Presence in records: documentation of hybrid mismatches & transfer pricing documentation
A corporate income tax return should be filed by a taxpayer with certainty and without reservations. Here, the general questions, as part of the corporate income tax return, play a significant role. In particular, for taxpayers in international multinational groups, there are more and more legal obligations that may be relevant at the time the corporate income tax return is filed. In this article, we would like to highlight these additional obligations as part of the taxpayer's records: 1) documentation of any presence of hybrid mismatches in the structure, 2) (additional) transfer pricing documentation obligations.
Hybrid mismatches
A European directive prescribes rules to combat tax avoidance through hybrid mismatches ("ATAD2"). Hybrid mismatches are situations where a tax advantage is obtained by exploiting the differences between the tax systems in the different countries involved in the legal structure. More specifically, by taking advantage of differences in the tax treatment (qualification) of legal entities (transparent versus non-transparent), financial instruments (e.g. loans) or permanent establishments.
Typical examples include interest on a loan being tax deductible in one country but not being taxed in the country where this interest is received (for example, because this country considers the loan to be equity rather than debt). Another example is that in one country a legal entity is considered an independent entity where the entity files an independent tax return, while in another country this entity is considered non-independent and the result is attributed to the shareholder(s) and does not file an independent tax return. Finally, hybrid mismatches can also arise, among other things, if one country designates a permanent establishment in the country, and another country considers this permanent establishment not present.
In the taxpayer's records, based on a legal requirement, it should be documented that research has been conducted to determine whether or not a hybrid mismatch exists. In addition, if there is a hybrid mismatch, what measures have been taken to correct these hybrid mismatches. This means that even if this legislation is not complied with, the administration must still show that there are no hybrid mismatches.
If the above is not evident from the taxpayer's records, the tax authorities may reverse the burden of proof, meaning that the taxpayer must make a plausible case that there is no hybrid mismatch or no adjustment needs to be made. This is a heavier burden of proof than would apply if the burden of proof is not reversed. In addition, (misdemeanor) fines may possibly be imposed by the Tax Authorities.
Transfer pricing
Transfer pricing documentation is required by law to establish the arm's length nature of internal transfer pricing of intra-group (international) transactions. For these transactions, internal pricing should be comparable as agreed between any third parties ("at arm's length principle"). The content of the documentation depends on the size of the consolidated turnover of the group."[1]
Consolidated group sales < EUR 50 million
For groups with a consolidated group turnover of up to EUR 50 million, the documentation requirement is form-free. In these cases, the taxpayer must include information in the records that shows how the so-called internal transfer prices were arrived at and information that shows that the conditions are the same as those that would have been agreed upon by independent parties in the course of business. In principle, no specific additional obligations apply in the corporate income tax return.
Consolidated group sales > EUR 50 million
As soon as the consolidated group turnover exceeds EUR 50 million, the local entity in the Netherlands must have an up-to-date group file ("Master File") and a local file ("Local File"). These files for the specific tax year should be in the taxpayer's records at the time of filing the corporate income tax return for that year. Unlike other EU countries, it does not have to be filed with the tax authorities, but it should be part of the administration.
In addition, the corporate income tax return from the year 2023 must confirm that this documentation requirement applies. However, for now, there is no need to confirm that the documentation has actually been prepared and/or is present in the records.
The presence of transfer pricing documentation is not merely an administrative requirement, but serves in part as a substantiation of arm's length pricing. If the mandatory transfer pricing documentation is missing or incomplete, the burden of proof shifts from the inspector to the taxpayer. This means that the taxpayer must convincingly demonstrate that the transfer pricing is arm's length and established beyond a reasonable doubt. This can be very challenging and highlights the importance of thorough transfer pricing documentation. In addition, significant (default) penalties can be imposed in the absence of the required documentation.
For further explanation of these additional documentation requirements, please see our earlier news release.
Other international concerns
Without addressing the following items in substance, we would like to note that some other general questions for international structures may also be relevant in the corporate tax return.[2] These include, for example, the following topics:
- Undertake intra-group international holding, licensing, renting, leasing, or financing activities.
- Receiving fees from foreign affiliates and/or individuals for the use of tangible and/or intangible fixed assets.
- Deducting a foreign exchange loss on a participation to which the participation exemption applies.
Conclusion and recommendation
In international structures, additional obligations in a taxpayer's administration may come into play (relatively quickly). Proper interpretation of any consequences often also requires communication with foreign countries, e.g. advisors abroad. However, the documentation should be present in the administration at the latest when filing the corporate income tax return. It is therefore advisable to have an annual insight into the possible obligations of these additional documentation requirements.
Are you part of an international group and do cross-border transactions (transfer pricing) take place within the group or are there hybrid mismatches? If so, we would be happy to advise you further on these possible documentation requirements in a timely manner.
[1] We have not included the obligations for taxpayers part of a multinational group with consolidated group sales of EUR 750 million for now ("country-by-country reporting").
[2] Of course, there are also several general questions included in the corporate tax return, which also apply to non-international structures.