The Netherlands

Author: | Published: 4 Jan 2001
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Over the last year, the Dutch venture capital market has been quite active in various respects. The Dutch venture capital firms like Gilde, NeSBIC, Prime Technology Venture and others, set up various new funds (IT, buy-out, biotech) which attracted Dutch and foreign professional investors. Other firms like Alpinvest and Halder have agreed to continue their activities under the colours of other private equity organizations (respectively NIB Capital Private Equity and the Belgian investment firm GIMV). And it appears from the annual report of the Dutch venture capital association, that the aggregate amount of investments made by the Dutch venture capital firms increased 40% to euro 1.5 billion ($1.2 billion) in 1999, achieving a total portfolio value of nearly euro 4.4 billion.

The focus of this article is to provide an overview of recent developments relevant to structuring a new fund in the Netherlands.

New Dutch Central Bank policy guidelines

Under the rules of the Dutch Investment Institutions Supervision Act (Wet toezicht beleggingsinstellingen) (Wtb), it is generally prohibited to raise money or other goods in or from the Netherlands, for participation in an unlicensed investment fund. The license must be obtained from the Dutch Central Bank (De Nederlandsche Bank (DNB)), which is the supervisory authority in this respect. After a license is obtained, it is necessary to comply with certain requirements.

Scope of the regulatory rules

The Wtb aims to protect the public from making investments in funds for joint account that do not fulfil certain minimum standards. The focus of the Wtb is not primarily the venture capital market. This market is generally a professional business, aiming for professional investors. Over the years, it has been argued that the Wtb should not govern venture capital funds. The DNB recognized this problem and provided a policy guideline. If the requirements in it are met, the venture capital fund will not be considered an investment institution within the meaning of the Wtb. This policy guideline was recently amended.

Relief from regulatory supervision

Before August 2000, in order to qualify as a fund not considered to be an investment institution within the meaning of the Wtb, the following requirements had to be met:

a) The shares of the portfolio companies in which the venture capital fund participates cannot easily be placed with the public.

b) The venture capital fund holds the participations for a long period (between five and 10 years). The termination of a participation takes place in consultation with the company involved.

c) The management of the venture capital fund offers, or stipulates, to support the management of the portfolio companies in which it participates.

d) The matters under b) and c) are laid down in a participation agreement.

Recent changes

The requirement referred to under b), in particular, was an obstacle for modern venture capital funds. The DNB reconsidered its policy guideline and issued a new one in August 2000. The requirements b) and c) have been replaced by the following:

b) The termination of the participation takes place in consultation with the company involved.

c) The venture capital fund exercises influence on the management and is actively engaged in the company in which it participates.

The requirement mentioned under c) gives rise to new questions that must be cleared, preferably on short notice.

Finally, it must be noted that if the venture capital fund is not an investment institution within the meaning of the Wtb, the issue of participation rights in the respective venture capital fund may still be governed by the Securities Transactions Supervision Act (Wet Toezicht Effectenverkeer (Wte)). In this respect, nothing changed.

Recent tax developments for the fund and its investors

There have been various developments in Dutch tax law which are relevant when setting up a new Dutch venture capital fund.

Fund taxation

Traditionally, venture capital funds in the Netherlands have been set up in the form of a Dutch besloten vennootschap (BV). A BV is a limited liability company with the status of a legal entity under Dutch law. A BV is not a fiscally transparent entity, so it is subject to the general rules of the Dutch Corporate Income Tax Act, and a 35% tax rate will be applied to its net profits. These profits do not include, however, the benefits that fall within the scope of the participation exemption.

Participation exemption

The Dutch participation exemption provides that all dividends received from, and capital gains realized on, shares in a portfolio company will be exempt from corporate income tax at the level of BV.

A BV that acts as a venture capital fund will be attractive for investors, only if it can benefit from the participation exemption. To be eligible for this exemption, various conditions must be fulfilled. For a venture capital fund, the Tax Code provides for the following (in the context of this article) relevant tests:

a) [for a domestic and foreign portfolio company:] ownership of 5% or more of the nominal paid-up capital of the portfolio company. Under certain circumstances, less than a 5% equity stake qualifies as well;

b) [for a foreign portfolio company only:] the shares must not be owned as a passive investment;

c) [for a foreign portfolio company only:] the portfolio company must be subject to a tax on its profits in its home country.

Recent developments

Recent rulings of the Dutch Supreme Court give further guidance as to the 5% ownership threshold test and the passive investment test.

The 5% ownership threshold

First, an ownership in the nominal paid-up capital of less than 5% is still eligible for the participation exemption if a) the venture capital fund is considered to be engaged in the conduct of an active business, and b) the shares in the portfolio company are not owned as a passive investment. The Supreme Court ruled that the test under b), is satisfied if the shares are owned by the taxpayer which aims to get a return beyond that normally achieved in normal asset management. Also, the question was raised as to the extent a venture capital fund is considered to be engaged in the conduct of an active business.

The passive investment test

A ruling of the Supreme Court of October 25 2000, gives further clarity on when a fund is deemed to be carrying out an active business for tax purposes. In the case of an active business, it is generally understood that the shares in the respective portfolio companies cannot form a passive investment. By contrast, these shares are the core business assets of the funds.

The taxpayer, a Dutch BV, acted as a private fund for five pension funds, and participated in innovative start-up companies. The BV conducted research with respect to the viability of the business plans of these start-ups. This research was contracted out in return for a fee. In consultation with the specialist members of the fund's advisory board (who were assigned to the board by the pension funds), an investment decision was made.

The Lower Court of Amsterdam ruled that the BV was engaged in the conduct of an active business. The Court based its judgment on the relatively high costs of the research activities incurred by BV, which, it said, pointed in the direction that BV's activities go beyond 'normal asset management'. The Lower Court ruled that BV had accepted substantial risks that an individual investor would not have accepted in the course of normal asset management. The fact that BV outsourced the research activities, and that it was not involved in the management of the portfolio companies, did not change the ruling of the Lower Court, which was confirmed by the Supreme Court decision of October 25 2000.

The conclusion from this case law is that a venture capital fund is considered to be engaged in the conduct of an active business if substantial costs are incurred and professional expertise is made available when investing in portfolio companies. Inhouse expertise is not required; the management skills may be contracted from other parties. Active involvement at the level of the portfolio companies will strengthen the active nature of the business of the fund.

Investor taxation – dividend withholding tax

In principle, a BV must withhold dividend tax on distributions it makes (a tax rate of 25%). A substantial reduction or elimination of the withholding tax burden must be achieved to make the fund attractive to foreign investors.

The developments in case law may be important when arriving at a structure that eliminates dividend tax for investors (typically investors from outside the EU) which otherwise cannot benefit from an elimination of this tax. This structure can be achieved through a commanditaire vennootschap (CV) fund, either as a main fund, or parallel to a BV fund.

Dutch and EU investors

Dutch and EU investors are generally in a position to eliminate fully the Dutch dividend withholding tax burden on distributions from a fund which has the legal form of a BV.

Consider first the case in which the investor is a Dutch resident company. If it holds 5% or more of the nominal paid-up share capital in the BV fund, an exemption applies.

Second, the case where the investor is a company resident in the EU. If it holds 10% or 25% of the nominal paid-up capital of, or voting rights in a BV, the Netherlands will generally exempt the distribution from dividend withholding tax under the EU Parent-Subsidiary Directive (the 10% threshold is applied for investors in certain jurisdictions, on the basis of reciprocity).

If the ownership threshold for an elimination of withholding tax under the EU Directive is not met, it could be considered to interpose a Dutch 'pooling BV' between the EU investor and the BV fund. This will structure the repatriation of the profits in a tax-efficient way, subject to the condition that the pooling BV holds at least 5% of the nominal paid-up share capital, and that the EU investor holds at least 10% or 25% in the pooling BV, as the case may be. In this way, no dividend withholding tax will be due on the repatriation of the profits.

Investors from outside the EU - CV structure

In many cases, investors in a BV cannot be offered a structure that eliminates the dividend withholding tax. This is true even where the non-EU investor is resident in a country which has concluded an income-tax treaty with the Netherlands. If the investor is entitled to the benefits of such a treaty, the treaty generally provides for a reduction of the tax rate to 15%. The application of a treaty seldom results in a zero withholding tax rate.

An alternative for setting up a venture capital fund in the Netherlands is the CV. A CV is not regarded as a legal entity. It is a limited partnership, entered into for the purpose of sharing the proceeds of what is contributed as capital by the respective partners.

Owing to the fiscal transparency of the CV, no dividend withholding tax is levied on the distributions by a CV. Transparency may be achieved if the limited partnership agreement sufficiently restricts the transferability of a limited partner's interest, the admission of a new limited partner and each change in the relative interests among the limited partners.

As a consequence of investing through a CV operated and managed by a Dutch-based management team, the limited partners may be considered to be engaged in the conduct of a Dutch business, and as such may become a foreign taxpayer with a Dutch permanent establishment to which the shares in the portfolio companies must be allocated. This should not be harmful, however, provided that the limited partner is a corporate taxpayer, i.e., a corporation or partnership that qualifies as a non-transparent entity from a Dutch tax point of view (rather than an individual). Namely, the capital gains realized through the CV and attributable ratably among the limited partners, should be eligible for the participation exemption when determining the taxable profits of the permanent establishment of the respective investor in the CV.

The CV structure, as a parallel entity, can be illustrated as follows (see chart 2).



Investor taxation – carried interest

The system for taxing individuals who are resident in the Netherlands will be replaced under the 2001 Tax Reform. Under the current system, dividends are subject to a progressive income tax rate of up to 60%. Capital gains are exempt from taxation.

Under the 2001 Income Tax Act, the taxable benefit from savings and investments such as shares and bonds, is deemed to be a 4% yield on the fair market value of these assets, regardless as to the actual return. This return of 4% will be taxed at a rate of 30% annually. Consequently, the income tax rate on savings and investments is effectively the equivalent of a net wealth tax of (4% * 30%=) 1.2%. The dividend tax withheld on the dividend income may be credited with the income tax due (any excess will be refunded).

The taxation on a deemed income basis is available only if the shares do not form a substantial interest, i.e., the shares may not represent 5% or more of the issued share capital (or 5% or more of a special class of shares).

As a result of the Tax Reform 2001, it may become more attractive for individuals to invest directly in the shares of a fund, rather than through a personal holding company.




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