On November 9, 2023 on the website of the Dutch tax authorities a position paper of the Knowledge Group dividend withholding tax and withholding taxes of the tax authorities on the applicability of the withholding exemption for Dutch dividend withholding tax purposes and the residing there criterion (KG:024:2023:20) was published. In this position paper the Knowledge Group answers the question whether the tax treatment of the shareholders/particpants of the beneficiary to the proceeds is relevant when assessing whether under the tax legislation of a Treaty State the (primary) beneficiary to the proceeds is residing/established there (in the other Treaty State)?

At International Tax Plaza we are somewhat struggling with this position paper, below under remarks by ITP we will elaborate on why we are struggling with this position paper. First we will give a synopsis of the position paper.

Facts

A Dutch corporation distributes dividends to an American corporation with an S-Corp status. The S-Corp status results in the inclusion of the S-Corp's income in the taxation of the S-Corp's shareholders. The shares of the S-Corp are held by an exempt pension fund. The Dutch corporation intends to apply the withholding exemption of article 4, Paragraph 2, section a, under 2° of the Dutch dividend withholding tax Act (hereinafter: DDWT Act) to the dividend payment.

Question

Is it for the assessment whether pursuant to the tax legislation of a Treaty State a beneficiary is considered "residing there", relevant to take the tax treatment of the shareholders/participants into consideration?

Answer

No, it should be assessed whether on the basis of the relevant national (profit tax) legislation of the concerning Treaty State the beneficiary to the proceeds 'is residing there'. In principle, who the beneficiary’s shareholders are and how these are treated for tax purposes is not important for this assessment. This is only different if these facts influence the outcome of assessment whether pursuant to the relevant legislation of the concerning Treaty State the beneficiary to the proceeds is residing there.

From the considerations of the tax authorities

Article 4, Paragraph 2 of the DDWT Act provides for a withholding exemption for international participation situations. One of the conditions for the application of this exemption is that the beneficiary to the proceeds is a legal entity that according to the tax legislation of:

1. another Member State of the European Union or another State that is a party to the Agreement on the European Economic Area (EEA), is residing there, or
2. a State with which the Netherlands has concluded a Convention for the Avoidance of Double Taxation, or a public bod within the Kingdom for which the Netherlands has made an arrangement to avoid double taxation that contains an arrangement for a dividends, other than a Member State of the European Union or a State that is a party to the Agreement on the European Economic Area.

Based on the (profit) tax legislation of the relevant Treaty State, it must be assessed whether the beneficiary of the proceeds is an entity residing there. According to the legislative history, the term “residing there” means that the entity as such is not treated as transparent there for tax purposes (Parliamentary Papers II, 2009/10, 32 129, no. 3, p. 71 and Parliamentary Papers II, 2017/ 18, 34 788, no. 3, p. 12).

If a body is treated as non-transparent in its country of residence, then for the assessment whether that body is residing there it is no longer relevant who the shareholders/participants are and how these shareholders/participants are treated for tax purposes.

Remarks by ITP

As we stated above, we are somewhat struggling with this position paper. The reason for this is not so much laying in the answer given and the legal assessment made by the Knowledge Group, but in the fact that the Knowledge Group seems to forget to explain how this theoretical assessment is to be applied in the of an S-Corp. Although it is not explicitly stated, we feel that one could understand the position paper in such a way that according to the tax legislation of the Treaty State (in this case the United States) an US corporation that has opted for an S-Corp status meets the residing there (in the US) criterion. Consequently one could read in the position paper that the withholding exemption for Dutch dividend withholding tax purposes would in principle apply to dividend distributions that are being made from a Dutch entity to a US S-Corp. We however wonder whether the position paper can be read in such way?

As we understand it for the United States federal income tax an S corporation (or S-Corp), is a closely held corporation (or, in some cases, a limited liability company (LLC) or a partnership) that elected to be taxed under Subchapter S of Chapter 1 of the US Internal Revenue Code. We furthermore understand that in general, S-Corps do not pay any US federal income tax. Instead, the income and losses of an S-Corp are divided among and passed through to its shareholders. The shareholders must then report the income or loss in their own individual income tax returns.

This seems also to be confirmed by the facts as the are presented by the tax inspector that presented the question to the Knowledge Group. If these facts were presented to us we would conclude that an S-Corp in general, and certainly the S-Corp in the underlying case, were to be considered to be a transparent entity for US federal income tax purposes. Our view in this seems to be confirmed by the OECD which with respect to the implementation of the Common Reporting Standard stated: “Partnerships (other than publicly traded partnerships), subchapter S corporations, grantor trusts, simple trusts, and common trust funds under section 584 of the Code are fiscally transparent entities for purposes of U.S. federal tax law.”

Therefore, while the Knowledge Group provides a theoretical consideration of how the given question should be answered in the event that abroad a body is treated as non-transparent for tax purposes, in our view the Knowledge Group seems to completely miss the mark. As we explained above we are of the opinion that an S-Corp is generally treated as transparent for US federal income tax purposes. In our opinion one is therefore oversimplifying when assuming that in the case of an US S-Corp, one would not need to take into consideration who the shareholders/participants in the S-Corp are and how they are treated for US federal income tax purposes. In our opinion in an S-Corp is a perfect example of a body where one should examine who the shareholders/participants are (in this case, the exempt pension fund) and how these shareholders/participants are treated for tax purposes. Therefore in our view the legal assessment of the Knowledge Group as laid down in the underlying position paper is incomplete.

Those that are interested in reading the position paper in the Dutch language as it was published on the website of the Dutch tax authorities can find it here.

Other position papers of the Knowledge Group dividend withholding tax and withholding taxes that we have reported on earlier can be found here.

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