## wpiea2021145-print-pdf

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### I. Introduction — scope and context
- International perspective on the Dutch capital income tax system covering:
  - international corporate taxation and taxation of capital income at the individual level;
  - overview of studies on profit shifting from and through the Netherlands and recent Dutch measures to fight international tax avoidance;
  - international reform efforts led by the OECD and the EU and possible future reforms;
  - distortions in the domestic capital income tax system and reform directions.
- Contextual points:
  - Dutch statutory CIT rate under multiple pressures: profit shifting, tax competition, and international reform efforts.
  - The Netherlands is a small open economy, fully integrated in the European economy.
  - Large sector of special financial institutions (SFIs) owned by foreign investors used as holding companies and conduits.
  - Dutch tax policy and the SFI sector affected by G20/OECD BEPS and the European Anti-Tax Avoidance Directive (ATAD).
- Active domestic policy work:
  - Ministry of Finance (2020) parliamentary report with 14 attachments.
  - Advisory Committee on the Taxation of Multinationals (2020) and subsequent advisory committee on conduit companies.
  - Large domestic research literature and Cnossen and Jacobs (2019) on tax design.

### II. Main features of the current capital income tax system
- Corporate Income — key features and rules:
  - Statutory CIT rate: 25 percent.
  - Reduced rate in 2021: 15 percent for incomes up to €245,000.
    - From 2022, the threshold of €245,000 will be increased to €395,000.
  - Depreciation aligned with commercial accounts; most standard methods permissible.
  - Loss carry forward: currently restricted to six years; from 2022 will be unlimited, but utilization will be restricted to 50 percent of profits (except for losses up to €1 million).
  - Interest deductibility: restricted to 30 percent of EBITDA with unlimited carry forward and an exemption of €1 million.
- Personal Income — three-box schedular system:
  - Box 1 (labor and business income, some capital income):
    - Progressive rates ranging from 37.1 to 49.5 percent.
    - Entrepreneurial income: 14 percent exempt; maximum rate against which income can be deducted being gradually reduced and stood at 43 percent in 2021; resulting effective tax rates for entrepreneurial income are currently between 31.9 and 43.5 percent.
    - Owner-occupied housing imputed rent: 0.5 percent of the property value up to €1.11 million, and 2.35 percent on the excess.
  - Box 2 (income from substantive shareholdings, defined as at least 5 percent): taxed at 26.9 percent (in addition to corporate-level taxes).
  - Box 3 (financial assets): effectively taxed through a net wealth tax of 0.59 to 1.764 percent, depending on the amount of assets.
    - Effective Box 3 rates derive from a notional return ranging from 1.90 to 5.69 and a tax rate of 31 percent.
    - Tax-exempt amount: €50,000 (€100,000 for married couples/partners).

### III. Corporate income tax evasion and avoidance — scale, evidence, and Dutch features
- Scale and exposure:
  - Netherlands’ share in global FDI (2019): inward FDI 12 percent of world FDI; outward FDI 15.3 percent of world FDI.
  - FDI positions (2019):
    - Netherlands inward: $4,370 billion, 481.7 percent of GDP, 12.0 percent of world FDI.
    - Netherlands outward: $5,582 billion, 615.4 percent of GDP, 15.3 percent of world FDI.
  - FDI inflows exceed 400 percent of Dutch GDP; outflows exceed 600 percent of Dutch GDP.
  - United States share of total inward FDI to the Netherlands: 22 percent; United States share of Dutch outward FDI partners: 16 percent.
  - Netherlands was the top destination for US outbound FDI with a share of 14 percent (contextual text).
- Special Financial Institutions (SFIs):
  - ‘Transit’ flows by SFIs comprise between 60 and 70 percent of FDI through the Netherlands.
  - Netherlands hosts over 12,000 SFIs.
  - Combined SFI assets: €3.37 trillion—almost four times Dutch GDP and larger than the banking sector of €2.2 trillion (DNB 2020).
  - FDI position of SFIs in the Netherlands comprised about 43 percent of total direct investment assets in 2019 in the Netherlands.
  - SFIs’ direct contribution to the Dutch economy (2016): between 8.8 and 13 thousand jobs (direct and indirect); SFIs spent between €0.65 and €1 billion on salaries and business services; SFIs paid €2.3 billion (0.3 percent of GDP) in tax revenue.
  - Total employed people in 2016 in the Netherlands: 8.427 million.
- Multinationals’ contribution to CIT revenue: about 50 percent of total CIT revenue in the Netherlands.
- Empirical evidence on profit shifting — mixed results:
  - Literature reports divergent estimates of CIT revenue losses; example estimates (percent of national CIT revenue) for the Netherlands:
    - Beer, de Mooij and Liu (2020): 1.7
    - Crivelli and others (2016): 5.4
    - Cobham and Jansky (2018): 8
    - Tørsløv, Wier, and Zucman (2018): -32 (Netherlands gains about 32 percent of CIT revenues from attracting tax base of foreign multinationals)
    - Clausing (2016): excess gross income booked in the Netherlands of $139 billion in 2012; effective tax on US multinationals in the Netherlands of less than 5 percent.
  - Cross-country and firm-level evidence suggests Netherlands often acts as a conduit; some firm-level studies find affiliates of multinationals pay substantially less tax than comparable domestic firms.
- Attractiveness of specific Dutch tax features (pre-/post-reform relevance):
  - Participation exemption:
    - Minimum participation share: 5 percent.
    - 100 percent exemption; no minimum holding period.
  - Bilateral tax treaties: 94 bilateral tax treaties, several with no or relatively low WHTs on royalties, interest, or dividends.
  - Advance Pricing Agreements (APA) and Advance Tax Rulings (ATR): used to provide tax certainty; previously used for tax planning structures.
  - Innovation box regime:
    - Reduced CIT rate on qualified income from know-how assets; introduced in 2007; pre-reform tax rate: 5 percent; budgetary cost reached €700 million in 2012.
    - Nexus rule later modified to align with G20-OECD BEPS minimum standard.

### IV. Recent domestic measures to curb tax avoidance and initial assessment
- Conditional cross-border WHT:
  - As of 2021, Dutch resident entity making interest or royalty payments, or (as of 2024 also) dividends to an affiliated entity in a ‘listed’ country is liable to a WHT at the full CIT rate of 25 percent.
  - The list includes jurisdictions on the EU list of non-cooperative jurisdictions and countries with a statutory CIT rate below 9 percent.
  - For 2021, listed countries include: Anguilla, Bahamas, Bahrein, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Fiji, Guam, Guernsey, Isle of Man, Jersey, Oman, Samoa, Seychelles, Trinidad and Tobago, Turkmenistan, Turks and Caicos Islands, United Arab Emirates, US Samoa, US Virgin Islands, and Vanuatu.
  - Anti-abuse rules counter artificial structures whose main purpose is to avoid the WHT.
- Revised practice of APAs and ATRs (since 2019):
  - Strengthened substance requirements, e.g., minimum salary payment of €100,000 and minimum office space.
  - Strengthened purpose test: deny rulings when primary purpose is tax avoidance or involves listed jurisdictions.
  - Validity of rulings generally limited to 5 years.
  - Enhanced transparency: publish summaries of individual tax rulings and yearly trend report.
- Modified innovation box:
  - Implemented BEPS Action 5 modified nexus requirement.
  - Tax rate raised to 7 percent in 2018 and 9 percent in 2021.
  - As of 2021, IP regimes of several countries offer a tax rate below 9 percent.
- Revisited tax treaty policy:
  - 2020 Memorandum aligns negotiating position with OECD Model Tax Convention of 2017 and BEPS Action 15.
  - For developing countries, negotiating position aligned with UN Model Tax Convention of 2011 on certain sources of income; willingness to accept higher WHTs and a services permanent establishment.
  - For poorest countries, willingness to accept source country taxing rights over technical services fees performed in the source country.
  - Implemented minimum standard on preventing tax treaty abuse via preamble statement and principal purpose test through MLI (covering 81 of its 95 DTAs) or bilateral negotiations.
- Additional measures targeting CIT base erosion:
  - Deny participation exemption for passive income in listed countries (CFC rules).
  - Deny deductions for interest expenses if net interest exceeds 30 percent of EBITDA; application covers all business with net interest exceeding €1 million; no group escape.
  - Limiting carryforward of losses to 50 percent of profits in a particular year.
- Public signaling and commitments:
  - Public statements: 2017 F&D interview Finance Secretary Snel: letterbox companies “not welcome anymore.” February 2021 Finance Secretary Vijlbrief: move “away from the dark side to prevent tax avoidance.”
  - Netherlands implemented all minimum standards of the 2015 BEPS package and most BEPS recommendations and best practices.
- Initial assessment of impacts and timing constraints:
  - Most measures recently entered or yet to be implemented; temporary grandfathering and other countries’ reforms complicate quantification.
  - Van ‘t Riet and Lejour (2020) simulate the conditional WHT lowers attractiveness as a conduit for interest and royalties but does not eliminate treaty shopping.
  - Four cases—Barbados, Bahrain, Panama, and the UAE—are incompatible with bilateral treaties; law provides 3-year delayed entry to allow renegotiation.
  - Structural FDI and SFIs: slight decline in number of SFIs; decline mainly in smaller SFIs; balance sheets of largest 400 SFIs show no noticeable change.
  - Limiting loss carryforward: Advisory Committee found 13 percent of companies made a loss every year in sample and 38 percent made more losses than profits over 2010-2017; limits can deter startups and entrepreneurship.

### V. Policy assessment and recommendations (domestic)
- Current focus:
  - Enforce and refine existing measures and close loopholes as detected.
  - Carefully monitor list of countries for conditional WHT and ensure focus on statutory tax rates does not allow abuse.
- Potential further actions:
  - Strengthen substance and purpose tests (e.g., increase minimum salary).
  - Continue aligning Dutch treaty network with updated policy, particularly for developing countries to strengthen source taxing rights and minimize negative spillovers.

### VI. International reform proposals — OECD two-Pillar approach and EU measures
- OECD Inclusive Framework two-Pillar approach (aimed at consensus by mid-2021):
  - Pillar One:
    - Reallocate a share of global residual profits of in-scope multinationals to market (destination) countries.
    - Nexus based on significant market presence and formulaic approach; global revenue threshold suggested at least €750 million.
    - Two elements: Amount A (new taxing right over share of residual profits) and Amount B (fixed return for baseline activities).
    - Relief from double taxation required; mechanism to identify paying entity/entities needed.
  - Pillar Two:
    - Ensure in-scope MNE profits taxed at a globally agreed minimum level; suggested minimum rate range: 9 to 12.5 percent.
    - Three interlocking rules: Income inclusion rule (IIR), Undertaxed payments rule (UTPR), Subject to tax rule (STTR).
- Operation and design of Pillar Two:
  - STTR application depends on treaty change and jurisdictional adoption.
  - STTR targets mostly interest and royalties.
  - IIR likely the main rule collecting top-up tax in country of ultimate shareholder.
  - UTPR applies as backstop when no IIR applies.
  - Minimum tax applied on jurisdictional basis by reference to effective tax rates.
  - Proposal includes broad notion of covered taxes, rules for allocating taxes and bases, and a carve-out for profits reflecting substantive activities on a formulaic basis.
- Expected global revenue impact:
  - Two-Pillar approach expected to increase global CIT revenue by less than 4 percent.
  - OECD (2020g) estimates Pillar One would reallocate about $100 billion of profits to market jurisdictions; Pillar One expected to raise modest additional CIT revenue (by less than 1 percent globally).
  - Additional revenue primarily from Pillar Two and US GILTI:
    - Estimated to raise global CIT revenues by additional 0.9 to 1.7 percent.
    - Pillar Two expected to generate indirect revenue gains from reduced tax competition possibly resulting in additional revenue gain by 0.8 to 1.1 percent.
    - Combined CIT increase from Pillar Two (including indirect gains) of 1.7 to 2.8 percent.
- Impact on Dutch CIT revenue — modelled estimates and uncertainty:
  - Highly uncertain; dependent on design parameters and behavioral responses.
  - Dutch Ministry of Finance modeled combined effect of both Pillars ranging from a CIT revenue loss of up to $711 million to a gain of up to $880 million.
  - Pillar Two modeled positive effect: $456 to $857 million (after behavioral responses).
  - Pillar One may lead to a CIT revenue loss of up to $1.167 billion (or up to 3.4 percent of total CIT).
  - Broad direction: additional revenue mainly from Pillar Two; potential loss from Pillar One if more tax base of resident affiliates reallocated abroad than allocated to Dutch market.
  - Policy implication: preserve Pillar Two gains by revising Innovation Box rate if global minimum above 9 percent; conditional WHT could be redesigned to operate as STTR for Pillar Two purposes.
- EU Anti-Tax Avoidance Directives (ATAD I & II) implementation:
  - Implementation dates provided: Interest limitation, GAAR and CFC: January 1, 2019; Exit taxation, Hybrid mismatches (except reverse hybrids): January 1, 2020; Reverse hybrid mismatches (with non-EU countries): January 1, 2022.
  - Dutch implementation highlights:
    - Interest limitation: 30 percent of EBITDA with safe harbor €1 million, unlimited carry-forward, no carry-back, no group escape.
    - CFC rule combines model A and model B, applying to entities in listed jurisdictions and passive tainted income unless genuine activities.
    - Judicially developed GAAR was already part of the Dutch system.
- Proposal for Common Consolidated Corporate Tax Base (C(C)CTB / CCCTB / BEFIT):
  - Step 1: common base with R&D incentives replaced by a ‘super-deduction’ of between 125 and 200 percent of actual costs and deduction for a notional return on equity.
  - Step 2: consolidation and formula apportionment with weights: assets (1/3), sales (1/3), number of employees (1/6), payroll (1/6); no harmonization of CIT rates.
  - European Parliament proposed adding digital permanent establishment and a “data factor” changing weights to: assets (1/4), sales (1/4), number of employees (1/8), payroll (1/8), data factor (1/4).
  - Trade-off: data factor could address digitalization but risks complexity and distortions.
- Digital Services Taxes (DSTs) and EU digital levy:
  - Commission proposed digital permanent establishment and EU DST in 2018; DST proposal foreseen to be withdrawn and replaced by a digital levy.
  - July 2020 European Council tasked Commission to propose new “own resources” including a digital levy by January 1, 2023 at the latest.
  - Implemented DSTs: Austria, France, Hungary, Italy, Poland, Spain, Turkey, and the United Kingdom; DST rates range from 3 percent to 7.5 percent.
  - DSTs typically raise very little additional revenue—around 0.02 percent of GDP or less.
  - Differences: Amount A under Pillar One broader than most DSTs; DSTs imposed on gross revenue, Amount A targets excess profits; Pillar One includes mechanism for double taxation relief.

### VII. Alternative reform directions and Dutch exposure
- Formulary Apportionment (FA):
  - Consolidate MNE profits and apportion across jurisdictions using formulaic factors.
  - Netherlands likely to lose CIT revenue under FA, especially if allocation emphasizes assets and payroll; less loss if based on sales by destination.
- Residual Profit Allocation (RPA):
  - Consolidated profits split into routine and residual; residual allocated formulaically.
  - Investment hubs likely to lose CIT revenue under RPA due to reallocation of excess profits.
  - Agreed minimum tax could mitigate tax competition for routine activities under RPA.
- Destination Based Cash Flow Taxation (DBCFT):
  - Destination-basis taxation with cash-flow treatment; universally adopted DBCFT would largely eliminate profit shifting and tax competition.
  - DBCFT not actively considered in Netherlands; Pillar One’s partial allocation based on sales by destination moves somewhat in DBCFT direction.
- Hypothetical DBCFT impact on Netherlands:
  - At the current CIT rate, a hypothetical DBCFT would reduce Dutch revenues, largely because of positive trade surplus.
  - Under DBCFT, imports taxed but exports not; countries with negative trade balance tend to gain.
  - Had the Netherlands adopted a DBCFT, the effect is estimated to be below 1 percent of GDP for 2015.

### VIII. Interaction of corporate and personal capital income taxation — distortions and reform guidance
- Systemic distortions:
  - Schedular system creates different taxation of similar incomes; difficult to split labor and capital in owner-run firms.
  - Debt bias arises because interest is deductible at corporate level while dividends face double taxation.
- Stylized system choices:
  - Comprehensive income tax: tax all income at same rate.
  - Dual income tax: capital income taxed at lower rate; compromise solution.
  - Consumption tax: only consumption taxed (exempts capital income).
  - Most economists favor dual or comprehensive income tax systems.
- Owner-managed businesses:
  - Minimum salary rules for owner-managers: must not be below the salary of the highest paid employee, 75 percent of the salary of the most similar employment, or €47,000, whichever is highest.
  - Incorporated owner-run firm taxation options: salary (Box 1), distributed profit (CIT then Box 2), retained profit (taxed at corporate level; capital gain at personal level taxed on realization).
  - Retained earnings receive a real tax saving because funds compound inside the firm.
  - Proposed cap on loans to owners: €500,000 from 2023 onwards (proposal mentioned).
- Reform options for owner-managed businesses:
  - Comprehensive: integrate corporate and personal tax of Box 2 firms via progressive tax on distributions, accrual taxation of capital gains, or passthrough treatment.
  - More limited: tighten rules for loans to owners (reduce €500,000 limit); abolish reduced CIT rate for profits up to €245,000 to remove growth/distribution distortions and allow reduction in dividend tax rate.
- Passive investment and Box 3 issues:
  - Box 3 taxation of notional returns leads to wide effective tax rates; effective tax on low returns can exceed 100 percent.
  - Notional return ranges from 1.90 to 5.69; Box 3 tax rate 31 percent; net wealth tax effective rates 0.59 to 1.764 percent.
  - Top 10 percent of wealthy households held 62 percent of total assets in 2018; including pension assets reduces this share to 48 percent.
  - Investing in pension funds remains much more attractive tax-wise; voluntary pensions make up about 4 percent of total pension savings (2018).
- Options for capital gains and wealth taxation:
  - Tax on accrual: theoretically efficient but difficult for nontraded assets and liquidity.
  - Tax on realization: common, implementation straightforward, lock-in effect.
  - Realization-based taxation with holding-period adjustments suggested (Auerbach (1991)) but not implemented in practice.
  - Compromise solutions favored: realization taxation with anti-avoidance rules for implicit annual capital gains.
- Owner-occupied housing:
  - Imputed rent calculated at 0.5 percent up to €1.11 million and 2.35 percent on excess; imputed rents systematically underestimated.
  - Imputed rents eroded by deduction forgiving 90 percent of imputed rent (phasing out scheduled complete only in 2049).
  - Mortgage interest deductible and often exceeds imputed rent, leaving a net housing subsidy.
  - Reforms: creditable rate on mortgage interest reduced to currently 43 percent with further reductions to 37.05 percent; limits on interest-only mortgages and maximum 30-year payoff.
- Reform options for housing:
  - Raise imputed rents to realistic levels phased in over time.
  - Shift housing to Box 3 and combine with broader reform moving Box 3 to taxing actual returns.
  - If taxing imputed rents infeasible, exempt imputed rents and disallow mortgage interest deductions; allow gradual payment provisions for liquidity in bequests or gifts.

### IX. Debt bias, effective tax rates, and policy options
- Causes and mechanisms:
  - Asymmetry: interest deductible; dividends not deductible at corporate level.
  - 62 percent of OECD countries have mechanisms mitigating double taxation of dividends (credit for CIT or lower dividend rates).
  - Mitigation incomplete due to tax-exempt marginal shareholders and foreign investors subject to lower or zero WHT.
- Effective tax rates (EMTR and EATR) — selected values (assumptions: Inflation 2%, real interest 3%, true and tax depreciation 12.25%, profit (EATR) 20%):
  - Tax-exempt marginal shareholder:
    - Retained earnings: EMTR 30.3, EATR 26.1
    - New equity: EMTR 30.3, EATR 26.1
    - Debt: EMTR -11.1, EATR 20.1
  - Box 2, 25% CIT rate:
    - Retained earnings: EMTR -38.5, EATR 24.3
    - New equity: EMTR 62.9, EATR 44.4
    - Debt: EMTR -5.4, EATR 26.6
  - Box 2, 15% CIT rate:
    - Retained earnings: EMTR -15.0, EATR 32.8
    - New equity: EMTR 67.5, EATR 52.6
    - Debt: EMTR -9.8, EATR 33.1
  - Interpretation: strong debt preference for tax-exempt shareholders and owner-run Box 2 firms; retained earnings often tax-preferred.
- Macro implications:
  - High private debt levels in the Netherlands suggest debt bias is a concern.
  - Debt bias increases macroeconomic vulnerabilities and crisis risks.
- Policy options to reduce debt bias:
  - Personal income tax: reduce tax on dividends relative to interest; caveat for Box 3 investors if Box 3 remains notional.
  - Corporate-level reforms:
    - Allowance for Corporate Equity (ACE): deduction for notional return on equity.
    - Allowance for Corporate Capital (ACC): notional return to both debt and equity and disallow interest deductions.
    - ACE/ACC are efficient and robust to bookkeeping choices but require anti-avoidance measures.
    - Caution: international minimum taxes could interact with ACE; ACE might be treated as a tax benefit and trigger minimum taxes.
  - Interest limitation rules (e.g., EBITDA rule): reduce debt bias as side effect but risk efficiency costs; can affect low-profit firms and raise cost of capital relative to ACE.

### X. Conclusions and strategic guidance for reform
- Reform must be strategic and consistent with an overall target:
  - If aiming for comprehensive income taxation:
    - Abolish boxes 1-3 and aggregate income at individual level.
    - Define realistic imputed rents and integrate corporate and personal taxes for dividends.
    - Retain reasonable pension tax preferences for lifecycle saving.
  - If aiming for dual income taxation:
    - Retain fewer boxes, converge to one box for labor and one for capital income.
    - Require rules to split mixed income.
- Practical priorities and sequencing:
  - Enforce and refine anti-avoidance measures, monitor international reforms (OECD/EU).
  - Consider revising Innovation Box and conditional WHT design in light of Pillar Two global minimum.
  - Address domestic distortions: debt bias, differential treatment of retained earnings, Box 3 notional return mechanics, and owner-occupied housing imputation and mortgage deductibility.
  - Use targeted reforms (e.g., tighten owner-loan limits, abolish reduced CIT band) when full system overhaul is not politically feasible.

*Italic: Source content extracted from wpiea2021145-print-pdf.*

### REFERENCES ___________________________________________________________________________________ 38

### I. INTRODUCTION

### Overview
- The paper provides an international perspective on the Dutch capital income tax system, focusing on:
  - international corporate taxation and taxation of capital income at the individual level;
  - an overview of studies on profit shifting from and through the Netherlands and recent Dutch measures to fight international tax avoidance;
  - international reform efforts led by the OECD and the EU and possible future reforms;
  - distortions in the domestic capital income tax system and reform directions.
- The paper is prepared as part of FAD’s initiative to support IMF surveillance and benefited from inputs and comments listed in the source.

### Key contextual points
- The Dutch corporate income tax (CIT) is under multiple pressures: profit shifting, tax competition, and international reform efforts.
- The Netherlands is a small open economy, fully integrated in the European economy.
- A country-specific issue is a relatively large sector of special financial institutions (SFIs) owned by foreign investors and used as holding companies and conduits.
- Dutch tax policy and the SFI sector are affected by G20/OECD BEPS and the European Anti-Tax Avoidance Directive (ATAD).

### Active domestic policy work
- Ministry of Finance (2020) published a parliamentary report on building blocks for a better tax system with 14 attachments on varied tax themes.
- Advisory Committee on the Taxation of Multinationals (2020) and a subsequent advisory committee under Mr. Ter Haar on conduit companies have examined multinational taxation and conduit issues.
- A large domestic research literature and Cnossen and Jacobs (2019) provide studies on tax design in the Netherlands.

---

### II. THE MAIN FEATURES OF THE CURRENT CAPITAL INCOME TAX SYSTEM

### A. Corporate Income — key features and rules
- Statutory CIT rate: 25 percent.
- Reduced rate in 2021: 15 percent for incomes up to €245,000.
  - Note: From 2022, the threshold of €245,000 will be increased to €395,000.
- Depreciation aligned with commercial accounts; most standard methods permissible.
- Loss carry forward: currently restricted to six years; from 2022 will be unlimited, but utilization will be restricted to 50 percent of profits (except for losses up to €1 million).
- Interest deductibility: restricted to 30 percent of EBITDA with unlimited carry forward and an exemption of €1 million.

### B. Personal Income — the three-box schedular system
- Schedular system with three boxes; capital income can be taxed under different schedules depending on type.
- Box 1 (labor and business income, some capital income):
  - Progressive with rates ranging from 37.1 to 49.5 percent.
  - Social security aligned with base and thresholds.
  - Entrepreneurial income: 14 percent exempt; maximum rate against which income can be deducted being gradually reduced and stood at 43 percent in 2021; resulting effective tax rates for entrepreneurial income are currently between 31.9 and 43.5 percent.
  - Owner-occupied housing imputed rent calculation: 0.5 percent of the property value up to €1.11 million, and 2.35 percent on the excess.
- Box 2 (income from substantive shareholdings, defined as at least 5 percent): taxed at 26.9 percent (in addition to corporate-level taxes).
- Box 3 (financial assets): effectively taxed through a net wealth tax of 0.59 to 1.764 percent, depending on the amount of assets.
  - Effective Box 3 rates derive from a notional return ranging from 1.90 to 5.69 and a tax rate of 31 percent.
  - Tax-exempt amount: €50,000 (€100,000 for married couples/partners).

---

### III. CORPORATE INCOME TAX EVASION AND AVOIDANCE

### A. Scale and exposure — what is at stake
- Netherlands’ share in global FDI (2019):
  - inward FDI: 12 percent of world FDI;
  - outward FDI: 15.3 percent of world FDI.
- FDI positions (Table 1, 2019):
  - Netherlands inward: $4,370 billion, 481.7 percent of GDP, 12.0 percent of world FDI.
  - Netherlands outward: $5,582 billion, 615.4 percent of GDP, 15.3 percent of world FDI.
- FDI inflows exceed 400 percent of Dutch GDP; outflows exceed 600 percent of Dutch GDP.
- Bilateral shares and partners:
  - United States share of total inward FDI to the Netherlands: 22 percent (Table 2).
  - For Dutch outward FDI partners, United States share: 16 percent (Table 2).
  - The Netherlands was the top destination for US outbound FDI with a share of 14 percent in the wider context noted in text.
- Special Financial Institutions (SFIs):
  - ‘Transit’ flows by SFIs comprise between 60 and 70 percent of FDI through the Netherlands.
  - Netherlands hosts over 12,000 SFIs.
  - Combined SFI assets: €3.37 trillion—almost four times Dutch GDP and larger than the banking sector of €2.2 trillion (DNB 2020).
  - FDI position of SFIs in the Netherlands comprised about 43 percent of total direct investment assets in 2019 in the Netherlands.
  - SFIs’ direct contribution to the Dutch economy (2016): between 8.8 and 13 thousand jobs (direct and indirect); SFIs spent between €0.65 and €1 billion on salaries and business services; SFIs paid €2.3 billion (0.3 percent of GDP) in tax revenue (DNB 2018).
  - For reference, total employed people in 2016 in the Netherlands: 8.427 million.
- Multinationals’ contribution to CIT revenue: about 50 percent of total CIT revenue in the Netherlands (Advisory Committee on the Taxation of Multinationals 2020).

### B. Empirical evidence on profit shifting — mixed results
- Literature reports divergent estimates of CIT revenue losses from profit shifting (Table 3 summaries):
  - Methods and results vary markedly by methodology and study.
  - Example estimates (percent of national CIT revenue) for the Netherlands from Table 3:
    - Beer, de Mooij and Liu (2020): 1.7
    - Clausing (2016): ** (excess gross income of $139 billion noted; revenue impact not directly stated)
    - Crivelli and others (2016): 5.4
    - Cobham and Jansky (2018): 8
    - Tørsløv, Wier, and Zucman (2018): -32
  - Clausing (2016) computes an effective tax on US multinationals in the Netherlands of less than 5 percent and reports excess gross income booked in the Netherlands of $139 billion in 2012.
  - Tørsløv, Wier, and Zucman (2018) estimate the Netherlands gains about 32 percent of CIT revenues from attracting tax base of foreign multinationals (shown as column (5) in Table 3 context).
- Cross-country and firm-level evidence:
  - Some studies suggest the Netherlands is primarily a conduit for funneling FDI rather than a final profit location.
  - Fuest and others (2021): 7.6 percent of profits of German multinationals are booked in a group of European investment hubs (including Ireland, Netherlands, Switzerland); less than 3 percent of total profits of these multinationals are shifted to these countries for tax reasons.
  - Firm-level analyses in other countries indicate multinational affiliates often pay substantially less taxes than comparable domestic firms (examples: Egger and others (2010); Bilicka (2019)).

### C. Attractiveness of specific Dutch tax features (pre-/post-reform relevance)
- Attractive features cited include:
  I. Participation exemption regime:
    - Minimum participation share: 5 percent (relatively low);
    - 100 percent exemption; no minimum holding period.
  II. Rich network of bilateral tax treaties:
    - 94 bilateral tax treaties, several with no or relatively low WHTs on royalties, interest, or dividends.
  III. Advance Pricing Agreements (APA) and Advance Tax Rulings (ATR):
    - Used to provide tax certainty on arm’s length remuneration and participation exemption application; once used to obtain certainty about tax planning structures.
  IV. Innovation box regime:
    - Reduced CIT rate on qualified income from know-how assets (patents, trademarks).
    - Introduced in 2007; included a nexus rule later modified to align with G20-OECD BEPS minimum standard.
    - Pre-reform tax rate: 5 percent; budgetary cost reached €700 million in 2012.

---

*Italic: Source content extracted from the provided IMF PDF chapter/section.*

### 16.      Several measures have been recently adopted to curb tax avoidance through the

### 16.      Several measures have been recently adopted to curb tax avoidance through the Netherlands

### Recent domestic measures adopted
- Conditional cross-border WHT:
  - As of 2021, a Dutch resident entity that makes interest or royalty payments, or (as of 2024 also) dividends to an affiliated entity in a ‘listed’ country is liable to a WHT at the full CIT rate of 25 percent.
  - The list of countries includes those on the EU list of non-cooperative jurisdictions for tax purposes and countries with a statutory CIT rate below 9 percent.
  - For 2021, the list of countries includes: Anguilla, Bahamas, Bahrein, Barbados, Bermuda, British Virgin Islands, Cayman Islands, Fiji, Guam, Guernsey, Isle of Man, Jersey, Oman, Samoa, Seychelles, Trinidad and Tobago, Turkmenistan, Turks and Caicos Islands, United Arab Emirates, US Samoa, US Virgin Islands, and Vanuatu.
  - The application of the WHT stipulates anti-abuse rules to counter artificial structures or transactions the main purpose of which is to avoid the WHT (through indirect payments to a listed country via a non-listed one).
- Revised practice of APAs and ATRs (since 2019):
  - Strengthened substance requirements, for example by introducing a minimum salary payment of €100,000 and minimum office space, among other requirements.
  - Strengthened purpose test: deny advance rulings when the primary purpose of a proposed structure is to avoid Dutch or foreign tax, or which involve transactions with listed jurisdictions.
  - Validity of rulings generally limited to 5 years.
  - Enhanced transparency by publishing summaries of individual tax rulings and a yearly report analyzing main trends.
- Modified innovation box:
  - Implemented the modified nexus requirement of BEPS Action 5 linking expenditures to develop the income-generating know-how asset to the tax benefit from the innovation regime.
  - Tax rate of the innovation box raised to 7 percent in 2018 and 9 percent in 2021.
  - As of 2021, the Intellectual Property (IP) regimes of several countries offer a tax rate below 9 percent.
- Revisited tax treaty policy (notably with developing countries):
  - 2020 Dutch Memorandum on Tax Treaty Policy aligns negotiating position with the OECD Model Tax Convention of 2017 and BEPS Action 15.
  - For developing countries, negotiating position concerning certain sources of income is in line with the UN Model Tax Convention of 2011, granting source countries more taxing rights regarding interest, dividends, and royalty payments, including willingness to accept higher WHT rates and a services permanent establishment.
  - For the poorest countries, willingness to accept source country taxing rights over fees for technical services subject to those being performed in the source country.
  - Implementing the minimum standard on preventing tax treaty abuse through inclusion of the preamble statement and adoption of the principal purpose test, either through the multilateral instrument (MLI) (covering 81 of its 95 DTAs) or through bilateral negotiations.

### Additional measures targeting CIT base erosion
- Rules in line with ATAD:
  - Deny the participation exemption for passive income in the listed countries—so-called CFC rules.
  - Deny deductions for interest expenses if net interest exceeds 30 percent of Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
    - Application is relatively broad covering all business with net interest exceeding €1 million.
    - Does not provide for a ‘group escape’ (affiliates of multinationals will be subjected to this rule even if they argue their debt is in line with the multinational group).
- Limiting carryforward of losses to 50 percent of profits in a particular year.

### Public signaling and international commitments
- Public statements: 2017 F&D interview Finance Secretary Snel stated letterbox companies were “not welcome anymore.” In February 2021, Finance Secretary Vijlbrief expressed a desire to move “away from the dark side to prevent tax avoidance.”
- Netherlands has implemented all the minimum standards of the 2015 BEPS package as well as most BEPS recommendations and best practices.

### Initial assessment of impacts
- Timing and measurement constraints:
  - Most measures have just recently entered into effect or are yet to be implemented (such as the conditional WHT on dividends), with temporary grandfathering of some arrangements and reforms in other countries, making quantification challenging.
- Conditional WHT effects:
  - Van ‘t Riet and Lejour (2020) simulate that the conditional WHT will lower the attractiveness of the Netherlands as a conduit especially for interest and royalties, but treaty shopping is not eliminated.
  - Example: Bermuda identified as an important destination for royalties coming from Ireland and the United States through Netherlands; conditional WHT applies because the treaty with Bermuda does not limit WHT on these flows.
  - Four cases—Barbados, Bahrain, Panama, and the UAE—are incompatible with bilateral treaties; law provides for a 3-year delayed entry into force of the conditional WHT to allow renegotiation of the relevant treaty.
- Structural FDI and SFIs:
  - Most recent data indicate a slight decline in the number of SFIs.
  - Decline expected particularly for ‘letter box’ companies that cannot satisfy nexus and purpose tests.
  - Reclassification and reforms in other countries (notably the United States) appear to have impacted SFIs, reflected by a decline in SFIs FDI flows.
  - Total balance sheet of SFIs has slightly declined recently; DNB (2020) detailed analysis suggests decline mainly driven by smaller SFIs and that the balance sheets of the largest 400 SFIs do not show a noticeable change.
- Limiting loss carryforward:
  - Advisory Committee on the Taxation of Multinationals (2020) finds 13 percent of companies in the dataset made a loss every year in the sample and 38 percent of entities made more losses than profits over the entire sample period (2010-2017).
  - While limits on loss carryforward can address tax avoidance, they come at an economic cost and may deter startups and entrepreneurship.

### Policy assessment and recommendations from the text
- Current focus:
  - Enforce and refine existing measures and close loopholes as they are detected.
  - Carefully monitor the list of countries for the conditional WHT and ensure that focus on statutory tax rates does not allow abuse.
- Potential further actions:
  - Strengthen substance and purpose tests, for example by increasing the minimum amount of salary.
  - Continue efforts to align Dutch tax treaty network with updated tax treaty policy, particularly regarding developing countries to strengthen their source country taxing rights and minimize negative spillovers.

### Box 1 — Examples of tax planning, rulings, and recent developments
- Informal Capital:
  - Description: interest-free loan from a related foreign company to a Dutch related company allows deduction of interest expense in the Netherlands without corresponding inclusion abroad.
  - Recent developments: foreign tax authorities can obtain more information through country-by-country reporting and automatic exchange of international tax rulings; revised Dutch practice no longer offers advance rulings if the main purpose is tax avoidance; March 2021 public consultation launched to amend transfer pricing rules to limit deductions that lead to downward adjustment to Dutch profits without corresponding adjustment abroad.
- Intermediate Holding Companies:
  - Description: parent company owns an affiliate through an intermediate holding company in the Netherlands to obtain reduced/no WHTs on dividends and to rely on participation exemption.
  - Recent developments: imposing substance requirements on Dutch holdings tackles shell concerns; anti-abuse provisions in bilateral tax treaties (including via BEPS Action 15) can allow source countries to impose WHT on distributed dividends to the Netherlands; revised Dutch practice no longer offers advance rulings if the main purpose is tax avoidance.

### International reform proposals and their impact on the Netherlands
- Netherlands’ participation:
  - Founding OECD member; committed to OECD/G-20 BEPS project.
  - Implemented all minimum standards of the 2015 BEPS package and most BEPS recommendations and best practices.
- Ongoing OECD/Inclusive Framework “two-Pillar approach” (multilateral negotiations aimed at consensus by mid-2021):
  - Pillar One:
    - Seeks to reallocate a share of global residual profits of in-scope multinationals to market (destination) countries.
    - Reallocation based on a new ‘nexus’ of significant market presence (sales) and a formulaic approach rather than entity-by-entity ALP.
    - Only large MNEs would be in scope; proposal suggests a global revenue threshold of at least €750 million.
    - Two main elements:
      - Amount A: new taxing right for market countries over a share of residual profits, defined as any excess profits over a fixed percentage return on sales to unrelated parties.
      - Amount B: a fixed return for defined baseline activities in the nature of marketing and distribution to ensure a minimum routine return.
    - Pillar One operates as a ‘correction’ to the current system; relief from double taxation will need to be provided (mechanism to identify the ‘paying entity (or entities)’ and method for relief).
  - Pillar Two:
    - Seeks to ensure that in-scope MNE profits are taxed at a globally agreed minimum level.
    - Suggested minimum rate range: 9 to 12.5 percent.
    - Comprises three interlocking rules:
      - Income inclusion rule (IIR): residence country of the ultimate shareholder collects a ‘top-up’ tax on foreign earnings when tax paid abroad is below the agreed minimum.
      - Undertaxed payments rule (UTPR): imposes a minimum tax on resident affiliates of foreign MNEs targeting base-eroding payments as a backstop to the IIR.
      - Subject to tax rule (STTR): permits source countries to impose, under their DTAs, additional tax on certain payments up to the agreed minimum rate.

*Italic: Source: wpiea2021145-print-pdf - 16.      Several measures have been recently adopted to curb tax avoidance through the Netherlands*

### 30.      Importantly, the proposed rule order means that the IIR is likely to operate as the

### 30. Importantly, the proposed rule order means that the IIR is likely to operate as the

### Operation and design of Pillar Two (IIR, STTR, UTPR)
- The application of the STTR will depend on treaty change and therefore its application depends on all relevant jurisdictions choosing to implement the rule.
- STTR is of limited application (targeting mostly interest and royalties but no other kinds of base-eroding payments).
- In practice the IIR is likely to be the main rule that will ensure group level minimum taxation by applying any top-up tax due in the country of the ultimate shareholder of the MNE group.
- The UTPR will only apply as a backstop in case no IIR applies (for example, when none of the (intermediate) holding companies is based in a country applying the IRR).
- The minimum tax will be applied on a jurisdictional basis and by reference to effective tax rates.
- The proposal includes:
  - A broad notion of covered taxes.
  - Rules for allocating taxes paid and tax bases to each jurisdiction in which in-scope MNEs operate.
  - A ‘carve out’ for some share of profits that reflect substantive activities on a formulaic basis likely involving tangible assets and payroll to target the operation of the minimum tax to excess profits.

### Expected global revenue impact of the two-Pillar approach
- The two-Pillar approach is expected to increase global CIT revenue by less than 4 percent.
- OECD (2020g) estimates:
  - Pillar One would reallocate about $100 billion of profits to market jurisdictions.
  - Pillar One is only expected to raise modest additional CIT revenue (by less than 1 percent globally).
- Additional revenue primarily from the combined effect of Pillar Two and the US GILTI provision:
  - Estimated to raise global CIT revenues by additional 0.9 to 1.7 percent.
  - Pillar Two expected to generate indirect revenue gains from reduced tax competition possibly resulting in an additional revenue gain by 0.8 to 1.1 percent in global CIT.
  - Combined CIT increase from Pillar Two (including indirect gains) of 1.7 to 2.8 percent.

### Impact on Dutch CIT revenue (uncertainty and estimates)
- Impact remains highly uncertain; depends on ultimate design parameters and complex dynamic effects.
- Dutch Ministry of Finance modeled expected impact using the OECD tool; estimates contain a high degree of uncertainty due to:
  - Many critical design parameters (in particular the level of the global minimum).
  - Limitations of underlying data.
  - Behavioral responses from MNEs and other countries’ policy responses.
- Modelled estimates show a combined effect of both Pillars ranging from:
  - A CIT revenue loss of up to $711 million to a gain of up to $880 million.
- Pillar-specific modeled effects:
  - Pillar Two is expected to have a positive effect on CIT revenue ranging between $456 and $857 million (after taking account of behavioral responses including government responses).
  - Pillar One may lead to a CIT revenue loss of up to $1.167 billion (or up to 3.4 percent of total CIT).
- Broad direction of Dutch estimates:
  - Additional revenue directly or indirectly generated mostly from Pillar Two.
  - Revenue loss from Pillar One to the extent that more tax base of resident affiliates is reallocated abroad through Amount A than is allocated to the Dutch market from affiliates abroad.
- Key design and policy implications for the Netherlands:
  - Revenue impact from Pillar Two is highly dependent on the yet to be agreed level of the global minimum and current effective tax levels of Dutch affiliates of in-scope MNEs.
  - To preserve Pillar Two revenue gains, the Innovation Box rate may need to be revised upwards in case of an agreed global minimum above 9 percent, so as to avoid the ultimate parent jurisdiction ‘taxing away’ the tax differential enjoyed by its Dutch Innovation Box affiliate.
  - The conditional WHT can be redesigned to operate as a STTR for Pillar Two purposes, including potentially in situations where currently a DTA would prevent the conditional WHT from applying.

### EU Anti-Tax Avoidance (ATAD) and related rules
- The Netherlands is committed to all EU anti-tax avoidance measures; all EU member states are required to implement within prescribed time limits the measures in the Anti-Tax Avoidance Directives (ATAD I & II).
- ATAD I & II seek coordinated EU implementation of some BEPS 2015 recommendations (beyond BEPS minimum standards).
- Table 4 implementation dates (as provided):
  - Interest limitation, GAAR and CFC: January 1, 2019
  - Exit taxation, Hybrid mismatches (except for reverse hybrids): January 1, 2020
  - Reverse hybrid mismatches (with non-EU countries): January 1, 2022
- Dutch implementation highlights:
  - Interest limitation rule of 30 percent of EBIDTA with a safe harbor threshold of €1 million, with unlimited carry-forward (but no carry-back) of excess interest, but without a group escape clause.
  - A CFC rule combining entity-based (model A) and transaction-based (model B) approaches, applying only to entities in listed jurisdictions and to specified types of (passive) tainted income, unless the entity mostly earns non-tainted income and performs genuine economic activities.
  - A judicially developed GAAR was already part of the Dutch tax system.

### Proposal for a Common (Consolidated) Corporate Tax Base (C(C)CTB / CCCTB / BEFIT)
- The C(C)CTB proposal envisages two elements:
  - Step 1: A common base (mandatory for the largest companies, optional for others) with features such as:
    - R&D incentives replaced by a ‘super-deduction’ of between 125 and 200 percent of actual costs (percentage larger for smaller firms).
    - Deduction for a notional return on equity to neutralize debt bias.
  - Step 2: Consolidation and formula apportionment with four factors (weights):
    - Assets (1/3), sales (1/3), number of employees (1/6), payroll (1/6).
    - No harmonization of CIT rates; each member state applies its own rate to the apportioned profit.
- European Parliament proposed changes to address digitalization:
  - Introduce a digital permanent establishment based on a significant digital presence.
  - Add a “data factor” in the profit allocation formula; proposed revised formula weights: assets (1/4), sales (1/4), number of employees (1/8), payroll (1/8), data factor (1/4).
- Trade-offs:
  - Adding a data factor could address digitalization concerns but risks complicating and potentially distorting the formula where value of digital user data is not easily observable.

### Digital Services Taxes (DSTs) and EU digital levy proposals
- The Commission proposed a “digital permanent establishment” and an EU DST in 2018; the DST proposal is now foreseen to be withdrawn and replaced by a digital levy.
- July 2020 European Council tasked the Commission to propose new “own resources” including a digital levy with a view to its introduction by January 1, 2023 at the latest.
- Several EU and other European OECD countries have implemented or announced forms of DST, but not the Netherlands:
  - Implemented DSTs: Austria, France, Hungary, Italy, Poland, Spain, Turkey, and the United Kingdom.
  - DST rates range from 3 percent to 7.5 percent and bases vary from narrow (e.g., online advertising) to broader (including user data).
  - Other countries with proposals or intentions: Belgium, the Czech Republic, Slovakia, Latvia, Norway, Slovenia.
- Differences between DSTs and Pillar One:
  - Scope of Amount A under Pillar One is broader than most DSTs.
  - DSTs typically raise very little additional revenue—around 0.02 percent of GDP or less.
  - Amount A targets excess profits; DSTs are typically imposed on gross revenue.
  - Pillar One contains a mechanism for relieving double taxation for reallocated tax base; DSTs generally lack such relief from residence jurisdictions.

### Impact of alternative reform directions: Formulary apportionment, RPA, DBCFT
- Formulary Apportionment (FA):
  - FA consolidates MNE profits and apportions across jurisdictions on a formulaic basis combining production factors and sales by destination.
  - The Netherlands is likely to lose CIT revenue under FA, especially when allocation is based on assets and payroll, but less so if based on sales by destination.
- Residual Profit Allocation (RPA):
  - Divides consolidated profits into routine and residual components; routine profits allocated where associated costs are incurred; residual allocated formulaically.
  - IMF/other research suggests investment hubs likely to lose CIT revenue from reallocating excess profits under RPA.
- Dynamic effects:
  - FA and RPA are more robust to profit shifting but do not eliminate tax competition; countries may still use tax incentives to attract production factors included in the formula.
  - Agreed minimum tax could mitigate tax competition for routine activities under RPA.
- Destination Based Cash Flow Taxation (DBCFT):
  - Combines destination-basis taxation through border adjustment with cash-flow treatment, effectively imposing a destination-based tax on rents.
  - Universally adopted DBCFT would largely eliminate profit shifting and tax competition.
  - DBCFT is not currently under active consideration in the Netherlands or elsewhere.
  - Pillar One’s partial allocation based on sales by destination moves somewhat in the DBCFT direction.

*Source: wpiea2021145-print-pdf - 30.*

### 49.      A hypothetical DBCFT, at the current CIT rate, would reduce Dutch revenues, largely

### 49.      A hypothetical DBCFT, at the current CIT rate, would reduce Dutch revenues, largely

### Effects of a Hypothetical DBCFT on Revenues in the Netherlands
- A hypothetical DBCFT, at the current CIT rate, would reduce Dutch revenues, largely because of positive trade surplus of the Netherlands.
- Under a DBCFT, imports are taxed but exports are not; countries with a negative trade balance tend to gain while others tend to lose revenue under a CIT.
- Had the Netherlands adopted a DBCFT, the effect is estimated to be below 1 percent of GDP for 2015.
- Figure reference: Figure 6. Effects of a Hypothetical DBCFT on Revenues in the Netherlands (Source: Hebous and Klemm (2019)).

### Conclusion (Section D)
- Further international tax changes will necessarily impact the Dutch CIT; this is inevitable in the 21st century global digital economy.
- The Netherlands should continue to actively participate in ongoing discussions at EU and OECD/IF level and anticipate impacts on its CIT of any internationally agreed changes.
- Potential threats and opportunities from international changes:
  - Threat: potential revenue loss from some measures (example given: from a reallocation of tax base under Pillar One).
  - Opportunity: strengthen anti-base erosion measures (example given: a more finetuned conditional WHT applied by reference to effective tax rates).
- Structural changes to consider in anticipation of other countries imposing more binding minimum taxation, for instance:
  - Reforming the Innovation Box regime if its tax benefit would otherwise be taxed away by other countries’ income inclusion type rules.

### Interaction of Corporate and Personal Capital Income Taxation (V)
- The interaction of corporate and personal income taxes creates distortions and different treatment of similar incomes, especially in schedular systems like the Netherlands.
- Common difficulty: taxation of owner-run firms where distinguishing capital and labor income is difficult but crucial because capital income is subject to different—or various different—tax rates.
- Debt bias arises because interest is taxed once only (at the personal level), while dividends are taxed twice (at the firm and the owner level).
- This section discusses inefficiencies and distortions in the broader capital income tax system.

### System choices and guidance for reforms
- A clear vision of the desired overall tax system would guide future reforms.
- Stylized systems described:
  - Comprehensive income tax: All income (labor and capital) taxed at same rate. Pros: Taxes returns from endowments and economic rents.
  - Dual income tax: Midway solution; capital income taxed, but at lower rate. Pros: Compromise solution.
  - Consumption tax: Only consumption taxed – equivalent to exempting capital income. Pros: Does not distort savings decisions.
- Most economists would favor dual or comprehensive income tax systems, minority favor pure consumption taxes.
- The current Dutch system resembles a dual income tax, except capital is taxed at multiple rates, and in some cases exceedingly low ones, distorting investment decisions between asset classes.

### A. Owner-Managed Businesses
- Taxing mixed income of an owner-run business requires splitting income into wage and profit components; the incentive is to minimize salary and treat most income as profit due to different (typically lower) taxation of capital income.
- Netherlands rules on minimum salary for owner-managers: must not be set below the salary of the highest paid employee, 75 percent of the salary of the most similar employment, or €47,000, whichever is highest.
- Taxation differences across legal forms:
  - Sole traders: typically taxed once under the standard tax system (Netherlands: Box 1).
  - Incorporated owner-run firm: income can be taxed as salary (Box 1), as distributed profit (corporate rate then Box 2 on dividends), or as retained profit (taxed only at corporate level; resulting capital gain at personal level not taxed unless realized).
- Retained earnings receive a real tax saving because such funds compound more quickly inside the firm (reduced just by the corporate income tax).
- Differences in effective tax rates across income types depend on expected profit level; Figure 7 provides overview revealing large differences in average tax rates.
- Box 1 entrepreneur faces progressive schedule (with the 14 percent reduction compared to a worker).
- Employer-paid social security contributions applied until income reaches €58,311.
- Incentive for owners to keep salary to the minimum required by law.
- Distributed profits face relatively similar tax rates as Box 1 income, except for very low profits, which are taxed less under Box 1.
- Retained earnings face much lower taxation, creating a strong incentive to keep savings inside corporations.
- Proposed cap on loans to owners: €500,000 from 2023 onwards (mentioned as a proposal).
- Figure reference: Figure 7. Average Tax Rates of Entrepreneurs (in percent), 2021 (Source: IMF staff calculations).

### Reform options for owner-managed businesses
- Comprehensive reform to remove distortions would require major changes:
  - Integrate corporate and personal tax of Box 2 firms; options include:
    - Charge a progressive tax on distributions so sum of CIT and distribution tax equals Box 1 rate (complexity: must heed labor income so lower rates not granted more than once).
    - Tax capital gains at accrual and at the Box 1 rate.
    - Treat Box 2 firms as passthroughs, attributing profit to owners and taxing under Box 1 irrespective of retention or distribution.
  - If aiming for neutrality between employed labor and entrepreneurial profits, abolish the 14 percent discount; if aiming for a dual income tax system then keep the discount.
- More limited reforms to improve efficiency without full neutrality:
  - Tighten rules for loans to owners by significantly reducing the proposed €500,000 limit; justification: such loans are granted by companies having cash to their owners who could take profits as dividends otherwise.
  - Abolish the reduced CIT rate for profits up to €245,000:
    - Reduced CIT rates discourage firm growth or trigger avoidance like splitting firms.
    - Reduced rates not well aligned with equity considerations because they reflect firm fortunes, not owner wealth.
    - Abolishing the reduced rate would allow reduction in the tax rate on dividends, mitigating tax preference for retentions over distributions.

### B. Passive Investment
- Financial assets generally subject to wealth rather than income taxation, leading to wide range of effective tax rates on returns.
- For assets held in Box 3:
  - Effective tax on low returns far exceeds 100 percent and would even be charged in case of losses, but rapidly drops as the return increases.
  - Notional return for high wealth is greater; given the €50,000 exemption, there is some progressivity in this tax (comparison of panels a and b of Figure 8).
  - Regressive effect: people with small fortunes favor low-return risk-free assets, those with high wealth can afford strategic financial advice.
- Wealth inequality context: According to CBS (2020), the top 10 percent of wealthy households held 62 percent of total assets in 2018; including pension assets reduces this share to 48 percent.
- Taxation of notional returns works against automatic stabilization: effective tax rates on actual returns rise in recessions and fall in booms (to extent aligned with financial cycles).
- Holding financial assets inside owner-run firms can achieve completely different tax levels, especially under 15 percent rate for small profits; this reduces tax rates provided distributions are avoided.
- Advantages of holding assets inside a firm are likely regressive since only better off people are likely to own firms.
- Investing in pension funds offers even more attractive taxation (exempt contributions, exempt accumulation, taxed distributions) but is possible only within limits and fulfils obvious policy rationale.
  - Most individuals participate in mandatory pension funds established in the industries they work in.
  - Voluntary pensions make up only about 4 percent of total pension savings (2018) according to CBS data.

### Options for capital gains and wealth taxation
- Replacing taxation of wealth stocks by a capital income tax would be straightforward; main difficulty is taxation of capital gains.
- Ways to tax capital gains:
  - On accrual: theoretically efficient; drawbacks: estimation difficult for nontraded assets and taxpayers may lack liquidity.
  - On realization: most common and relatively easy to implement; drawback: lock-in effect—effective tax rates drop the longer an asset is held following a large gain.
  - On realization but based on holding period (Auerbach (1991) suggestion): avoids lock-in, never tried in practice, arguably similar to taxing assumed returns.
- Implementing perfect capital gains taxation is difficult, but compromise solutions exist:
  - Most countries tax capital gains on realization, which is better than exemptions.
  - Rules to prevent avoidance strategies (e.g., discounted bonds, zero-coupon bonds) can require taxation on implicit annual capital gain.

### C. Owner-Occupied Housing
- Neutral taxation of owner-occupied housing: tax imputed rent and grant deductions for all costs including mortgage interest—this aligns incentives and removes overinvestment or excessive mortgage incentives.
- Many countries find taxing imputed rents politically or practically difficult; second-best: disallow mortgage interest deductibility.
- In the Netherlands:
  - Imputed rents are in theory part of tax base but in practice hardly taxed.
  - Imputed rents are systematically underestimated given low rate of return of just 0.5 percent of home value (except for high value properties).
  - Imputed rents are eroded by a deduction that currently forgives 90 percent of the imputed rent (unless already covered by mortgage interest deduction).
  - Phasing out of this deduction is scheduled to be complete only in 2049.
  - Mortgage interest is deductible and in many cases exceeds imputed rent, leaving taxpayers with a net housing subsidy.
- Consequences:
  - Incentive to overconsume housing and use excessive mortgage financing.
  - With supply-constrained sector, likely strong price effects rather than improved access to housing.
  - Subsidization through mortgages encourages indebtedness.
- Measures taken to reduce housing subsidy through mortgages address symptoms but not underlying causes:
  - Creditable rate on mortgage interest reduced below maximum Box 1 rate to currently 43 percent, with further gradual reductions to 37.05 percent (the basic Box 1 rate) underway.
  - Regulations limit interest-only mortgages and require regular payoff over a maximum of 30 years.
  - These reforms reduce distortion but do not eliminate it because tax rate on interest deduction remains high compared to alternative investments and imputed rents remain undertaxed.

### Reform options related to owner-occupied housing
- Raise the value of imputed rents to realistic levels; phase in over time to avoid sudden housing-market movements and financing difficulties for recent buyers. Note: if taken alone, would not address incentive for excessive mortgages while saving in pension funds or Box 3.
- Shift housing to Box 3:
  - Would automatically increase imputed rents (assuming same return as other assets).
  - Would remove incentive to go into mortgage debt while investing in financial assets (though incentive would remain for pension fund savings, which are limited).
- Combine with broader reform of Box 3 that moves to taxing actual rather than notional returns:
  - Would allow more equitable taxation across housing markets and assets.
  - Taxing capital gains important in such reform; accrual taxation sensitive for owner-occupied housing, at least realization-based taxation should apply (including bequests and gifts).
  - Realization-based taxation implies lock-in effects and remaining undertaxation of housing, but would much reduce tax preference for housing compared to current system.
- If taxing imputed rents at realistic level is politically infeasible, alternative is to exempt imputed rents (practice in most countries) and disallow deductions of costs related to home ownership, most importantly mortgage interest.
  - To address liquidity concerns in bequests or gifts, provisions could be added to allow gradual payment over time.

_Italic source: IMF staff content from wpiea2021145-print-pdf (selected pages)._

### 68.      Debt bias a common feature of tax systems around the world, but might be more

### Debt bias a common feature of tax systems around the world, but might be more severe in the Netherlands, given the full double taxation of dividends.

### Causes and mechanisms
- General debt bias stems from the asymmetry of allowing deduction of interest, but not dividends from the corporate tax base.
- In most countries this corporate-level asymmetry is mitigated at the personal level through lower taxation of dividends than interest.
- "62 percent of OECD countries have some mechanism in place to mitigate, or in some cases eliminate, the double taxation of dividends, either by granting a credit for CIT paid or by applying a lower tax rate on dividends."
- Mitigation is incomplete because integration can be partial and many firms’ marginal shareholders may be tax-exempt (such as pension funds) or foreign investors (subject to a lower or zero WHT).

### Additional distortions across assets and boxes
- Differential taxation across assets creates further distortions:
  - Mortgage interest deductibility at a relatively high rate compared to the rate applicable to high-yielding financial assets or assets held in a business encourages leverage in owner-occupied housing.
  - An owner of two Box 2 businesses, one paying CIT at the higher rate and one at the lower rate, would have an incentive to maintain high debt in the higher-taxed firm and accumulate assets in the lower-taxed firm.
- For owner-run Box 2 firms, retained earnings can be the tax-preferred source of finance.

### Evidence: Effective tax rates (Table 6)
- Note: The marginal effective tax rate (EMTR) measures the extent to which taxation increases the pre-tax rate of return required by investors to break even. The average effective tax rate (EATR) is the ratio of the pre-tax NPV of the investment minus its post-tax NPV divided by the NPV of income net of variable costs and economic depreciation. Assumptions: Inflation: 2%, real interest: 3%, true and tax depreciation: 12.25%, profit (EATR): 20%. Source: IMF staff calculation.
- Effective tax rates shown in Table 6 (EMTR and EATR):
  - Tax-exempt marginal shareholder
    - Retained earnings: EMTR 30.3, EATR 26.1
    - New equity: EMTR 30.3, EATR 26.1
    - Debt: EMTR -11.1, EATR 20.1
  - Box 2, 25% CIT rate
    - Retained earnings: EMTR -38.5, EATR 24.3
    - New equity: EMTR 62.9, EATR 44.4
    - Debt: EMTR -5.4, EATR 26.6
  - Box 2, 15% CIT rate
    - Retained earnings: EMTR -15.0, EATR 32.8
    - New equity: EMTR 67.5, EATR 52.6
    - Debt: EMTR -9.8, EATR 33.1
- Interpretation: For a corporation whose marginal shareholder is a tax-exempt entity, there is a strong debt preference over all types of equity. For an owner-run Box 2 firm there is strong debt preference compared to new equity, while retained earnings are tax-preferred.

### Macro implications and Dutch context
- "The very high private debt levels in the Netherlands suggest that debt bias is indeed a concern."
- Figure 10: Credit to Non-financial Corporations and Households (%GDP), 2019 — Source: BIS statistics.
- Debt bias leads to efficiency costs by distorting risk behavior and investment decisions and intensifies macroeconomic vulnerabilities, for example it increases the probability and length of macroeconomic and financial crises (Bernanke and Campbell 1988, Bianchi 2011).

### Policy options to reduce debt bias
- Personal income tax reforms:
  - Reduce income tax on dividends compared to taxes on interest. Caveat: this would not help firms whose shares are taxed under Box 3 unless that Box converts to taxation of actual returns.
  - Reforms to the housing sector would reduce incentives for excessive mortgage taking.
- Corporate-level reforms:
  - Allowance for Corporate Equity (ACE): allows a deduction for a notional return on equity, thereby reducing the advantage for debt.
  - Allowance for Corporate Capital (ACC): applies a notional return to both debt and equity while disallowing deduction of interest, achieving equal treatment.
  - Advantages of ACE/ACC: efficient (investment is not discouraged) and robust to bookkeeping choices such as depreciation methods.
  - Cautions on ACE introduction:
    - Other aspects of capital income taxation may require more urgent reform.
    - International reform developments (e.g., minimum taxes) might affect its impact: minimum taxes could either facilitate or undermine ACE depending on implementation; ACE could be treated as a tax benefit and trigger minimum taxes by other countries.
    - If Europe adopts a CCCTB, ACE might be included as part of the proposal.
  - Implementing an ACE requires an appropriate set of anti-tax avoidance measures.
- Interest limitation rules:
  - Reduce the debt bias as a side effect by limiting the deductibility of interest beyond certain amounts.
  - Should not be tightened excessively because they impose efficiency costs.
  - Example: EBITDA rule can bite not only high-debt firms but also firms with low profits, increasing the cost of capital and potentially harming investment compared to ACE.

### Conclusions on capital income taxation
- Tax reform cannot start from a clean slate; a strategy is needed to move toward an overall target.
- If the target is comprehensive income taxation:
  - Ultimately abolish boxes 1-3 and aggregate income at the individual level.
  - Correct aggregation requires defining realistic imputed rents for owner-occupied housing and integrating corporate and personal level taxes for dividends.
  - Tax preferences for pension funds could be retained within reasonable limits to allow efficient lifecycle saving decisions.
- If the target is dual income taxation:
  - Retain different boxes but fewer schedules, converging to one box for labor income and one for capital income.
  - Rules will be needed to split mixed income into the two boxes.

*Source: IMF staff calculation.*

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_Source: https://www.imf.org/-/media/files/publications/wp/2021/english/wpiea2021145-print-pdf.pdf_