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NID and NIDCo’s: the Belgian corporate tax deduction for risk capital – Belgium’s position as a top European location for foreign investors not jeopardised11/06/2008. Source: Dechert. Eric Deltour, Richard J Temko, Jean-Yves Steyt
 On 26 February 2008 the Belgian Prime Minister Guy Verhofstadt and Belgian Minister of Finance Didier Reynders confirmed that the Notional Interest Deduction (NID), a major stimulus to recent foreign investment in Belgium, would not be withdrawn as some had feared. Their statements finally lifted the political controversy of the last few months as to whether to maintain, amend or even cancel this unique tax investment stimulus which was drawing significant capital funds into the country, and thereby put an end to the legal insecurity resulting therefrom, write Eric Deltour, Richard J Temko, and Jean-Yves Steyt of Dechert.
Background
The NID, introduced at the initiative of the Belgian government in 2005, reinforced Belgium’s position as an attractive location for international investors lured by the European market. The main objective of this unique feature in international tax law was (i) to attract international investors, (ii) to encourage capital intensive investments in Belgium, (iii) to strengthen the financial position of companies by stimulating equity financing, and (iv) to simultaneously lower the effective corporate tax rate for all companies subject to Belgian corporate tax.
NID was introduced by the Belgian Law of June 22, 2005, and entered into effect in 2006. The timing of this new legislation must be viewed in the context of the legal debate a few years ago questioning the conformity with EU Law of the Belgian coordination centre regime (“BCC”) which had been introduced in 1983 and whose main feature was not to tax interest earned from intragroup financing activities at the level of the coordination center. In 2003 the European Commission decided that the BCC regime constituted a prohibited state aid under EU law, a conclusion which was largely confirmed by the Court of Justice of the European Communities. Although Belgium was nevertheless allowed to apply a transitional phase-out period for this tax regime, the government immediately sought ways to set off the resulting cutback in tax competitiveness in order to maintain and even improve the country’s position as a top European location attractive to foreign investors. It is in this context that NID was conceived. Contrary to the BCC regime, NID is not susceptible to being challenged as a prohibited EU State Aid since it applies to both Belgian and foreign companies with a taxable presence in Belgium.
What is NID?
The underlying idea of NID is to provide for a similar tax treatment whether company’s activities are funded by shareholder equity or by debt (loans and bonds). Stated otherwise, NID aims at narrowing or bridging the gap between the formerly existing “discrimination” between companies that on the one hand use their own capital to invest (which is remunerated through dividend payments which are not tax deductible), and on the other hand companies funding their activities through debt (which is remunerated through tax-deductible interest).
This has practically been implemented through a unique tax provision allowing Belgian companies and Belgian branches of foreign companies to deduct a fictitious or deemed (“notional”) interest charge from their annual taxable income. It is a fictitious interest charge because the company does not actually incur any interest expense with respect to its own share capital. The amount of the deduction is calculated on the basis of the company’s equity (the company’s “risk capital”), subject however to a number of adjustments (excluded items) in order to avoid double use of tax deductions and/or abuses. The equity to be considered is the company’s equity under Belgian GAAP in the opening balance sheet of the taxable period and includes the share capital, share premiums, profits carried-forward and other reserves (legal reserve, nondistributable reserve, tax-exempt reserves and distributable reserves). Changes during the financial year, such as capital increases or redemptions, are taken into account. A specific rate is then applied to the company’s adjusted risk capital. Such rate is based on the average annual interest rate on Belgian 10-year government bonds, and is subject to an annual review by the Belgian government. For the tax year 2009 (i.e., accounting year 2008 for calendar-year taxpayers) the NID rate is 4.307%.5 In other words, the formula is currently:
NID = (equity – excluded items) x 4.307%
A brief example for demonstration purposes: Company A has an adjusted share capital of 100,000 euros and a profit before tax of 50,000. Without the NID the corporate tax of 33.99% would be applied on 50,000; with the NID, the corporate tax is only applied on 50,000 – (100,000 x 4.307%) = 45,693. Subject to the specific circumstances of each case, NID can therefore constitute a substantial structural reduction to the effective tax rate, proportionate to the invested equity.
The adjusted equity corresponds to the equity minus a number of items, mainly (i) the net fiscal value of shareholdings recorded as financial fixed assets (depending on each specific case, this can substantially or entirely reduce the NID base), (ii) the net fiscal value of the shares the company holds in its own share capital, (iii) the net fiscal value of shares in collective investment companies the dividends of which qualify for the dividends-received deduction, (iv) the net assets of foreign permanent establishments located in countries with which a double taxation treaty has been concluded, (v) the net accounting value of foreign real property located in countries with which a double taxation treaty has been entered into, (vi) subsidies, tangible fixed assets whose attendant costs are unreasonably high, and (vii) other investments that are not acquired in order to produce a regular income for the company.
NID is recurrent in the sense that the notional interest is deducted every year again on the company’s adjusted equity. Furthermore, the portion of the NID amount which cannot be (fully) deducted from the company’s taxable base in a given taxable period (referred to as excess or unused NID) can be carried forward for seven years. Note however that NID cannot be carried forward in the event of a change of control of the company if the change of control does not respond to legitimate financial or economic needs in the sense of article 344 § 1 of the Belgian Income Tax Code. Furthermore, NID is subject to a number of restrictions, such as the unavailability of this regime for certain companies (such as BCCs) and the fact that the NID amount cannot be immediately distributed to the shareholders but must remain in the company for at least three years.
Why are NIDCo’s attractive vehicles for foreign investors focusing on the EU?
NID interacts with several other business-friendly tax measures which attracted many foreign investors using Belgium as their European hub. Special reference can be made to the EU Parent-Subsidiary Directive, pursuant to which dividends paid to a parent company in another EU Member State are exempt from withholding tax in the source state and exempt from further taxation in the state of receipt—subject to conditions such as a minimum holding percentage of 15% (10% as of January 1, 2009) and a minimum holding period requirement of twelve months—as well as to the Belgian Royal Decree of December 21, 2006, which extends the benefit of the Belgian witholding tax exemption under the EU Parent- Subsidiary Directive to dividends paid to companies established in countries that have entered into a double taxation treaty with Belgium.
Because of such interaction, operating in Europe through a Belgian NIDCo vehicle offers attractive tax planning opportunities to international investors operating in the European Union. Another brief example: a parent company (U.S.Co) contributes capital to its wholly owned Belgian subsidiary (NIDCo). No capital registration tax is due any longer on such a contribution. The contributed capital will increase the NID base of NIDCo, which uses the capital to provide inter-company loans to other subsidiaries wholly owned by the U.S.Co in France (FrCo), Italy (ItCo) and Portugal (PoCo). The interest paid by the latter subsidiaries to NIDCo is deductible from their taxable bases. The dividends paid by NIDCo to U.S.Co would benefit from withholding tax (WHT) exemption under the U.S./Belgian income tax treaty. If NIDCo were held by U.S.Co through an EU parent company located in another EU Member State, the European participation exemption would be available (subject to the relevant conditions) for the dividends received by the latter from its Belgian subsidiary.
Recent Developments
Since its introduction, this tax measure appears to have proven to be successful in accomplishing the stated objectives. It is considered that NID has attracted many foreign investors and generated substantial new jobs in Belgium. It also appears that Belgian companies, in order to maximize their NID benefits, performed capital increases for an overall amount of 48.7 billion Euro in 2006 as compared to 5 billion Euro back in 2005.
It is worthwhile noting that at the end of 2006 a proposal was made to the Parliament of the Grand Duchy of Luxembourg to introduce a NID system in that country’s corporate tax regime. The proposal was, however, finally rejected in 2008 for technical reasons.
In Belgium, especially during the last several months, in the context of the formation of a new Belgian government, certain politicians have expressed concerns with regard to the budgetary impact of NID for the Belgian treasury. The importance for Belgium of maintaining NID is crucial and has therefore been supported by most business organizations. Many of the latter even strongly advocate a further reduction of the current corporate tax rate set currently at 33.99%.
Conclusion
The main feature of NID is that it interacts with several other attractive tax measures available in Belgium, such as but not limited to (always subject to the relevant conditions) the 95% intercorporate dividends-received deduction, the full exemption for capital gains on share participations, the extension of the full exemption from Belgian withholding tax on outgoing dividends paid to substantial shareholders located in other EU countries to payment to substantial shareholders in countries with which Belgium has signed a double taxation treaty, the recent patent royalties deduction,9 the prior loss deduction, the investment deduction, the broad system of advance tax rulings (binding upon the tax authorities) and Belgian’s extensive tax treaty network. It is the combination of such competitive tax measures which makes Belgium a choice location for foreign investors. And NID is now playing a key role in this overall Belgian tax environment to attract additional foreign investors.
Dechert is an international law firm with over 700 attorneys. It provides practical business solutions to a diverse client base. For more information please visit www.dechert.com.
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