Netherlands: Allocation of debt and equity to PE, other transfer pricing issues (appellate court decision)

A Dutch appellate court (Gerechtshof‘s-Hertogenbosch) addressed the allocation of debt and equity capital to a permanent establishment (PE) in a case with other transfer pricing issues.

The appeals court held that part of the interest reported at the level of the Dutch legal entity was allocated to the PE, and in turn, this resulted in the PE having a lower profit and a lower corporate tax object exemption claim in the Netherlands. With the court’s decision, the taxable profit of the taxpayer was increased to €95 million (from €30 million) for the 2012 financial year.

The case identifying information is: no. 19/00771 and 19/00779, ECLI:NL:GHSHE:2022:1198 (13 April 2022)

One of the issues presented in this case concerned whether an arm’s length interest rate was taken into account for a PE in Libya in connection with the application of the object exemption for the PE’s profits. More specifically, the dispute was whether the creditworthiness of the Dutch legal entity was correctly taken as a starting point and whether sufficient adjustments were made for the increased risk profile of the Libyan PE.

The appellate court agreed with the lower court’s view that the capital allocation approach, when read in conjunction with the fungibility approach, was regarded as the preferred method for the application of Article 7 of the OECD Model Convention in the Netherlands and therefore was the appropriate method for determining the amount of the PE profit exemption, even though no tax treaty existed between Libya and the Netherlands.

Other issues addressed by the appeals court included:

• Were all assets and liabilities denominated in U.S. dollars be valued as a whole? In the opinion of the appeals court, the mere fact that assets and liabilities were denominated in the same currency was insufficient to conclude that there was a correlation between them.
• Was the profit of the taxpayer’s Dutch subsidiary deliberately set too high? The appeals court concluded that the taxpayer had not made a plausible case that its profit had been determined at an unreasonably high level.
• Was the transfer pricing adjustment of over €42.8 million with regard to the supply agreement concluded between the taxpayer and a foreign group entity correct? The appellate court reached a conclusion based in part on the transfer price documentation.  

An appeal has been filed with the Dutch Supreme Court.

Tax professionals have described this case as a landmark decision, and note that the decision also indicates that global (and consistent) transfer pricing documentation is crucial. Note that the Netherlands has a separate 2011 decree for the transfer pricing of PEs (tax professionals expect an update to the decree soon).

Read a June 2022 report* [PDF 212 KB] prepared by tax professionals of the KPMG member firm in the Netherlands