from the taxable profit.
Therefore, the participation exemption does not only bring advantages. Acquisition and disposal costs of a shareholding cannot be deducted either.
General rule of shareholding
A shareholding exists if the parent company holds at least 5% of the nominal paid-up capital in a company whose capital is wholly or partly divided into shares. This is the general rule. Section 13, subsection 2 of the Dutch Corporation Tax Act contains additional situations for shareholdings or participating interests.
The equivalence provision
There are several situations that do not meet the 5% requirement, but in which a shareholding nevertheless exists. For example, due to the equivalence provision, other interests can also be qualified as participating interests.
The equivalence provision also applies to profit-sharing certificates and hybrid loans. Therefore, if you have a shareholding, the ancillary profit-sharing certificates also belong to it. And the same applies to hybrid loans provided to the shareholding. Consequently, such loans are also called participating loans.
The condition is that a shareholding already exists on the basis of the general rule. Profit-sharing certificates and hybrid loans can never constitute a participating interest in themselves. They are ‘equated’ with an already existing participating interest.
In addition to the equivalence provision, there is also a so-called affiliation provision. Based on this provision, an interest of less than 5% will still be qualified as a participating interest under certain conditions. This is the case if a so-called ‘affiliated entity’ has a participating interest. Therefore, it is a relaxation of the general rules.
Qualifying investment participation, or not?
If shares are held as an investment, different rules apply to these interests. This is because the participation exemption applies to qualifying investment participations but not to non-qualifying investment participations. The legislature aims to prevent participation exemption to apply to investment participations in low tax rate countries as well.
A qualifying investment participation exists, if:
- the shareholding is liable to profit tax resulting in real taxation by Dutch standards (liability test), or
- usually less than half of the assets of the shareholding consists directly or indirectly of low-taxed free investments (assets test).
If the shareholding meets one of these tests, the participation exemption applies.
The liability test compares the foreign taxation of the shareholding’s profit with taxation according to Dutch standards. A rate of 10% is usually a real taxation.
Definition of affiliated entity
The definition of the term ‘affiliated entity’ is subject to the so-called ‘one-third interest’ criterion. In the following (succinctly described) situations, an entity is ‘affiliated’ to your company:
- your company holds at least one-third of the shares in the entity;
- the entity holds at least one-third of the shares in your company;
- the entity is part of a group for corporation tax purposes with your company;
- another legal entity holds at least one-third of the shares in the entity, while this other legal entity also holds at least one-third of the shares in your company.
Profit certificates and hybrid loans are again also subject to this rule.
Then, there is another relaxation of the 5% requirement. The law provides that the participation exemption continues for another three years if the shareholding has dropped below 5%. Strictly speaking, there is no longer a participating interest in that case.
But the rules of the ‘participation interest dropping below the threshold’ provide that you may nevertheless continue to apply the participation exemption if you meet the following conditions:
- the shareholding has been in your possession for more than one year;
- the participation exemption has uninterruptedly applied to the shareholding.
The last exception to the 5% requirement is for shares in companies from the European Union. An interest of less than 5% is still a participating interest, if:
- it concerns shares in a company with a registered office in a EU member state;
- the shareholding represents at least 5% of the voting rights;
- a treaty to prevent double taxation has been concluded with the EU member state;
- a cut of dividend taxation has been agreed in the treaty, based on the number of voting rights.
No request needed
The participation exemption applies by operation of law. Therefore, it is not necessary to submit an application request to the Belastingdienst. But of course, the tax authorities can always be asked in advance whether, in a certain (future) situation, the participation exemption will apply, or not.
Sometimes interests in entities whose capital is not divided into shares can also qualify as shareholdings.