Profit adjustments arising from transfer pricing discussions

Since the last decade, the Dutch tax authorities have become increasingly alert for transfer pricing issues.

The fact that foreign investors could repatriate their profits from The Netherlands through unlimited, sometimes even fictitious cost charges, is definitely over. Also in The Netherlands there is an increased alertness for transactions which (may) evade the Dutch tax base.

You may also assume that the topic of transfer pricing is a standard (and priority) subject of investigation in tax audits and processing of tax returns.

Foreign investors which do business in The Netherlands can no longer afford not to pay attention to this subject. They must be prepared for scrutiny from the Dutch tax office with regard to internal prices for services rendered and goods delivered to/by Dutch entities within the group.

When an entity trades with a related party, the price setting can be influenced by shareholders motives. The profit allocation between related parties is thus not per definition businesslike.

The Dutch transfer pricing rules are in fact an instrument for the Dutch tax authorities to adjust non-businesslike price settings between related parties. Subsequently, profit adjustments aiming to adjust such non-businesslike price settings between affiliated companies (transfer pricing adjustments) can occur.

Transfer pricing adjustments can typically occur as a consequence of processing a tax payer’s tax return, a tax audit or upon the tax payers own instigation, by voluntary adjustment in the tax return filed (with or without an advance tax ruling). Also the information provided by the tax payer in the context of the Country by Country Reporting can form the basis for scrutiny for the transfer pricing of a tax payer which can then result in profit adjustments.

Transfer pricing adjustments can relate to the taxable basis for the levy of Dutch corporate income tax, Dutch dividend withholding tax, or to the levy of transaction taxes, such as the Dutch real estate transfer tax. Transfer prices may also be adjusted for the levy of indirect taxes such as custom duties or VAT. For the levy of custom duties in The Netherlands special transfer pricing rules apply, which will not be further elaborated on.

The primary adjustment is usually relating to the levy of the Dutch corporate income tax. Adjustment for other taxes then follow as secondary adjustments.

For Dutch tax purposes a company’s annual accounts are the basis for profit determination. The annual accounts should properly reflect the financial position of a company, with the profit and the equity as key parameters. Corporate income tax is assessed on taxable profits. The annual taxable profit for corporate income tax purposes is determined consistently in accordance with the legal concept of "sound business practice" that may differ from generally accepted accounting principles: for example, trading income and capital gains are not separately distinguished; both are included in the taxable profits.

The concept of sound business practice is not defined in law and is predominantly developed in case law. It is based on general accepted accounting principles with certain adjustments for tax purposes (exemptions etc.) which may lead to either permanent or temporarily differences between the fiscal profit and the profit according to the annual accounts.

If profits are adjusted for the levy of corporate income tax, there can be secondary tax consequences. For example: if it has been established that a Dutch tax payer reported too little profits on a transaction with a related party, the taxable profits may be increased. Such an upward profit adjustment, may be accompanied by the assumption of a (deemed) dividend which may trigger the levy of Dutch dividend withholding tax.

If a profit adjustment relates to a cross border transaction, the tax authorities of the state where other involved parties are established may be forced to allow a corresponding profit tax adjustment on the bases of an applicable Dutch tax treaty.