See also our Tax Flash dated 6 October 2020 as well as our news article dated 7 July 2021 for more background information with respect to the new loss compensation rules.
The latter raises questions about the concurrence of the new loss compensation rules with the Dutch fiscal unity regime, in particular when companies becoming part of a fiscal unity have pre-fiscal unity losses. It is unclear in this respect how the 1 million euro threshold needs to be allocated within the fiscal unity to companies with pre-fiscal unity losses or in case the fiscal unity terminates with respect to companies with losses allocable to them. We conclude with the recommendation to keep records of the method of loss compensation used within the fiscal unity.
How to deal with loss compensation in case the fiscal unity consists of profit-making and loss-making companies?
A first issue arises with regard to the new loss compensation rules arises if a fiscal unity overall is reporting a taxable profit in a certain year, which is the sum of negative and positive results of the companies forming part of the fiscal unity. Before losses of previous years can be compensated, it needs to be determined in what manner the stand-alone losses and stand-alone profits allocable to the various companies that are part of the fiscal unity should be offset against each other. According to the Dutch fiscal unity Decree, stand-alone losses of fiscal unity companies are compensated as a first step with stand-alone profits of companies of the fiscal unity that do not have pre-fiscal unity losses available. As a second step, profits of the companies of the fiscal unity that do have pre-fiscal unity losses available are offset, in proportion to the stand-alone profits of these companies. The reason for this so-called horizontal loss compensation mechanism is to optimize loss compensation as much as possible.
The question now arises whether the limitation of these new loss compensation rules should also be applied in the second step in proportion to the profits of that company with pre-fiscal unity losses. If this is the case, this would mean that horizontal loss compensation would become less flexible under the new loss compensation rules than currently is the case, while the aim of these rules is to facilitate the compensation of pre-fiscal unity losses. Therefore, in our view it should be reasonable to freely allocate the limitation of the new loss compensation rules to companies with pre-fiscal unity losses, without taking into account their proportion of the taxable profits. In general, we are of the view that the rules concerning horizontal loss compensation should be made more flexible in order to optimize the compensation of the pre-fiscal unity losses as much as possible.
Two limitations in the event of a fiscal unity?
When a company becomes part of a fiscal unity, it might avail of pre-fiscal unity losses. According to the Dutch Corporate Income Tax Act 1969 (CITA), these losses can only be offset against taxable profits of the fiscal unity that are generated by the company that incurred the pre-fiscal unity losses. Imagine, for example, that a fiscal unity has an annual taxable profit of 10 million euro, of which 6 million euro can be allocated to a subsidiary, which has pre-fiscal unity losses available. Under these circumstances, the question arises whether the limitation of the compensation of losses to 50% of the taxable profits should be tested at two levels:
- at the level of the taxable profits of the fiscal unity as a whole (10 million euro); and
- at the level of the taxable profits of the fiscal unity that can be allocated to the company that has available the pre-fiscal unity losses (6 million euro).
Although it is not clear from the text of the relevant legislation, it seems prudent that the limitations should be applied to both amounts, as otherwise a company that is part of a fiscal unity might be able to offset more losses than a company that is not part of a fiscal unity. In this example, 5 million euro of profits would be available for loss compensation if only the first limitation would be taken into account (ignoring the 1 million euro threshold in this example). However, the maximum amount of loss compensation should be 3 million euro if the second limitation would (also) be taken into account. Unfortunately, this is not entirely clear from the text of the relevant legislation and we anticipate this will be explicated in the aforementioned announced decree.
Allocation of the 1 million euro threshold in the event of pre-fiscal unity losses
The limitation of the loss compensation rules does not apply to the extent that taxable profits of a company do not exceed the threshold of 1 million euro. However, when a company becomes part of a fiscal unity, this threshold applies at the level of the fiscal unity and not at the level of the individual companies. This can be regarded as a disadvantage of forming a fiscal unity. Furthermore, the question arises how this threshold should be allocated when in a certain year more than one company of the fiscal unity seeks to offset its pre-fiscal unity losses. In our view the position can be taken that the threshold should be allocated to those companies with pre-fiscal unity losses that would benefit the most from using the threshold. This is in line with the purpose of the aforementioned horizontal loss-compensation mechanism as laid down in the fiscal unity Decree.
Allocation of the 1 million euro threshold prior to companies leaving the fiscal unity
Eventually, a company may leave a fiscal unity. Subject to certain conditions, it is possible upon request to allocate a part of the fiscal unity losses to the company leaving the fiscal unity. The question then arises to what extent the threshold has been allocated to this company in the years that is had been part of the fiscal unity. This is relevant, because the prior allocation of the threshold affects the amount of carry-forward losses that are connected to this company and ultimately can be passed on to such leaving company. However, from an administration point of view this might be difficult to determine as we expect that it will not be specifically recorded in the annual corporate tax returns. Hence, it is important for the fiscal unity to keep a record of the allocation of the threshold in order to be able to substantiate the amount of losses that can be allocated to the company leaving the fiscal unity. As long as no guidance is available (e.g. the fiscal unity Decree is not amended), we are of the view that taxpayers should have flexibility in the chosen allocation method.
Conclusion and recommendations
The abovementioned problems illustrate the uncertainties about the concurrence between the new loss compensation rules and the fiscal unity regime. It has been announced that the Dutch fiscal unity Decree will be amended, in which these uncertainties hopefully will be addressed. As long as the Decree has not been amended with regard to the new loss compensation rules, multiple methods of loss compensation and allocation of the threshold seem to be possible. In any case, we strongly recommend fiscal unities to keep extensive records of the method used.
In short:
- As of 1 January 2022, the annual loss compensation rules of corporate taxpayers in the Netherlands will be limited to 50% of the taxable profits to the extent the losses exceed 1 million euro.
- This raises questions about the concurrence between these new rules and the Dutch fiscal unity regime, especially if the companies within the fiscal unity have pre-fiscal unity losses.
- Until these uncertainties are clarified by in the fiscal unity Decree, multiple methods of loss compensation within a fiscal unity seem to be possible. It is therefore important for taxpayers to substantiate their chosen method and administer this accordingly.
Should you have any questions about the above, or in case you would like to discuss the impact of future developments concerning the compensation of losses on your business, please contact your trusted adviser at Loyens & Loeff.
