Executing Projects in the Netherlands
Some legal and tax aspects of projects intended to be carried out within the Netherlands by foreign companies
By: Hans J. Hoegen Dijkhof

Introduction

The more international business is becoming, the more we see foreign companies carrying out various activities in The Netherlands. We would like to say a few words about some aspects involved therewith. In view of the many aspects involved and the various imponderabilia involved, one cannot be one hundred percent exact in these matters. We therefore provide the reader with a global picture only. There are permit, income tax, social security, corporate tax, contractual and other issues involved.

Work permits and residence permits

We begin with the question of permits for the foreign work force assumed to be involved.

People may be lined up and roaring to go, but will need a work permit and a residence permit. There may be a treaty allowing independent businessmen to establish themselves in The Netherlands, but this does not apply to a work force intending to come and carry out a large project. The normal procedure would then have to be followed. This means that the Dutch authorities should be convinced that everything reasonably possible has been done to attract Dutch workers and if this failed, EU workers and if this failed, then the foreign work force involved can in principle obtain the required permits. Then of course housing problems have to be solved, etc..In connection with the above, one will need detailed advice from a specialist on immigration law, who will burn some hours on this. Of course one also has to take into account what the local trade unions might say, although unions become more and more less representative organizations.

Where a certain country is not yet part of the European Union, the workers may not simply come to The Netherlands to do the job, if there does not yet exist a right of free movement of workers from this State into a Member State of the European Union. An Association Treaty between the non EU State and the European Union may contain a right of settlement of the foreign companies involved in a Member State of the European Union, but usually does not contain the explicit right to bring a (large) number of foreign workers employed by the company – except from “key-personnel” – to the Member State of the EU.

Where an Association Treaty may be rather new and there may be not yet much case law from the European Court, it is not sure if the treaty allows a foreign company to render services in an EU. Member State with a (large) number of foreign workers, who are legally employed by the foreign company. The answer on this question will require study and research, sometimes more than is possible in the timeframe that is available. But usually it is worth to make more enquiries on this subject.

More than one foreign company, from another non EU State may be involved. Also, there may be a company from another EU State involved. Maybe this might be a basis to proceed with, as there is case law of the European Court of Justice saying that a company from one of the Member States of the European Union may render services in one of the other Member States and may bring for this purpose their own staff of workers to render these services. As their own staff of workers also could be considered foreign workers, who are legally employed in that EU State by the EU State company. Required is a legal employment in the other EU State. Maybe that can be arranged.

Taxation of personnel

There may be a double taxation treaty with the foreign non EU State. The situation under this treaty may be as follows.

Under Dutch law, Dutch taxation will largely depend on a person's actual residence. In practice, an expatriate is considered to be a Dutch resident if his family accompanies him to the Netherlands. Married or single, persons are considered to be Dutch residents on the basis of the factual circumstances, particularly personal and economical ties.

Without prejudice to the stipulations of a certain double taxation treaty Country X / The Netherlands preventing double taxation with regard to dual residence, based on the 2001 Dutch Income Tax Act, a resident of the Netherlands owes tax on his income, irrespective of where in the world this is earned. This so-called "world-wide" income therefore also includes foreign income. Owing to the fact that tax may also be levied on this income in another country, this income can incur double taxation: at home and abroad. To avoid double taxation, the Netherlands has concluded tax relief treaties with a number of other countries.

These treaties allocate the right to levy tax on the various sources of income among the different countries involved. Most of these treaties include a provision regulating a country's competence to levy tax on income from employment. Take the provision in the treaty between the Netherlands and Hungary as an example in the following. The majority of treaties contain a similar provision. Section 15, subsection 1 of the Netherlands/Hungary treaty allocates the taxation of income from activities carried out in the Netherlands and performed under an employment contract, to the Netherlands. Section 15, subsection 2 of the treaty makes an exception to this general rule and employment-income earned in the Netherlands, may as yet be taxable in Hungary, if the following conditions are met:

an employee remains in the Netherlands for a period or periods of less than 183 days in a calendar year, and

the remuneration is paid by or on behalf of an employer not a resident of the Netherlands and

the remuneration is not charged as such to a Dutch permanent establishment.

If no appeal can be made to the exception as described above, the foreign employee will be subject to tax in the Netherlands over his labor income. Apart from the two principal taxes, wage and personal income tax, Dutch residents are also subject to certain other taxes and national insurance premiums. As far as I am aware now, there is no social security treaty with Hungary. This means in principle that the Dutch will levy the social security premiums.

Expatriates who temporarily accept employment in the Netherlands, may be eligible for application of the provisions of the 30% tax free allowance legislation, more popularly known as “the 30% ruling”, issued by the Dutch Ministry of Finance, if they have specialist skills. This also applies where the above work permits are concerned. This 30 % ruling is an interesting instrument and allows a flat allowance of 30 % of the salary, after which the other normally available deductions come into the picture. I would say that the above has to be discussed with the local tax people and a solution has to be found in advance, in the form of a ruling. Not only a 30 % ruling, if possible at all, but a ruling for the overall situation of the personnel and in this connection, of the employer involved. The risks are too great otherwise. Wage tax and social security premiums must normally be withheld by the employer and paid by him to the authorities.

Minimum wages

Is there a minimum compulsory monthly salary or hourly salary in the Netherlands? If so how much? Can we include the wages received by a worker in for example Hungary? There is a minimum compulsory salary in the Netherlands.

These amounts stand on their own. Therefore the wages paid cannot be lowered by including the wages received by the employee in for example Hungary. Is there a minimum social security tax payable in the Netherlands? If so, how much?

Indeed the employee owes 29,4% social security contributions on his/her salary (2002). These are the general insurance premiums (AOW / ANW / AWBZ) and are due by the employee. These amounts are withheld by the employer who must then pay these premiums to the Dutch tax-authorities. There is no minimum of general insurance premiums, but there is a maximum. The general insurance premiums are levied only on the first EURO 27.847 of income. The maximum general insurance premiums payable by the employee in one year are therefore EURO 8.186 (29,4% of the maximum premium-income of EURO 27.847).

No WW premiums are due on the first € 55 per day.

There is a 'Law on the Minimum Wages and the Minimum Holiday Allowance' (in Dutch 'Wet Minimumloon en Minimum Vakantiebijslag'), of 27 November 1968 (Stb. 1968, 657). Article 4 of this Law says, in translation by me, in so far as relevant:

For the applicability of what has been determined by or by virtue of this law, an employee is understood as the natural person, who is being employed.

Whoever does not fulfill his employment within the Realm, is only regarded as employee, if he is residing within the Realm and his employer is also residing or established within the Realm. In so far as an employer has within the Realm a permanent establishment for carrying out his business or profession, or has a permanent representative residing or established within the Realm, he is equaled for the application of the previous full sentence with an employer established within the Realm. Whoever is fulfilling his employment as meant in the Law labor Mine building North Sea, is deemed to be an employee at any rate.

By or by virtue of a general administrative decree, it can be determined that persons, who are not residing within the Realm, can also be regarded as employees, in sof ar as they are fulfilling their employment within the Realm.

By or by virtue of a general administrative, a deviation can be made from the contents of the first and second paragraph, with regard to persons, who are only temporarily residing within the Realm, or are only temporarily employed within the Realm.

According to the comments in the loose-leaf 'Employment Agreements' (in Dutch 'Arbeidsovereenkomst'), it ”'has to be assumed that the claim to minimum wages and minimum holiday allowance arises under this Law as soon as a an employee in the

It might also appear desirable to bring groups of persons who are only temporarily employed within the Netherlands outside the scope of applicability of the law. A reason therefore might be present if it appears from the nature of the legal relationship or ' from the nature of the activities that the persons meant cannot be deemed to belong to the Dutch legal sphere. The fourth paragraph opens the possibility to exempt these persons from the scope of applicability of the law. Until now, this possibility has not yet been used.' The Ministry of Labor confirmed this. Relevant would also be the existence of a 'compact' (in Dutch 'CAO', which is the abbreviation for 'collectieve arbeidsovereenkomst”', or 'collective employment agreement'). Such a CAO might contain stipulations requiring that no distinctions of this type shall be made between employees.

The information that a foreign company having foreign employees from the Dutch point of view, working on the basis of a subcontract (entrepreneurship), is not liable to pay to his own employees minimum salaries that would otherwise be payable to Dutch employees, therefore does not seem to be correct. We assume that the foreign company is an 'entrepreneur', not the employees. An employment relationship is very quickly assumed in this country. The key element is being 'subordinated', having to follow instructions.

Changing constructions

Current situations of projects are ever-changing as it happens with such projects all the time, at least according to my personal experience. Sometimes, the corporate/ contractual structure is completely changed. For example, the principal will directly sign up with a German Company (AG) which will have the foreign workers under an employment contract (thus having E101) and this company will basically 'lend' these workers to the working site. This AG has its special license from the EU to carry out such works. This AG will in turn 'borrow' the workers from another German company which has its special license to employ them through its foreign branch office. By the above structure, it is then hoped to avoid non-EU issues and some taxation issues as well. Lawyers will have to study and finalize the structure, together with tax lawyers.

Vat and other numbers to be applied for

One needs to apply for a vat number and for wage tax and social security numbers for the employer. The personnel will have to have a 'sofi' number. This takes some time.

Setting up a branch or a subsidiary

Then the question is, do we set up a branch (with personal liability of the branch manager) or do we set up a separate B.V. company? This to be considered, but we are inclined to recommend a branch. We can set this all up for clients and I think this is the least of the problems. This can be done quickly.

Corporate tax situation of contractor

Then we come to the construction for the employer. Will they have a permanent establishment or not over here? It is rather likely. The duration of 12 months in the double taxation treaty X / The Netherlands is usually exceeded. This constitutes Dutch corporate income tax duty. Then the question arises whether a profit will be made or not and how the taxes will treat this situation. Also here, in my view a prior ruling is needed, to establish what the Taxes want, in terms of corporate tax, in advance. This might also fulfill the requirement to minimize the corporate tax burden. In case of a ruling request, beneficial owners will have to be mentioned and Rotterdam is the central authority for ruling applications.

The taxation of the permanent establishment

We will now deal with the taxation of the permanent establishment in more detail. The reasoning of the Tax authorities seems to be as follows. We specifically reserve a point of view on this reasoning and are only signaling. The basic rule for profit allocation to a permanent establishment is the business split. Seeing the nature of the activities in the Netherlands and the low-risk allegedly connected thereto, a profit will have to be booked. It is up to the tax payer to make acceptable that additional expenses have been made which can be attributed to the Dutch activity.

The theory of determining the profit of a permanent establishment in the case of carrying out of works.

In principle a business is only taxed in the country where it is established. Profits of this business may only be taxed in another country in the event there is a permanent establishment in this other country. The basics for the attribution of profit are laid down in article 7 of the OECD Model Treaty. Paragraph 1 of article 7 reads as follows: “The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to that permanent establishment.” Therefore the result has to be determined in a way in which only those parts are taken into account which can be attributed to the permanent establishment. [ii]

The question is how to determine the advantages which may be attributed to the permanent establishment. The total advantages which are made with the project have to be divided between main establishment and permanent establishment. The advantages which may be attributed to the permanent establishment, will depend on the functions carried out by the permanent establishment. These functions, in combination with the risks connected thereto and the assets used, determine the profit. Article 7 paragraph 2 of the OECD Model Treaty says: “Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State be attributed to that permanent establishment the profits which it might be expected to make if it were a distinct and separate enterprise engaged in the same or similar activities under the same or similar conditions and dealing wholly independently with the enterprise of which it is a permanent establishment.”

From this it appears that the OECD Model Treaty expressly takes the position that the permanent establishment has to deal with the main establishment as if the permanent establishment is an independent third party. [iii] This is a fiction of independence. This fiction means that between main establishment and permanent establishment, the “arms- length” principle is applicable. It has been said in OECD connection, that the “Transfer pricing guidelines for multinational enterprises and tax administration” are also applicable to the relationship main establishment/ permanent establishment. [iv] The Under-Secretary for Finance also confirmed this. [v] The basis for this can be found in article 9 of the OECD Model Treaty.

Article 9 of the OECD Model Treaty provides us with a definition of 'affiliated businesses: Where:

an enterprise of a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or

the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State

and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.'

It has been remarked above that the independence fiction has to be the departure point, to determine the profit of a permanent establishment. However, before a comparison with free market transactions can take place, the functions fulfilled by the parties to the transaction, have to be determined. Depending on the functions fulfilled and taking into account the assets used and the risks run, a comparison can be made with the indemnification agreed to by independent businesses. The process of researching and describing the functions, activities and risks in transactions between affiliated parties, is the carrying out of a 'functional analysis'.

In a functional analysis of the carrying out of works, the following method is applied in main lines:

it is investigated which functions are fulfilled by the permanent establishment and which by the main establishment;

it is determined which assets are being used by the permanent establishment and under what conditions;

it is determined where the various risks of the transactions lie (price risks, financial risks, risk of naught, etc.)

This rounds off the functional analysis. Then the profit allocation follows. This is the attributing of the outputs and expenses to the functions, assets and risks. In principle, the profit will follow from the functional analysis and the profit allocation. The attribution of the outputs and expenses therefore in fact is the mirror image of the functions carried out, the assets used and the risks.

The contents of the project usually are laid down in one or more agreements. These agreements usually go into the tasks and functions of the contractor in detail. Legally speaking, the foreign businessman is the contractor of the project. The phenomenon 'permanent establishment' does not exist in civil law. In fiscal law, the project organization carrying out the work is a “permanent establishment” in the Netherlands. Parts of the project will be carried out by the Dutch permanent establishment and parts by the main establishment.

Based on the agreement and the preliminary calculations made, an analysis can be made to establish which functions can be determined in the project. The analysis has to lead to a chronological overview of functions and risks within the project and a division thereof between permanent establishment and main establishment. This because it cannot be excluded that functions and risks shift during the carrying out of the work, from permanent establishment to main establishment and vice versa.

Subsequently, the profit can be allocated by attributing in the preliminary calculation a businesslike indemnification to each function carried out by the permanent establishment and each risk run by the permanent establishment. In doing so, one should take into account the added value of the relevant function and the risk run. On logical grounds a large part of the expense follows the attribution of the proceeds. In principle at that moment a result of the permanent establishment is known. Proceeds which do not have a direct relationship with the permanent establishment, are attributed to the main house. Of course the expenses relating hereto can then not be allocated to the permanent establishment anymore.

Depending on the circumstances, only a limited number of internal expenses can be deducted from the result of the permanent establishment. These are expenses for special services and expenses of the management. In the event the main establishment supplies a service to the permanent establishment, it is not unreasonable that these expenses will reduce the result of the project. The idea is to invoice these expenses on, based on a key which is justified in view of the specific character of the project. [vi]

The practical application of the profit determination.

The profit determination on the basis of the “cost plus method”, is based on the expenses made by the business or part of the business. Added to these expenses is then a fitting surcharge, to determine an “arms-length profit”, in view of the functions carried out and the risks run. The price established in this way is an arms-length indemnification for the transaction or activity.

The Under-Secretary of Finance (expressed in the Resolution of 25 April 1985 [vii] ) an opinion about the cost plus ruling in the case of activities which have to be qualified as “supporting” or “preparatory” activities. The activities in case of carrying out of work will normally speaking exceed [viii] the level of preparatory and/or supporting work. In the resolution it is however expressly mentioned that profit determination on a cost plus basis is not limited to exclusively the activities mentioned in the resolution. The resolution is an indication to the Tax Department about the height of the surcharge in the case of assisting activities and supporting activities. Where activities are concerned which exceed that level, the percentage will have to be higher.

Which expenses do belong to the basis in the cost plus method? If we answer the question in the framework of carrying out of work, the expenses which have to be deemed to belong to the basis of the arrangement, generally are all expenses which directly are connected with the activities performed by the business of the permanent establishment. In case of carrying out a work these expenses are therefore all project expenses which can be attributed to the permanent establishment, including the expenses which the main establishment invoiced on and which have been invoiced by third parties. This attribution has to flow from the functional analysis. Costs with “disbursement character” can remain outside the basis. These are expenses which in first instance have been paid by the permanent establishment, but generally are invoiced separately to the other party, such as official dues, court dues and expenses of services rendered by third parties. [ix]

The height of the profit surcharge depends on the added value to the project profit by the permanent establishment. In principle, a surcharge of 5% is an arms length indemnification for supporting and preparatory activities and assisting activities as described in the resolution of the Under-Secretary of Finance. [x] As soon as the activities are bigger in size and a certain business risk is run, the percentage can go up to 10 to 15%. Of course this is dependent on concrete facts and circumstances.

In case of application of the cost plus method, the permanent establishment makes a result which is independent of the factual product result. This also goes for that part of the result which is dependent on the factual execution. Think of favorable or unfavorable weather circumstances, quicker or slower building time, to lower or higher expenses, etc. The departure point is that a risk is not run in the permanent establishment with regard to the activities. The permanent establishment only deals with the execution. This also is the justification for a lower surcharge being attributed to the permanent establishment.

The above is the policy conducted by the Netherlands in conformity with the OECD Model Treaty and under double taxation treaties, with regard to the profit determination of permanent establishment.

Offices of the client

Evidently are relatively easy to put in to place.

Contractual aspects

Usually an Operating Company will conclude a contract with one or more Main Contractors, A Main Contractor may then conclude a sub contract with the Operating Company. Operating Company then concludes a sub - sub contract with foreign non EU Company. Who will then actually have to be deemed here in this country to be the employer and set up a branch or subsidiary and have a permanent establishment?

One needs to see copy of the contracts to be concluded or already concluded. At least of the Mirroring Agreements to be signed with a Main Contractor. These contracts will no doubt be complicated and lengthy and refer to certain standard terms which one also needs to see. A work of this size can go wrong in a variety of ways and be a loss maker instead of a money maker. Therefore indeed these contracts and any subcontracts, require close scrutiny. However where one does just provide labor at fixed rates, this may be different.

Further caveats

If you work with 2 different companies, then the danger might be that both are deemed to have a permanent establishment here. I also do not think right now that switching from one offshore company to the other every 11 months or so will work. The Taxes will most probably see through this. If the work is for 12 months and over then we have a permanent establishment. The whole point is that the permanent establishment will usually be there and then one has to pay taxes here. That will be over the profit, which is turnover minus all reasonable costs, etc., or over the deemed profit and that profit will be taxed with 34,5 %, as far as I see it now.

The role of a company can be more or less materially that of an intermediary. One could think of a commission payable. This then has to be usual and acceptable and then should be deductible from the turnover, as a business cost. This will then reduce the profit and thus the tax burden. There will probably also be certain management fees to be invoiced to the permanent establishment.

At the moment it usually looks like it that the permanent establishment will be there and that taxes will have to be paid at the normal level by the permanent establishment unless one could convince the taxes that a cost-plus is applicable here and has to be granted.

But one has to have ammunition for this. The cost-plus is only applicable I think in the case where certain works have to be carried out. Does one carry out certain works or does one just provide a labor force to others, who are carrying out works inter-alia with the people put at their disposal by way of a loan out?

One needs a good tax man who has a good contact with the local Taxes in Rotterdam and who does not exclude that the cost-plus might be granted.

By Hans J. Hoegen Dijkhof
Senior Partner Hoegen Dijkhof Advocaten
The Rembrandt Tower, 13th Floor
Amstelplein 1, 1096 HA AMSTERDAM
Tel: +31 20 462 40 70 , Fax: +31 20 462 40 80
E-mail: HD@HD-DUTCHLAWYERS.NL