Dutch FII-regime may apply to foreign funds that invest in Dutch real estate

Dutch FII-regime

Dutch FIIs (in Dutch: Fiscale Beleggingsinstelling) are open or closed end funds that are used for passive (real estate) investments. The purpose of the Dutch FII-regime is to create tax neutrality for investors that prefer to collectively invest. The Dutch FII-regime may be applied to both listed and non-listed (real estate) investment funds. The Dutch FII-regime provides for (amongst others) a 0% corporate income tax (“CIT”) rate on operational profits and capital gains and a 15% Dutch withholding tax (“WHT”) rate upon dividend distributions to the participants (reductions under relevant double tax treaties may apply). As a consequence, effective taxation is transferred from the Dutch FII to the participants.

The Dutch FII-regime was modified significantly in 2007. In order to apply the Dutch FII-regime, certain conditions should be met (e.g. legal form requirement, investment restrictions, distribution requirement, shareholder/investor restrictions and leverage restrictions). Foreign investment funds may also apply the Dutch FII-regime if they meet these conditions.

The Dutch FII-regime may be applied from the beginning of the financial year. In case the Dutch FII-regime has not been applied as of incorporation, the assets of the entity must be revalued up to their fair market value prior to the application of the Dutch FII-regime. Any (capital) gains derived from this revaluation should be subject to Dutch CIT at standard rates.

The case

As from 1996, a German Publikumfonds in the form of a Sondervermögen (“Sondervermögen”) holds real estate in the Netherlands as a direct investment. Under German law, the Sondervermögen was considered to be a separate capital without legal personality that invests for the account and risk of the participants. The Sondervermögen was not subject to German profit tax but the profits were taxable at the level of its participants. However, profits derived from the Dutch real estate assets were not taxed at the level of participants.

For years, the Sondervermögen had been in discussions with the Dutch tax authorities about its CIT tax liability in the Netherlands and the application of the Dutch FII-regime. The Dutch tax authorities argued that the Sondervermögen did not meet all the conditions for the Dutch FII-regime. Moreover, the fact that the profits derived from the Dutch real estate assets were not taxed at the level of participants, would be contrary to the main principles of the Dutch FII-regime.

Judgement of the Court

The first question the Court had to answer in this case (ECLI:NL:GHSHE:2021:2629) was  whether the Sondervermögen was subject to CIT in the Netherlands. The Court ruled that the Sondervermögen qualified as a special purpose fund (in Dutch: doelvermogen) and therefore qualified as a CIT payer in the Netherlands.

The second question related to the conditions of the Dutch FII-regime. As the Dutch FII-regime has undergone significant amendments in 2007, the Court made a distinction between the years before and after the law amendments. For the years before the law amendments, the Court ruled that the Sondervermögen would only meet the conditions (in particular the distribution requirement) of the Dutch FII-regime if it agreed to a so-called “substitution payment”. Through the substitution payment, the Sondervermögen would voluntarily pay a similar amount of WHT as Dutch FII’s would upon (minimum) profit distributions. The Sondervermögen did not agree with the substitution payment and could therefore not apply the Dutch FII-regime.

For the years after the law amendments, the Court ruled that, in principle, the Sondervermögen did meet the conditions for the Dutch FII-regime. According to the Court, the Dutch tax authorities’ argument that profits derived from Dutch real estate assets should be taxed at the level of the participants, is not a formal requirement for non-resident FII’s based on Dutch tax law. However, in order to apply the Dutch FII-regime, the Sondervermögen had to agree to a taxable revaluation of its Dutch real estate assets to fair market value in 2007. The Sondervermögen did not agree with this revaluation and therefore could not apply the Dutch FII-regime.

Relevance for the real estate practice

Non-resident real estate investment funds that meet the requirements of the Dutch FII-regime may benefit from a 0% Dutch CIT rate on Dutch real estate investments. Whether or not the profits derived from Dutch real estate investments are effectively subject to WHT at the level of participants is irrelevant. As a consequence, participants and foreign investment funds applying the Dutch FII-regime are effectively not taxed in the Netherlands on their Dutch real estate income.

We note that the case may be brought to the Dutch Supreme Court who will decide on the application of the Dutch tax law. Furthermore, the Dutch government announced it would evaluate the current FII-regime depending on the Dutch Supreme Court ruling.