The Netherlands. Determination of a taxable profit. The ruling policy

The relationship between the tax rules on the determination of taxable profit and the commercial (e.g., IAS/IFRS) rules of determining business profits (fiscal versus commercial accounting)

One of the several attractive tax characteristics in Dutch tax system is the possibility to determine the income of the enterprise by fiscal and commercial accounts. Fiscal accounts are prepared in order to compute the corporate income tax of the entity due for payment, based on the results generated in the reporting year. They are prepared for the tax authorities only. In contrast to fiscal, commercial accounts reflect the company’s results (profit or loss), assets and liabilities, as well as level of liquidity. These accounts serve as a reporting for the shareholders of the company, to give a clear, fair and true picture of the company. Unlike in Germany, where the accounts are served to protect the creditor, in the Netherlands commercial accounts are prepared primarily for the shareholders.

The annual accounts are prepared in accordance with the principle of sound business practice. Although, this principle is not defined by the legislator, the case law of Supreme Court of the Netherlands provides that accounting should be in accordance with generally adopted accounting standards and it should not be in conflict to the tax rules of the country. In other words, the concept of sound business practice had become a separate accounting standard that can be applied by the entities in the Netherlands, but should not violate the tax law. However, the commercial accounts of the publicly traded companies should be prepared in line with IFRS/IAS.

The concept of the sound business practice is grounded on three major principles: prudence, reality and simplicity. The principle of prudence requires the company to account the profit only if it is or will be certainly realized. The principle of reality determines that the profit is calculated according to the transactions, which were held in the reporting period; the substance (liabilities and risks) of the transactions prevails over (legal) form and the calculated profit will not be questioned in the other periods. Finally, the principle of simplicity provides that the method of profit determination is practical and should be in line with the size of the enterprise¹.

Although these major principles overlap each other in tax and commercial accounting, some of them will prevail during the preparation of the accounts for different purposes. As such, principle of reality will dominate over principle of prudence and simplicity in the preparation of fiscal accounts. This can be exemplified by the fact that foreseeable losses (but not realized in the reporting period) cannot be taken into account with the realized profit, in order to minimize the taxable profit. Furthermore, the government had implemented additional tax limitations in concept of the sound business practice. For example, depreciation of some assets is limited to 20%, whereas according to the sound business practice this percentage can be higher due to the short useful life of the assets.

In essence, the primary feature of the Dutch tax system that the fiscal and commercial accounts are independent from each other in such a way, that changes in the commercial accounting do not influence the tax accounting. For example, the fiscal evaluation of the enterprise’s profit may be different from the commercial due to the applied principles, for example tax deductions (i.e. investments deductions). There is no requirement that the same principles used in tax accounts should be applied in the commercial accounts. Having in mind that both fiscal and commercial accounts are rooted to business operations, each of them independently determines the taxable profit of the company.

The ruling policy

The Netherlands is well known for its concept of open system of ruling policy. The taxpayers of the country may obtain an advance decision or a guidance from the tax authorities on various tax issues related to their transactions in the Netherlands, namely advance tax rulings (ATRs). Ruling is defined as a binding agreement between the tax authorities and taxpayer on a specific tax matter, obtained in advance, based on specified facts and circumstances within the national tax and case law of the Netherlands. Should the circumstances change the ruling is no longer valid. In addition to ATRs, the Dutch tax authorities issue the advance pricing agreements (APAs) on transfer pricing matters. Under the APAs, the companies may request an advance ruling on cross-border transfer pricing transactions.

In order to obtain ATR, the taxpayer should prove that: the company has enough substance in the Netherlands; the structure of transaction is not in conflict with the tax law of the country and international tax law; it does not intended to get a tax avoidance or erase tax base; it does not violate the tax law of the treaty country; and, the information related to the cross-border transaction is true and fair as if it would be presented in the other state. The ATRs are generally requested on participation exemption, hybrid entities and financial instruments, matter of Dutch income due to permanent establishment and the classification of activities.