Japan and the Netherlands sign new tax treaty - Ernst & Young T ...

7 September 2010
International
Tax Alert
Japan and the Netherlands
sign new tax treaty
Executive summary
On 25 August 2010, the Ministry of Finance of Japan and the Ministry of
Finance of the Netherlands announced that they signed a new tax treaty
(New Treaty) for the avoidance of double taxation.
The New Treaty contains reduced withholding rates primarily for
dividends, interest and royalties to encourage mutual investments and
trade between Japan and the Netherlands. Following the trend of recent
treaties concluded by Japan, the New Treaty contains various provisions
to prevent treaty abuse (among others, a new Limitation on Benefits
(LOB) article , a provision for hybrid entities, as well as (in the Protocol) a
provision allowing Japan to tax distributions from a Tokumei Kumiai (TK)
agreement).
To enhance mutual investments, the following reduced withholding tax
rates are proposed:
Dividends
Qualifying dividends
(Minimum shareholding) Other
Interest Royalties
Current treaty 5% (25%) 15% 10% 10%
New treaty
0% (50%)
5% (10%)
10%
0% (e.g., banks)
10% (other)
Both countries have stated their intent to implement the treaty before 1
January 2011, although this target date may be optimistic.
The New Treaty is an important improvement to the current treaty and
would encourage investments from Japan into the Netherlands, and vice
versa. In addition, the New Treaty should enable certain United States
and other foreign investors to invest in Japan through the Netherlands
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and benefit from the reduced
withholding tax rates, including
the 0% withholding tax rate for
dividends, and other benefits of the
treaty.
Main features
Residence
A person is considered resident of
a country if such person is liable to
tax under the laws of that country
by reason of his domicile, residence,
place of head office, place of
management or any other criterion
of a similar nature. This definition
also applies to a qualifying pension
fund. In the case of dual residency,
a person (other than an individual)
shall be deemed to be resident
in the country where its head (or
main) office is located.
Dividend income
The general withholding tax rate
on dividend distributions is limited
to 10%. The withholding tax rate is
reduced to 5% for situations where
the recipient of the dividends is
a company that is the beneficial
owner of shares representing at
least 10% of the voting rights of the
company making the distribution,
provided it has owned those
shares for a period of at least
6 months before the dividend
is determined. Dividends are
exempt from withholding tax if the
company receiving the dividends
is the beneficial owner and owns
shares representing at least 50% of
the voting power of the company
making the distribution, and has
owned those shares for a period
of 6 months ending on the date on
which entitlement to the dividends
is determined. In addition, to be
eligible for the zero withholding
tax rate, the receiving entity must
meet one of the conditions under
the LOB provision as detailed below.
The full exemption of withholding
tax on dividend distributions applies
also to any distributions made to
pension funds that meet the LOB
provision.
The reduced dividend withholding
tax rates are not available for
certain deductible dividends, such
as distributions from a REIT, and
dividends paid on certain preferred
shares or other similar interests
unless an ultimate beneficial owner
is a resident of a 3rd country and a
treaty between the payor country
and the 3rd country provides
equivalent or more favourable
benefits if the 3rd country resident
owned equivalent preferred shares
or other similar interests.
With respect to the Netherlands,
liquidation distributions or income
from the buyback of shares fall
under the dividend article.
Interest income
The withholding tax rate on interest
payments remains at 10%, provided
the recipient is the beneficial
owner of the interest income. If
the beneficial owner meets the
LOB provisions, a full exemption
from withholding tax on interest is
granted if the interest is beneficially
owned by:
1. the government, political
subdivision or local authority
of the country of which
the recipient is a resident,
including the central bank or
any institution owned by that
government;
International Tax Alert
2. a resident on debt-claims
guaranteed, insured or
indirectly financed by any of the
government institutions included
under point 1. above;
3. a resident that is a bank,
insurance company, securities
company or any other enterprise
that in the 3 years preceding the
interest payment derived more
than 50% of its liabilities from
bonds issued in the financial
markets or from taking deposits
and more than 50% of the assets
consist of debt-claims against
persons that are not considered
associated companies as defined
under Article 9 of the New
Treaty;
4. a pension fund;
5. a resident and is paid with
respect to debt resulting
from the sale on credit of any
equipment, merchandise or
service;
The 10% and 0% rates will not
apply in the case of interest paid
on debt-claims if the entity owning
that debt-claim owes interest on the
debt-claim to another person that
would not have been able to enjoy
the same (or better) withholding
tax rates if it would have owned the
debt-claim against the entity that
pays the interest directly.
Royalty income
Royalty payments are fully
exempt from withholding tax if the
recipient is the beneficial owner of
the royalties and meets the LOB
provision.

The exemption of withholding
tax will not apply if the entity
receiving the royalties for the use
of intangible property pays royalties
for the use of the same intangible
property to another person that
would not have been able to enjoy
the same (or better) withholding tax
rates if it would have received the
royalties for the use of intangible
property directly (from the endlicensee).
Capital gains
Capital gains derived by a resident
arising from the disposal of
immovable property will be taxable
in the country where the immovable
property is located.
Capital gains derived by a resident
from the disposal of shares in a
company, interest in a partnership
or trust where the value of such
shares or interest consists directly
or indirectly of more than 50% of
immovable property located in
the other country may be taxed
in the other country unless the
relevant class of the shares or
interest is traded on a recognized
stock exchange specified in the
LOB provision and that resident
and related persons own in the
aggregate 5% or less of that class of
shares or interest.
Capital gains on shares acquired by
a resident after the entry into force
of the New Treaty in a financial
institution of the other country,
which receives substantial financial
assistance from the other country
in connection with imminent
insolvency of that financial
institution will be taxable in the
other country for a period of 5
years after the financial assistance
has started.
Taxation rights with regard to other
capital gains are exclusively granted
to the resident country, following
the normal OECD treaty provision,
which means that for disposal of
shares the right to levy capital gains
is allocated to the country of the
alienator.
Capital gain treaty protection is only
available if the resident satisfies the
LOB provision.
TK distributions
Any income or gains derived by a
resident of the Netherlands from
a TK, a silent partnership, or other
similar contract, may be taxed
by Japan in accordance with its
domestic laws.
Other income
Other income is generally taxable
only in the resident country of the
beneficial owner of such income.
However, in cases where, due to a
special relationship between the
resident and the payor, or between
them and a third person, the
amount of other income exceeds
the arm’s length amount of income,
the excess amount of other income
may be taxed in both countries
according to their domestic laws.
Hybrid entities
Detailed rules apply to determine
if, and under which conditions,
treaty benefits will be applicable to
income derived by hybrid entities.
In essence, these rules are aimed
International Tax Alert
at avoiding abuse of the treaty
in situations where an entity is
treated differently in the two treaty
countries.
LOB provisions
Perhaps the most important change
in the New Treaty is the introduction
of a so-called Limitation on Benefits
provision. Broadly speaking, this
provision aims to prevent non-
Japanese and non-Dutch investors
from accessing treaty benefits that
they would otherwise be unable
to obtain by investing directly
into either country. In general,
genuine Japanese investors/
companies investing in/or through
the Netherlands and genuine Dutch
investors/companies investing in/
or through Japan should have
access to the benefits of the New
Treaty. Moreover, United States
and other foreign investors could
also benefit from the New Treaty
benefits, including the 0% dividend
withholding tax rate and capital
gains tax protection, accorded
to Japanese and Dutch residents
under various LOB applications,
including the equivalent beneficiary
test for listed companies and
certain other qualifying investors,
the active trade or business test, or
the headquarters test.
With respect to dividends and
interest, the LOB provision is only
relevant when the full exemption
from withholding tax is applied
for. In addition, the LOB provision
applies to all royalties, capital gains
and so-called ”other income.”
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Under the LOB provision, a resident
of a country enjoying benefits
as described in the previous
sentence will only be entitled to
such benefits if such resident is
a qualifying person as stipulated
in the New Treaty. Nevertheless,
even if a resident does not satisfy
the qualifying person test, treaty
benefits may still be available if
one of the following tests is met:
equivalent beneficiary test, active
trade or business test, headquarter
test, or competent authority test.
Elimination of double taxation
The provisions are generally in line
with OECD standards as well as
other recently concluded treaties
by Japan and the Netherlands.
The most notable aspect in this
article is that Japan will exclude
dividends received from a Dutch
subsidiary in accordance with its
domestic provisions (i.e., effectively
95% of the dividend will be exempt
from Japanese tax) provided the
Japanese company owns at least
10% of the voting shares (or total
shares) of the Dutch subsidiary.
Whereas under its domestic law,
Japan only exempts dividends if a
Japanese company owns at least
25% of the shares in a foreign
subsidiary.
Mutual Agreements Procedure
The New Treaty contains a
mandatory arbitration provision.
Under this provision, if both
countries do not reach resolution on
the disputed item within two years,
such dispute will be submitted to
an arbitration panel for mandatory
arbitration, so that in the end
resolution is always achieved. This
new procedure may also apply to
disputes that are or can be dealt
with under the Mutual Agreement
Procedure of the current treaty.
It should be noted that this is the
first treaty for Japan with such a
provision.
Entry into force
The treaty will enter into force
on the 30th day after Japan and
the Netherlands have exchanged
diplomatic notes indicating that for
both countries the treaty has been
approved in accordance with the
legal procedures of each country
(ratification). Depending on when
these ratification procedures are
completed the treaty provisions
may have effect as early as from 1
January 2011.
If a person under the current treaty
is entitled to greater benefits than
under the new treaty such person
can elect for the current treaty to
remain effective in its entirety for
a period of 12 months from the
date the new treaty would normally
have become effective as described
above.
Conclusions
Based on the published text, the
New Treaty is clearly an important
improvement to the current treaty.
The reduced withholding tax rates
should especially be of interest to
International Tax Alert
multinational groups. The capital
gains article remains favourable,
most importantly for investments
in Japan, as compared to other
treaties concluded by Japan.
The LOB provision may affect thirdcountry
investors who make use
of the current Japan-Netherlands
treaty. Such investors should review
the impact of the New Treaty on
their existing investment structure.
However, United States and other
foreign investors could enjoy the
reduced withholding tax rates and
other treaty benefits of the New
Treaty, including the 0% dividend
withholding tax rate and capital
gains tax protection, under various
LOB applications.
Investors investing in a TK or TMK
through the Netherlands should
review the impact of proposed
changes in the treaty to such
vehicles.
For situations where hybrid entities
are used, the impact of the new
treaty needs to be reviewed.
The published treaty, including
the protocol, provides clarity.
Nevertheless, it can be expected
that the interpretation of certain
terms and provisions will be
clarified further once the Japanese
and Dutch governments issue their
Memorandum of Explanation in
connection with the ratification
of the treaty in their respective
parliaments.

For additional information with respect to this alert, please contact the following:
Ernst & Young LLP, Belgium-Netherlands Tax Desk, New York
• Roderik Rademakers +1 212 773 3390 roderik.rademakers@ey.com
• Klaas Jan Visser +1 212 773 2569 klaasjan.visser@ey.com
• Rienk Kamphuis +1 212 773 4933 rienk.kamphuis@ey.com
• Sebastiaan Kuijper +1 212 773 5187 sebastiaan.kuijper@ey.com
• Dirk Jan Sloof +1 212 773 4869 dirkjan.sloof@ey.com
• Linda Herms +1 212 773 6811 linda.herms@ey.com
• Najib Aheztan, FSO +1 212 773 6213 najib.aheztan@ey.com
• Hans van Haelst, Belgium Tax +1 212 773 7907 hans.vanhaelst@ey.com
Ernst & Young LLP, Belgium-Netherlands Tax Desk, Chicago
• Frank Schoon +1 312 879 5508 frank.schoon@ey.com
• Sebastiaan Boers +1 312 879 3726 sebastiaan.boers@ey.com
Ernst & Young LLP, Belgium-Netherlands Tax Desk, San Jose
• Frank Van Hulsen +1 408 947 6503 frank.vanhulsen@ey.com
• Joost Iding +1 408 947 5617 joost.iding@ey.com
Ernst & Young LLP, Asia Pacific Business Group, New York
• Jeff Hongo +1 212 773 6143 jeff.hongo@ey.com
• Kazuyo Parsch +1 212 773 7201 kazuyo.parsch@ey.com
Ernst & Young Shinnihon Tax, Tokyo
• Chizuko Tomita +81 3 3506 2111 chizuko.tomita@jp.ey.com
• Koichi Sekiya +81 3 3506 2447 Koichi.sekiya@jp.ey.com
International Tax Alert
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International Tax Services
• Global ITS, Jim Tobin, New York
• Americas, Jeffrey Michalak, Detroit
• Asia Pacific, Alice Chan, Shanghai
• Europe, Middle East, India and Africa, Alex Postma, London
• Japan, Kai Hielscher, Tokyo
• Latin America, Alberto Lopez, New York
• Argentina Carlos Casanovas Buenos Aires
• Australia Daryn Moore Sydney
• Austria Roland Rief Vienna
• Belgium Herwig Joosten Brussels
• Brazil Gil Mendes Sao Paulo
• Canada George Guedikian Toronto
• Central America Rafael Sayagues San José
• Chile Osiel Gonzalez Santiago
• China Becky Lai Beijing
• Colombia Ximena Zuluaga Bogota
• Czech Republic Libor Frýzek Prague
• Denmark Niels Josephsen Soborg
• Finland Katri Nygård Helsinki
• France Claire Acard Paris
Régis Houriez Paris
• Germany Stefan Koehler Frankfurt
• Hong Kong Chris Finnerty Hong Kong
• Hungary Botond Rencz Budapest
Balazs Szolgyemy Budapest
• India Vijay Iyer Bangalore
• Ireland Kevin McLoughlin Dublin
• Israel Sharon Shulman Tel Aviv
• Italy Mario Ferrol Milan
Gaetano Pizzitola Rome
• Japan Kai Hielscher Tokyo
• Korea Kyung-Tae Ko Seoul
• Luxembourg Frank Muntendam Luxembourg
• Malaysia Hock Khoon Lee Kuala Lumpur
• Mexico Koen van ‘t Hek Mexico City
• Middle East Tobias Lintvelt Abu Dhabi
• Middle East Michelle Kotze Dubai
• Netherlands Johan van den Bos Amsterdam
• Norway Oyvind Hovland Oslo
• Peru Roberto Cores Lima
• Philippines Ma Fides Balili Makati City
• Poland Lukasz Ziolek Warsaw
• Portugal Antonio Neves Lisbon
• Russia Vladimir Zheltonogov Moscow
• Singapore Andy Baik Singapore
• South Africa Corlie Hazell Johannesburg
• Spain Federico Linares Madrid
• Sweden Erik Hultman Stockholm
• Switzerland Markus F. Huber Zurich
• Taiwan Jennifer Williams Taipei
• Thailand Yupa Wichitkraisorn Bangkok
• Turkey Feridun Gungor Istanbul
• United Kingdom Matthew Mealey London
Jim Charlton London
• United States Jeffrey Michalak Detroit
Phil Green New York
• Venezuela Jose Velazquez Caracas
• Vietnam Carlos Llanes Navarro Bogota
6 International Tax Alert
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