“Starbucks tax deal equates to illegal state aid”: it was with this headline that NRC Handelsblad reported on 21 October 2015 that the European Commission has t– instigated by Margrethe Vestager, the European Commissioner for Competition – had ruled that the Netherlands had been favoring Starbucks with an “illegal” tax advantage in the 20 to 30 million euro range. It was not just arrangements of this kind that the European Commission has targetted: it might also be going after the Dutch “limited partnership-limited company” mechanism (CV/BV Structure) which has become such a firm favorite with predominantly US-based multinational companies (such as Starbucks).
This article addresses the question as to whether the CV/BV Structure should indeed be dismissed as illegal state aid, as a topic for whose discussion I would consider the timing of this discussion to be appropriate, given (i) the prevalence of the structure, (ii) the potentially huge impact of the “state aid” qualification, and (iii) the recently launched negotiations between the United States and the Netherlands on the applicable double taxation convention.
The Dutch limited partnership-limited company mechanism (CV/BV structure)
A Dutch limited partnership-limited company set-up is used as a vehicle for enabling a US-based party to hold a participating interest in a Dutch-based limited partnership (CV), with the latter in turn participating in a Dutch-based private limited-liability company (BV) that acts as a holding company on behalf, more often than not, of the various European operating companies. The CV has (at least) one general (or managing) partner and one limited (or silent) partner, the latter being a US-based group company. As the CV has a fiscally-controlled status, which can result in the underlying partners rather than the partnership being liable for Dutch taxes, this ensures fiscal transparency where the CV itself is concerned.
The United States – much differently to the Netherlands – offers the option of conferring fiscal transparency or non-transparency upon foreign group companies. This is what is known as the “check the box” system. The US will tax the US-based limited partner where it considers the Dutch CV to be lacking in transparency. The object of this mechanism (and thus its main attraction) is to relay – as dividends, interest or royalties – earnings generated (more often than not) by European operating companies to the CV, with the aforementioned disparity enabling taxation being deferred owing to the fact that (i) the Netherlands will not levy taxes at all at the level of the CV (the hybrid entity) whereas (ii) the United States will refrain from doing so unless and until the earnings in question are repatriated from the CV to its US-based limited partner.
In contrast to the United States, the US-based limited partner additionally has Dutch tax liability where it concerns payments made by the BV to the CV. The US-based limited partner (i) as a beneficiary of the proceeds on the one hand will owe 15% in dividend tax which the limited company will deduct from dividends paid out to the limited partnership, while (ii) in its capacity of foreign taxpayer, on the other hand, may be liable for 25% corporation tax on profit participating royalties collected in connection with the limited partnership’s licensing of intellectual property to the limited company. However, thanks to the double taxation convention in force between the Netherlands and the United States the US-based limited partner will qualify for mitigation of its tax charge to 5% (where it concerns dividends) or even reduced to 0% (where it concerns qualifying dividends, interests, and royalties).
Illegal state aid?
The fly in the ointment where the US-based limited partner’s reliance on the above tax advantages is concerned has been article 24(4) of the double taxation convention between the Netherlands and the United States, waging war as it has been on the use of such hybrid entities. As this was a thorn in the side of the (then) Dutch State Secretary for Finance, it was decreed in 2005 to leave the stipulation in question out of the double taxation convention between the Netherlands and the United States on condition that particular substance requirements in or via the Netherlands should be satisfied.
However, the application of the aforementioned Decree has prompted the question as to whether there could be a question of illegal state aid given that the application of the double taxation convention with the United States will result in the Netherlands refrain from levying a tax on dividends. TFEU, the Treaty on the Functioning of the European Union, defines illegal state aid measures as any scenario involving (i) an advantage having been made available to a business (ii) for the funding of which state resources have been used, (iii) which aid-related measure is having a disruptive effect on competition and commerce within the European Union (iv) as well as being selective in nature.
The question has to be asked on the one hand to what extent the Netherlands has been favoring US-based multinational companies that rely on the Decree and if this has reflected in a tax ruling issued by the Dutch Tax and Customs Administration. Dividends represent a particularly thorny issue, as only (dividend) tax is levied on the distribution of dividends rather than (corporation) tax being levied on the entity’s dividend income. Moreover, the set-up in question, rather than having been created with the aim of stopping dividend tax being levied, has been devised for the purpose of deferring US taxes being levied on paid out earnings so that it cannot be said to favor particular players.
There are those who profess that royalties paid by the BV to the CV should likewise be liable for corporation tax. It is my opinion that this remains very much to be seen, as the profit entitlement clause merely deals with royalties relating to profit entitlement and it is the very essence of a royalty that it should be turnover-related. Here too the conclusion – mutatis mutandis – would have to be that there is no question of particular players being favored.
Then again there is a lot to be said against the alleged selectiveness of the aid measure. This would call for (i) the identification of the reference framework in order to enable (ii) the assessment being made as to whether said reference framework is being departed from for the benefit of particular economic agents that are similar both factually and legally to other agents, with (iii) the departure in question being justifiable by virtue of the nature of the reference framework. The mere implication underpinning the “inadmissible state aid argument”, viz. that the object and purport of the Decree favor particular US-based enterprises, is open to debate. In addition, there are plenty of critical comments to be made on the reference framework and the associated selectiveness.
It cannot be denied that the European Commission’s allegation to the effect that the CV/BV structure is tantamount to the Netherlands (covertly) furnishing state aid hinges on several highly-debatable presumptions. On top of this, it very much remains to be seen whether the state aid measure is the appropriate tool for combating mismatches involving hybrid entities. Add to this the frequency with which the Dutch CV/BV structure is practiced and the conclusion has to be that the ratification of the European Commission’s verdict is a long way off.
Tax treaty negotiations pending: “reduction of dividend withholding tax?”.
The United States and the Netherlands have recently been reported as having taken up fresh negotiations on the topic of the double taxation convention between the two countries. If it is the case that the CV/BV structure, with its alleged state aid, has indeed helped spark the tax treaty negotiations, now might be a good time to do away with dividend tax between the Netherlands and the United States altogether. This de facto reciprocity and the potential absence of approving policies, by virtue of tax exemption for dividends originating in the Netherlands, are instrumental in curbing the risk of alleged state aid. Furthermore, I am firmly convinced that, were this to happen, any question of alleged state aid at all will be completely dismissed.
We would be happy to determine the state aid risk in specific cases. Feel free to contact us.