Requirement for Tax Substance in Tax Planning Designs

Oct 28, 2018

Requirement for Tax Substance in Tax Planning Designs

The concept of substance over the legal form has become crucial in the rightful representation as well as the reliability of info captured in financial statements. The main goal of the concept is ensuring that all business transactions are presented in a manner that demonstrates the real position of the business.

This post demonstrates how the principle applies outside the focus of financial statements. In particular, it looks at how it affects the larger tax planning community.

A closer look at the concept of substance over the legal form

The concept, substance over the legal form enables the tax authorities to set aside the legal form of a business and take a glance at what actually took place in transactions. The aim is preventing the artificial structure from abuse especially through tax avoidance.

For any company to enjoy a beneficial tax regime (jurisdiction with lower tax rates), it is required to comply with tax substance requirements set by the tax authorities. These requirements often vary from one country to another. Here is an outline of these requirements;

The substance of the business structure includes things such as location (physical presence) and presence of all the operational components such as staff, assets, and directors.
The substance of the business transactions revolves around the nature and where the transactions were done. It also seeks to answer the question, “How does the party benefit?”

A glance at the tax rulings in the Netherlands

The Netherlands, one of the countries with a very advanced mechanism of real substance identification uses a system referred to as tax rulings. The tax ruling is a confirmation from the tax authorities that allow business owners to establish well in advance the tax burden, their rights, and duties in various circumstances.

The tax ruling framework uses two types of agreements from the tax authorities; the advance tax ruling and advance pricing agreement.

The advance tax ruling is an agreement based on the Dutch tax system classification of international businesses based on the applicability of participation exemption as well a permanent establishment.
The advance pricing agreement is an agreement that approves the determination of the method of calculating profit in relation to cross-border transactions between a company and foreign establishments.

In order for a tax ruling to be issued, the tax authorities must ensure that the cross-border transactions where a Dutch company is a party actually took place. Here are the requirements for tax substance.

Half of the company’s managing directors reside in the Netherlands.
Managing director resides in the Netherlands and is qualified for the position.
The company has salaried employees.
The company has running bank accounts in the Netherlands.
Bookkeeping is done in the Netherlands.
The company has met all fiscal obligations.

Steps to make your company demonstrate substance

Having looked at the case of the Netherlands, the main question remains, how can you demonstrate substance in your situation? Like in the Netherlands, the concept of substance is tailor-made. This implies that any attempt to generalize the books or presentation will not work.

The target for your business should be redefining your operational goals and make the operations open. Here are some of the ready solutions to help you demonstrate substance:

Always seek a tax opinion about transactions and the entire concept of tax substance in relation to your enterprise.
Make sure to follow proportionality when distributing the business functions, losses, profits, and assets.
Ensure to maintain a functional office with all the functions such as staff and assets.
Keep the business records well and continuously develop the company.
Comply with all the tax and other laws in the country of operations.

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