Tax optimization of the financing of a Dutch company

The optimal finance structures 

Minimum capital is not a requirement for a Dutch L.L.C (B.V.), not meaning that a minimum amount of capital is always the best strategy. 

The optimal finance structure for your Dutch business will first depend on the operational needs of your business. Although the operating cash flow can be advanced to the current account, this is generally not tax-effective, as it forces the lender to recognize interest from income when the corresponding interest expense at the level of the Dutch company does not create a tax benefit until the moment the Dutch company becomes profitable. 

The solvability of a Dutch company is a deciding factor in the marketplace. The parties with whom the Dutch company will do business (banks, suppliers, clients, and partners) will prefer a counterparty furnished with high equity. Please note that only the amount paid in capital will be recorded in the Trade Register, as accessible by the public.  

Once the permissible amount of loan financing from an operational perspective is determined, it may be considered to look into an optimal tax strategy for financing the business.

In general, there are three different ways to finance transactions and investments:

1. (High) Equity
2. By loans 
3. By hybrid instruments

Each of these three forms of financing has its fiscal implications. Companies also have reasons - fiscally driven or not - to prefer one form of financing, which could be a limitation of liability, maximum flexibility, or profit-dependent remuneration.

What is the best finance structure for your Dutch business?

In general, loan financing, from a Dutch tax perspective, is more beneficial than equity financing because under normal circumstances:

1. The issuance and the repayment of a loan have no Dutch tax implications (provided that "arm's length" conditions are met);  
2. Interest payments are generally tax deductible, whereas dividend payments are not;  
3. Outbound interest payments are only subject to a withholding tax under extraordinary circumstances, whereas dividends are always subject to a 15% withholding tax at source.

When the foreign lender is a qualifying substantial shareholder in the Dutch company or directly or indirectly related to such a party, the interest may become subject to Dutch corporate or personal income tax. We note that in most cases, tax treaties prevent the Netherlands from exercising this right on taxation.

The second and third points are less relevant for Dutch resident company shareholders. A Dutch resident company is subject to tax for interest received against the same rate as the company that pays the interest. The dividend withholding tax rate is 0% if the Dutch parent can claim the participation exemption.

For foreign shareholders, financing with loans is, in most cases, more favorable than financing with equity. Under certain circumstances, however, the equity financing of a Dutch company can still be a preferred option for foreign shareholders. This could occur in the following situations:

• The Dutch tax rate is lower than the tax rate in the country of the shareholder, so interest expenses are preferably allocated at the shareholder level
• The Dutch business is not expected to become profitable in the direct future (interest expense would only increase the loss and not result in tax benefit)
• The shareholder has no efficient structure in place to shelter or defer interest income from taxation 
• The Dutch company can allocate the equity to a foreign branch, a consequence of which it is eligible for an exemption from Dutch taxation for the income generated by the branch. 

What are the Dutch tax limitations for loan financing?

When a Dutch company is funded with loans, certain limitations apply. The most important limitations of loan financing are:

1. To the extent loans are to be qualified as capital according to the Dutch criteria, they will be treated as capital for Dutch tax purposes (substance over form and capital resemblance test). 
2. Interest paid on loans that fall under the definition of profit-sharing loans is not tax deductible and is subject to Dutch dividend withholding tax. 
3. Interest paid on particular categories of loans (usually resulting from inter-company transactions) can only be tax deductible under stringent conditions.
4. Earnings stripping limits the deductibility of ‘excess’ net interest expenses. According to this rule, excess interest costs (i.e., the balance of interest costs and interest income, including foreign exchange results on the loans) are only deductible up to 20% (2023) of the earnings before interest, taxes, depreciation, and amortization (EBITDA); The earnings stripping rule contains a threshold of € 1,000,000 (2023). Excess interest expenses, up to 1,000,000 euros, are not included.
5. Interest paid on loans provided by qualifying group companies will only be tax-deductible to the extent the loan conditions are at "arm’s length" and specific documentation requirements are met (transfer pricing).

The tax implications of equity financing

Net equity financing requires a legal entity with capital divided into shares, like a Dutch B.V., a branch can also be funded with equity, but this will, in most cases, mirror the funding of the foreign head office. For Dutch tax purposes, the equity of a Dutch branch is determined through the allocation of assets and liabilities.

Capital contributions into a B.V., for example, in exchange for new shares or as share premium by the meaning of cash, in kind, or equity allocation to a Dutch branch, are not subject to Dutch capital registration tax. 

The return on equity in the form of dividends may attract a 15% Dutch dividend tax at source. Due to applicable tax treaties (many countries concluded bilateral agreements to prevent double taxation,) the dividend tax is reduced to even nil. An overview of the Dutch treaty rates is included in the Dutch Tax Treaty Database. The E.U Parent-Subsidiary Directive conditionally forbids the levy of withholding taxes on dividend payments to major E.U corporate shareholders. Various anti-abuse provisions apply.