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Netherlands: Interest deduction limit (thin cap rule) for banks, insurers

Netherlands: Interest deduction limit (thin cap rule)

The Dutch government in March 2019 launched an internet consultation, thereby affording interested parties an opportunity to respond to a draft bill that proposes a “thin cap” rule for banks and insurers. The internet consultation closes on 15 April 2019.

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Background

The government is seeking to encourage the use of equity to conduct business by limiting the tax benefits for debt. This goal has resulted in the introduction of a generic interest deduction limitation (earnings stripping measure) that provides the amount of net payable interest that can be deducted will be limited as of 1 January 2019. Because businesses in the financial sector (at the fiscal unity level) typically receive interest, they will not be affected by this general deduction limitation. 

However, the introduction of a thin cap rule for banks and insurers (proposed to be effective 1 January 2020) would expand the thin cap rule to the financial services sector, so that the sector contributes to the reduction of the corporate income tax rate. 

Proposed thin cap rule for banks, insurers

The thin cap rule would limit the interest deduction for tax purposes if banks and insurers have excessive debt. 

Banks and insurers are defined as banks and insurers with a license issued under the Financial Supervision Act (Wet op het financieel toezicht) or that have received a notification from the Dutch Central Bank (De Nederlandsche Bank N.V.) This means that a large number of banks and insurers would be affected. The proposal not only concerns licensed banks and insurers with a registered office in the Netherlands, but also foreign banks and insurers (both inside and outside the EU / EEA) with a permanent establishment in the Netherlands. 

Initially, the interest deduction was proposed to be limited to that part of the debt exceeding 92% of the balance sheet total for accounting purposes. The government has abandoned this plan by not linking this percentage to the balance sheet total for accounting purposes, but by aligning it as much as possible with variables familiar to the sector. According to the government’s proposal, this change would be because of the existing regulatory frameworks for banks and insurers. As banks and insurers are already familiar with various variables within those regulatory frameworks, it means that for the purposes of calculating the deductibility of interest under the proposed thin cap rules, different rules would be used for banks and insurers. 

A closer look at the rules for banks

With regard to banks, the consolidated leverage ratio in the Capital Requirements Regulation would be used. The thin cap rule for banks and banking groups would limit the deductibility of the interest expense for loans (interpreted in accordance with the definition used for the generic interest deduction limitation), if there is a shortage of equity. 

Under the proposal, there would be a shortage of equity if the leverage ratio of a bank or banking group is less than 8%. Insofar as there is a shortage of equity, a fractional part—(8-L) / (100-L)—of the annual interest expense payable on loans would be excluded from deduction.

  • For these purposes, L represents the percentage of the leverage ratio rounded-off to one decimal point.
  • The fraction’s numerator (8-L) is the shortage of equity, expressed as a percentage.
  • The fraction’s denominator (100-L) is the percentage share of the debt in, briefly put, the adjusted balance sheet total.
  • The outcome of the fraction, multiplied by the interest expense on the loans, would be the non-deductible part of the interest expense on those loans. 

A closer look at the rules for insurers

Insurers do not have a leverage ratio. This means that insurers use the “equity ratio” in the Solvency II Regulation when determining whether there is a shortage of equity. The ratio is, in principle, determined at the group level, but there are two exceptions: (1) when the equity ratio cannot be determined on the basis of the group report, or (2) in the case of an insurer with limited risk exposure. 

The thin cap rule for insurers and insurance groups would limit the deductibility of the interest expense for loans (interpreted in accordance with the definition used for the generic interest deduction limitation), if there is a shortage of equity. 

There would be a shortage of equity if the equity ratio of an insurer or insurance group is less than 8%. Insofar as there is a shortage of equity, a fractional part—(8-ER) / (100-ER)—of the annual interest expense payable on loans is excluded from deduction.

  • In this fraction, ER stands for equity ratio. The equity ratio is the equity expressed as a percentage, rounded off to one decimal point, of the consolidated balance sheet (according to the rules of the Solvency II Directive) at the level of the insurance group of which the taxpayer is a member.
  • The fraction’s numerator (8-ER) is the shortage of equity, expressed as a percentage.
  • The fraction’s denominator (100-ER) is the percentage share of the debt in the adjusted balance sheet total.
  • The outcome of the fraction, multiplied by the interest expense on the loans, would be the non-deductible part of the interest expense on those loans. 

Other points to note

The bill provides for rules if both a bank and an insurance company are members of a fiscal unity for corporate income tax purposes. In addition, the bill addresses how the thin cap rule would have to be applied at permanent establishments of foreign banks and insurers.

The bill also covers the overlap between the interest deduction limitations in the earnings stripping measure and those under the thin cap rule. 

KPMG observation

This proposed thin cap rule for banks and insurers is expected to increase the tax burden on the financial sector. In addition to repeal of Section 29a Corporate Income Tax Act 1969, as of 1 January 2019 (which means the remuneration on additional Tier 1 capital instruments is not automatically deductible), an interest deduction limitation would also now be introduced for banks and insurers as of 1 January 2020. Tax professionals are not surprised by this proposal, given that this had already been announced by the government and given that the OECD had recommended that an interest deduction limitation specifically for banks and insurers be incorporated into national legislation.

It appears that the Netherlands could be the first OECD member state to act on this recommendation, and some believe this could lead to a deterioration in the competitiveness of the Netherlands as a location for the financial services sector. 


Read a March 2019 report prepared by the KPMG member firm in the Netherlands

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