On April 26, 2022, the North Holland District Court ruled that four Dutch real estate investment companies correctly claimed the Dutch fiscal investment institution regime (fiscale beleggingsinstelling, or FBI), which is a Dutch REIT, even though the interest paid on the shareholder loans may have been higher than in an arm’s length situation.

An FBI benefits from a tax rate of 0%, provided that certain conditions are met, including a specific condition that a profit distribution is done within eight months from the end of the financial year. Profit distributions by an FBI are subject to a 15% dividend withholding tax, unless reduced by a tax treaty or domestic provision. An FBI must limit its statutory as well as actual activities to normal portfolio investment activities. In addition, an FBI is not allowed to finance the tax book value of its real estate out of more than 60% debt. Furthermore, no individual is allowed to own 5% or more of the shares and at least 75% of all shares must be held by individuals, tax exempt entities, listed FBIs or regulated FBIs.

The case at hand involved all Dutch companies that had invested in Dutch office buildings. The shareholders provided the financing—40% in the form of equity and 60% in the form of shareholder loans. The shareholder loans carried interest rates between 7% and 10%, had a term of 10 or 15 years without a repayment schedule, and early repayment was possible at any time without penalties. The loans were unsecured and did not include loan-to-value (LTV), an interest rate coverage ratio or debt-service coverage ratio covenants or any other covenants. After the loans were concluded, transfer-pricing specialists prepared benchmark studies to support the arm’s length character of the interest rates. The majority of the shareholders were Israel-based pension funds and life insurance companies that invested in the shares and loans for the risk and benefit of their beneficiaries and policyholders. For two of the four companies, the tax inspector confirmed in writing that the beneficiaries of the pension funds could be regarded as the economic owners of the shares and that, therefore, the shareholder test had been met.

The companies elected to be treated as an FBI in their corporate income tax returns. The tax inspector denied the application of the FBI regime because the interest on the shareholder loans was too high, and as a result the risk profile of the companies was not in line with the risk profile that a normal portfolio investor would have accepted having regard to its return on equity. In addition, the tax inspector argued that, by adding short-term debts (that were covered out of short-term assets) to the 60% financing debt test, the companies exceeded the 60% financing debt condition. Finally, the tax inspector argued that, for two companies, their object clause was too broad and allowed for activities and risks that could not be regarded as normal portfolio investment activities.

The court ruled that in order to determine whether these activities could be considered normal portfolio investment management, the interest rate on the shareholder loans is, in principle, not relevant. The court added that although the interest rates may be regarded as relatively high, the tax inspector did not prove that this created a risk that a normal portfolio investor would not have accepted, when considering the actual return on equity, which still seemed reasonable after deducting the interest. Furthermore, the court ruled that when testing the 60% debt limitation, the short-term liabilities arising as a result of the exploitation of the real estate investment should not be taken into account.

As a result of the above, 12 of the 13 Dutch corporate income tax reassessments at stake were reduced to nil (by applying the Dutch REIT tax rate of 0%). The court ruled that there is no need to address the arm’s length character of the interest rate for the 12 cases because it would not have an influence on the height of these corporate income tax assessments.

The court agreed with the tax inspector that, for one of the companies, its object clause in the first year of investment was too broad, as it permitted participation in business enterprises. Therefore, the court had to assess whether the tax inspector proved that the interest rate of 8% was above the arm’s length range, and secondly whether the tax inspector proved that the interest rate of 1.78% was arm’s length. The court ruled that the tax inspector successfully proved the first point, but not the second. Therefore, the court, without producing its own benchmark, assessed an interest rate of 4.5% as reasonable. The court supported this with reference to (i) the statement of a real estate financing consultant that obtaining bank debt at a 50% LTV for five years against 3% interest should have been feasible, (ii) various public reports indicating that in 2015–2016 interest rates above 4% were rare, and (iii) the actual terms and conditions of the shareholder loans that had a term of 15 years.

The taxpayer and the tax inspector can still appeal the court’s verdicts.

Our observations

The above case makes it clear that timely adjustment of the object clause is crucial for application of the REIT regime. It also highlights the importance of preparing a solid transfer-pricing study to support the envisaged debt level and the interest rate. Taxpayers should ensure that they fully understand the applied transfer-pricing method, including its strengths and weaknesses, the impact of the assumptions made as well as the selected comparables on the reliability of the presented arm’s length range. A court will not make its own transfer-pricing report, so it would need to be convinced of the trustworthiness of any such report.