On November 22, 2021, a report of the Dutch Conduit Companies Committee (The Committee Ter Haar) was released. At the request of the House of Representatives the Committee has spent six months investigating the activities of conduit companies in the Netherlands, also sometimes referred to as letterbox companies.
In the report, the Committee discusses the phenomenon of conduit companies in a broad sense, including the nature, the scope and the cause of this phenomenon. Particular attention is paid to three main themes:
1. What is the extent of conduit activities and their contribution to the Dutch economy?
2. What are the tax motives for conduit activities in the Netherlands?
3. What are the non-tax motives for conduit activities in the Netherlands?
4. What is the relationship between money laundering and tax avoidance?
5. What is the effect of (recent) international developments?
Characteristics to identify a conduit company
Therefore according to the Committee the assessment of the existence of a conduit company should be made based on a number of characteristics.
The characteristics are as follows:
1. There is a Dutch entity (i.e. an entity incorporated or entered into under Dutch law, or an entity incorporated under the law of another country and actually located here) that is part of an international structure. Although the term 'company' is often used, it does not necessarily have to be a company within the meaning of the Dutch Civil Code (BW) -such as a public or private limited company. A conduit company can also have another legal form, such as a cooperative or a foundation, or be a legal person incorporated under foreign law and established in the Netherlands, or another type of legal entity.
2. The Dutch entity's transactions are (mainly) with (directly or indirectly) related parties.
3. The Dutch entity has no actual presence in the Netherlands (e.g. no own office and domiciled at a trust and company service provider) or only a limited presence (e.g. a small office with only a few employees).
4. In the international structure, use is made of the Dutch entity to obtain one or more financial, fiscal, legal or other benefits.
5. Substantial amounts flow through the Dutch entity from and to foreign countries. Cash flows in this context refer to dividends, interest, royalties, rental or lease payments. These need not be annual income streams. Apart from the above cash flows, there are no substantial business activities in the entity (and in the Netherlands).
6. The Dutch entity has substantive balance sheet positions, for example several participations in foreign subsidiaries with a high book value.According to the Committee the presence of some of these characteristics indicates a 'conduit' or a 'conduit company'.
Unfortunately the Committee seems to focus on the entity itself instead of focusing on a group’s presence/substance/activities in a jurisdiction to determine whether an entity ticks the boxes for being a conduit company. For example: Why would a subsidiary that itself employs just a few employees and that is residing at the same address as the head office, which for example employs 1,500 employees, be considered to meet criterion 3? In such case there are more than enough available employees available in a jurisdiction to take care of all the operations of the group entities residing in said jurisdiction.
Most important conclusions and suggested actions
Most important conclusions
· In 2019, the Netherlands had approximately 12,400 conduit companies with a balance sheet total of approximately EUR 4,500 billion or 550 per cent of Gross Domestic Product (GDP).
· The interest, royalty and dividend payments that flow through these conduit companies annually amounted to an average of EUR 170 billion in the period 2015-2019.
· Compared to their size, the importance of conduit companies for the Dutch economy is limited, both in terms of employment and tax remittance.
· The committee concludes that the contribution of the conduit sector to the Dutch economy is limited and disproportionate to the lost tax revenues and risks of improper access to investment protection in other countries, especially developing countries.
· The aforementioned is undesirable because of the possible consequences for those countries as well as bad for the Netherlands' international reputation and, accordingly, its negotiating position.
What is the extent of conduit activities and their contribution to the Dutch economy?
Using data from the Dutch Central Bank (DNB), the committee mapped the extent of conduit activities in the Netherlands. In 2019, the Netherlands had approximately 12,400 conduit companies with a balance sheet total of approximately EUR 4,500 billion or 550 per cent of Gross Domestic Product (GDP). The interest, royalty and dividend payments that flow through these conduit companies annually amounted to an average of EUR 170 billion in the period 2015-2019. The size of the flows mentioned and the fact that incoming and outgoing flows are of the same order of magnitude confirms the existing image of the Netherlands as a transit country. The fact that a relatively large proportion of these payments flowed from the Netherlands to low-tax jurisdictions, while the ultimate parent company is based in the United States (US), emphasises the relevance of tax motives.
Compared to their size, the importance of conduit companies for the Dutch economy is limited, both in terms of employment and tax remittance. Direct employment is estimated at three to four thousand jobs. The corporation tax remittance of conduit companies is estimated at about EUR 650 million in 2019, or 0.2 per cent of total tax revenues. According to the committee, this is disproportionate to the adverse effects on other countries and thus on the reputation of the Netherlands. It is difficult to say exactly how much other countries miss out on in terms of tax revenue because of the conduit activities in the Netherlands. However, it is assumed that developing countries are especially sensitive to treaty shopping through the Dutch treaty network.
What are the tax motives for conduit activities in the Netherlands?
The Netherlands has traditionally been fiscally attractive for international companies and also for conduit companies. The most relevant elements of the Dutch tax system that have made the Netherlands attractive for conduit companies, at least until recently, are the participation exemption, the extensive treaty network, the absence of withholding tax on interest and royalties and the practice of tax rulings. In combination with the well-organised financial advice and service sector, the Netherlands became a common intermediary for these elements to avoid withholding taxes elsewhere. For a long time, the government deliberately refrained from obstructing the emergence of this conduit practice.
To find out how the Netherlands currently compares to other countries in certain areas the committee commissioned an external study. This study shows that the Dutch system has not been unique in the abovementioned respects for some time; other countries (now) also have an extensive treaty network and a participation exemption.
In addition, the Netherlands - partly following the European and global developments in this area - has recently taken and announced several measures to discourage certain forms of conduit activity as they are not (or no longer) considered desirable by the legislator. For example, a conditional withholding tax on interest and royalties was introduced as of 2021, the practice of tax rulings was tightened as of 1 July 2019, and the Netherlands aims to include a Principle Purpose Test (PPT) in all tax treaties. The effects of many of these measures are not yet visible in statistics but should be in the coming years.
The committee concludes that a certain 'policy stacking' has taken place recently while the effects of the measures taken are still largely unclear, partly because the relevant figures only become available after a number of years. That is not to say that there are no voids in what has been regulated or announced in the meantime, or that nothing can be said about the effectiveness of rules that have been introduced. For example, many Dutch companies have foreign shareholdings and only act as conduits for dividends and capital gains. This suggests that further measures could be taken to reduce unwanted use of the Dutch jurisdiction.
What are the non-tax motives for conduit activities in the Netherlands?
The committee's investigation shows that, in addition to tax rules, other factors play a role in the decision to establish a conduit company in the Netherlands. Experts interviewed by the committee point to the generally favourable business climate in the Netherlands, particularly the legal infrastructure, including the presence of knowledgeable service providers such as lawyers, civil-law notaries and tax consultants, and the quality of the judicial system. Also, the flexibility of Dutch company law compared to other countries appears to be a reason to establish a conduit company in the Netherlands. In addition, the bilateral investment treaties concluded by the Netherlands reduce the risk for investors abroad. The Netherlands is also sometimes chosen as a neutral jurisdiction to establish a conduit company, for example if two companies from two different relatively large countries decide to set up a joint venture
What is the relationship between money laundering and tax avoidance?
Various elements associated with conduit activities, tax-driven or otherwise, are also relevant in the context of money laundering. The tax and investment climate can provide financial incentives for the proceeds of crime to flow through the Netherlands, just as it does for 'legal' conduits. In addition, money launderers may use conduit companies to disguise the origin of the assets and the identity of beneficial owners. Large-scale cash flows also offer money launderers the opportunity to merge their criminal transactions and cash flows into a larger, legal whole. The infrastructure of service providers, especially trust offices, which is associated with extensive conduit activities is susceptible to money laundering risks.
In recent years, various measures have been taken at both national and international level to combat money laundering. They include strengthening the role of the gatekeepers of the financial system as well as various other measures aimed at reinforcing the anti-money laundering chain. This includes improving the transparency of legal entities, including through the introduction of an ‘ultimate beneficial owner’ (UBO) register. Although many steps have been taken, the committee does see possibilities to improve the framework. The elements that provide opportunity for money laundering, as outlined above, can be discouraged by:
i) promoting transparency among legal entities,
ii) preventing abuses of and by service providers and
iii) reducing the attractiveness of the Netherlands as a conduit country.
What is the effect of (recent) international developments?
The latest International Monetary Fund (IMF) figures on Foreign Direct Investment (FDI) run until the first quarter of 2021 and suggest a downward adjustment of conduit acticity volumes via the Netherlands. It cannot be ruled out that this is caused by international developments. Although the figures are certainly incomplete, they do not provide any basis to expect that conduit activities via the Netherlands have ended up on a structural downward path. Nor did the committee receive any indications of this in the interviews it has conducted.
The committee concludes that unilateral measures do not directly solve international tax avoidance and that stricter rules in the Netherlands are expected to lead to more conduit activities elsewhere. That would perhaps be good for the reputation of the Netherlands but not helpful for those countries that continue to miss out on tax revenue because of conduit activities. Therefore, the committee views the international initiatives in tax reform, tax harmonisation, and the fight against tax avoidance with interest. In addition, the initiative of the OECD Inclusive Framework has recently gained momentum due to a changed position on the part of the USA, although its direct effect on conduit structures seems to be limited for the time being. Within the framework of the Communication on Company Taxation in the 21st century, the European Commission is also working on an initiative to 'combat the abuse of shell entities for tax purposes.' At the same time, the committee (on conduit companies) notes a changed attitude on the part of the Netherlands in the international discussion on tax avoidance, with a more proactive stance in the negotiations. The committee believes that tax avoidance and other undesirable forms of conduit activities are best tackled multilaterally. Nevertheless, meaningful steps can also be taken unilaterally on specific issues.
Framework for action, advice and recommendations
Although there may be legitimate reasons for setting up a conduit company, the committee concludes that some of the conduit activities through the Netherlands are driven by tax or investment protection and are undesirable from an international perspective. The committee concludes that the contribution of the conduit sector to the Dutch economy is limited and disproportionate to the lost tax revenues and risks of improper access to investment protection in other countries, especially developing countries. This is undesirable because of the possible consequences for those countries as well as bad for the Netherlands' international reputation and, accordingly, its negotiating position. Also, several elements associated with tax avoidance are susceptible to abuse by criminals.
The committee started out from a certain action framework to get a tighter grip on both the tax and non-tax driven conduit activities, especially on the large group of low-substance entities with little added value for the Dutch economy. The committee is aware of the (complicated) selection regarding these entities. It has sought ways to reduce the attractiveness of the Netherlands for low-substance entities, such as by increasing the proverbial "price tag" in a targeted manner. It looked at the tax burden, information exchange, administrative obligations, transparency, access to bilateral investment treaties, further research and monitoring.
The committee notes that many measures have already been taken at the national level to counter conduit activities, mainly in the area of taxation. Many measures have also been taken to combat money laundering and terrorist financing. However, it is not yet clear how effective the fiscal measures are at preventing conduit activities, partly because the effects are not yet visible in the (lagging) figures. International agreements are also needed to prevent international tax avoidance through 'shell entities'. The Netherlands cannot do this alone but does have a responsibility to play a leading role, given the size of the financial flows through the Netherlands. Developments in this area have been accelerating for a few years now. This results in a combined uncertainty about the effectiveness of national measures already taken and the outcome of international negotiations in this area. This combined uncertainty can be seen as a reason for restraint in the recommendations for new measures and an opportunity for the Netherlands – as an important conduit jurisdiction -to send a clear signal.
In its advice the committee combines both these elements with the position that it is advisable to closely monitor the effects of the measures already taken and the outcome of the international negotiations. The committee recommends that the Netherlands adopt a constructive and, where possible, initiating attitude towards current international initiatives.
However, the committee certainly sees opportunities for measures in the areas of increased transparency, strengthened supervision and reporting requirements.
The committee further recommends that a clear signal be sent internationally that the Netherlands is taking its responsibility seriously and will continue to actively work to reduce the flow of money through the Netherlands (even if this is not yet evident from the statistics), and that, in addition to the measures already taken, a number of additional fiscal measures should also be pursued. For example, it could be investigated, preferably at the European level, whether the application of tax benefits such as the participation exemption can be restricted in a targeted manner for low-substance conduit companies. In any case, the tax transparency of conduit companies can be increased, for example by actively exchanging information on conduit companies with foreign countries.
The committee also recommends increasing the transparency of legal entities to prevent abuse by further tightening up the UBO concept in certain respects and making adjustments to the UBO register. It is also important to advocate internationally for the introduction of public UBO registers. Furthermore, the limited requirements for preparing financial statements, which currently apply to many conduit companies, can be brought more in line with the reporting requirements for legal entities with substantial economic activities. The committee also recommends that stricter action be taken against trust and company service providers that evade the requirements of the Trust Offices (Supervision) Act 2018 (Wtt 2018), so called 'illegal' trust offices, and that capacity and resources be made available for this purpose. The Netherlands could also put more effort into international cooperation to effectively combat the improper use of Dutch legal entities for money laundering and other criminal activities. Finally, the committee recommends that the relationship between conduit activities and money laundering be further investigated by the Financial Expertise Centre (FEC), a partnership between the authorities involved.
Overview of suggested tax and non-tax policy measures
· The removal of the safe harbour for interest and royalty conduit activities
· Extension of the spontaneous exchange of information on companies.
· Spontaneous exchange of information in the case of exempted gains on disposal.
· Extension of the PPT to the entire tax treaty (if not multilaterally regulated).
· A proactive stance on the forthcoming EU directive proposal on shell entities.
· A clear interpretation of the EU anti-abuse principle.
Transparency of UBOs
· Tighten up the obligations where 'senior management' is designated as UBO.
· Make currently public data in the UBO register more easily searchable
· International introduction of UBO registers with public data
· Deletion of the exceptions in Article 2:403 of the Dutch Civil Code.
· When determining the size of a company, always include data from holdings and, if relevant, financial income.
Monitoring and Investigation
· Tighten approach to combatting illegal trust services.
· Follow-up research on money laundering and conduit activities.
· Intensifying international cooperation in countering criminal conduit activities.
Bilateral investment treaties
· Deny conduit companies access to bilateral investment treaties.
The English version of the report can be downloaded here.
The PWC report titled: “Comparative analysis of the taxation of conduit companies” can be downloaded here.
The IBFD Quick scan the report refers to can be downloaded here.
The Dutch version of the report can be downloaded here.
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