Royalty conduit companies are legal entities which contractually receive certain types of cross-border income but contractually pay a large part (94 – 98%) onwards to a client outside the Netherlands, in similar format. The royalty definition in international tax law is much wider than the corresponding one in civil law or common law. Not only cross border licensing activities give rise to royalty income in a tax sense, but also cross-border operational lease payments or rental payments. Technical service fees and consultancy fees are often treated in similar fashion for international tax purposes. Such money flows usually attract steep withholding taxes (25% or more, levied from the gross amount of the payment) and are therefore often prohibitive, as any tax credit in the country of the recipient will be restricted to the tax payable on the net income of the transaction. In addition, the royalty expense may not be tax deductible for the payor if paid directly to a so-called Black List country (low tax jurisdiction).
Such withholding tax problems can still be resolved in relatively easy fashion by contractually interposing a legal entity in the Netherlands into the money flow. The base transaction (leasing; licensing; servicing) is in fact cut into two parts. The owner of the intangible (licensing) or the asset (leasing) will transfer title to the proceeds thereof to a Dutch legal entity (BV) which is owned by a Dutch resident. This entity will subsequently enter into a user license, operational lease or consultancy agreement with the user. This legal separation, although relatively simple to achieve, will reduce withholding taxes considerably (in many cases even to nil) and takes care of the Black List issue as well. Very many multinational enterprises, even the biggest, therefore use the Netherlands as a stepping stone country for their leasing, licensing and consulting income, internal or external.
The Netherlands does not levy a withholding tax on outgoing royalties, regardless of destination. This, in combination with the favorable tax treaty network for incoming royalties, makes the Netherlands an ideal jurisdiction to host royalty conduit vehicles and the country therefore hosts many thousands of them.
In 2001, special rules have been published by the Dutch tax authorities, after consultation with the European Commission, in order to address the ”beneficial ownership” issue which came up during the Harmful Tax Competion discussions in the EU. The Dutch rules, effective per 1/1/2006 when the transition rule for structures which existed when the 2001 rules were efectively enacted, lapsed, were a severe setback to the traditional Dutch fiduciary services industry, as using Dutch conduit entities owned by the group got much more expensive due to a whole new list of ”substance” requirements, but left our ”third party” solution unaffected.
The latest developments in this area are the introduction of LOB provisions in tax treaties which render traditional conduit solutions impossible
The legal entities we advocate are inserted into royalty income flows of clients as independent parties, so there is no need for expensive transfer pricing benchmark studies, or equally expensive attempts to secure an advance tax ruling from the Dutch Revenue Service. It should be noted that as of 1-1-2016 as a result of the BEPS programme of the OECD, such easy ”treaty shopping” may well become impossible and will need to be replaced by a much more sophisticated structure that we currently have on our drawing board. Interestingly, such advanced structures can again be more easily implemented in the business model we advocate (”third party owned conduits”) than in traditional set-ups where transfer pricing rules and regulations apply. The Netherlands CIT Act contains a whole series of rules (which have recently been sharpened) that deal with related party conduit structures. These rules can legally to a large extent be avoided by ensuring the Dutch conduit is not an affiliate of the payor or ultimate receiver of the royalty flow.