Tax Advantages in the Netherlands for Nonresident Taxpayers

by Frank L.M. van den Corput, KPMG Meijburg & Co., Amstelveen
(KPMG Meijburg & Co. in the Netherlands is a member firm of KPMG International)

As of 2001, Dutch nonresident taxpayers can opt to be treated as resident taxpayers of the Netherlands.¹ The benefit of this 'deemed resident' status is that the taxpayer can claim certain tax deductions (for instance, mortgage interest deduction for a non-Dutch principal residence) on his or her Dutch source income, that are not allowed to nonresident taxpayers who did not opt for this special status.

This article describes, with the use of some typical examples, the benefits and frequently overlooked negative consequences of choosing to be treated as a deemed resident taxpayer of the Netherlands. In practice, it appears that only Dutch nationals that have been living near the Dutch borders with Belgium or Germany generally use the special status of deemed resident taxpayer of the Netherlands. Such individuals moved from the Netherlands to less expensive areas in these neighboring countries, but are still working in the Netherlands. Non-Dutch qualifying 'cross border workers' could opt for this special—and very beneficial—status too.

Opting for deemed resident status can be advantageous, if the employee's worldwide income is, to a large extent, subject to Dutch income tax. However, particularly when the deemed resident taxpayer has deductible mortgage interest regarding his or her principal residence (which usually yields the most), there can be a few negative—and often overlooked—consequences. In case facts and circumstances change, the Dutch tax "advantage" from using this option may be (partly) taxed again in the Netherlands.

Residence and Non-residence in the Netherlands

The Dutch tax system distinguishes between resident and nonresident taxpayers. Residence is based upon facts and circumstances. Generally, the nature and length of stay in the Netherlands and whether or not the taxpayer's family accompanies him or her to or from the Netherlands, determine whether the taxpayer's center of economic and social interests lies in the Netherlands, resulting in Dutch residence for tax purposes.

A Dutch resident taxpayer is subject to Dutch taxation on his or her worldwide income (including investment income). Tax deductions (e.g., alimony payments, mortgage interest paid in respect of principal residence) may be claimed.

A Dutch nonresident taxpayer is subject to Dutch taxation on his or her Dutch source income only, and, in general, tax deductions are limited to child-care and annuity premiums.

Background of Deemed Resident Status: Schumacker Case

Basically, in the Schumacker-case (14-2-1995/C-279/93), the European Court of Justice (ECJ) ruled that a European Union (EU) member state is not allowed to treat nonresident taxpayers more disadvantageously than resident taxpayers from a tax perspective, if this nonresident taxpayer earns more than 90 percent of his or her income in that member state.² In such an event, the working state should grant the individual the usual tax credits, allowances, and deductions for personal circumstances, which are applicable to resident taxpayers. The Dutch Ministry of Finance (MoF) responded to this case with the possibility of opting for deemed resident status under the new Dutch Income Tax Act 2001. The MoF claimed that this new legislation went beyond what was required based upon the Schumacker case since nonresidents that make less than 90 percent of their total income in the Netherlands have the opportunity to claim all deductions and credits that resident taxpayers do.

Deemed Resident Status: Conditions

Provided that a nonresident taxpayer has Dutch source income and he or she is a resident of an EU member state or is a resident of a state with which the Netherlands has concluded a tax treaty that contains a provision for the exchange of information, that taxpayer may elect to be taxed as if he or she was a resident of the Netherlands. Please note, that for Swiss residents with Dutch source income, opting is not possible.

Deemed Resident Status: Consequences for Taxable Income

Once the election has been made, it will be applicable for the whole tax year. Such an election will have certain repercussions. On the one hand, the taxpayer who opts for deemed resident status will be taxable in respect of his or her worldwide income in the Netherlands and, therefore, will be able to claim deductions such as alimony and other extraordinary expenses. With a few minor exceptions, all deductions and the income tax part of the Dutch general tax credit can be claimed—in principle, only resident taxpayers are entitled to this. According to the Dutch Income Tax Act, mortgage interest related to the taxpayer's principal residence is, in principle, fully tax deductible. Thus, the deemed resident taxpayer's Dutch taxable income may even be reduced with "negative income" derived from a principal residence outside the Netherlands.

On the other hand, the deemed resident taxpayer will be able to claim relief from double taxation in respect of non-Dutch source income, which is allocated to the resident state according to the applicable tax treaty. This is to escape double taxation, since the taxpayer, as a resident of another state, must report his or her worldwide income in that state as well.

Furthermore, the taxpayer's partner/spouse can qualify as a "partner" according to the Dutch Income Tax Act, which may have additional advantages. If the deemed resident taxpayer owns a foreign principal residence with his fiscal partner/spouse, he or she is entitled to take the deductions only in terms of his or her "personal" part. For instance, if the taxpayer is married "in community of property," he or she could deduct only 50 percent of this negative income. To enable the full deduction, the fiscal partner/spouse can request deemed resident status too (even if he/she does not have Dutch source income). As qualifying fiscal partners/spouses, according to the Dutch Income Tax Act, it is possible to transfer certain parts of their income (such as negative income from their foreign property) to each other's income—this permits a 100-percent deduction from the highest Dutch personal income. However, the deduction is only allowed as long as the taxpayer's spouse does not have the ability to deduct the negative income from a principal residence in another state.

Most Costly Risk: Claw Back if Deemed Resident Status Is Not Requested in Subsequent Year

Opting can be advantageous in a particular year. However, once the choice to be treated as a deemed resident taxpayer is made, there is a claw-back possibility for the Dutch tax authorities.

Once the taxpayer no longer chooses to be treated as a deemed resident taxpayer of the Netherlands, in the last year before the year in which the taxpayer chooses not to be treated as a deemed resident taxpayer anymore, (some of) the deducted amounts of income from eight consecutive years will be added to his or her taxable income. The claw-back clause does not concern deductions such as alimony or other personal deductions and tax credits. However, this claw-back clause does concern deductions of mortgage interest! Consequently, the Dutch tax to be (re) paid could be huge.

Please note that the claw-back clause is only applicable in the year in which the taxpayer has the opportunity of choosing deemed resident status. If the taxpayer is no longer subject to Dutch taxes—for instance, in case of dismissal or death—he or she is unable to choose deemed resident status in the next tax year. Consequently, the claw-back clause would not be applicable then. Thus, once the choice has been made to opt to be treated as a deemed resident taxpayer, and provided that he or she has the ability to choose (e.g., is nonresident and has Dutch source income), the deemed resident taxpayer will more or less be forced to choose each successive year to avoid the expensive claw-back clause, even if there appears to be a small disadvantage by making the choice.

In other words, planning is essential, otherwise leaving the Netherlands from a tax perspective—or on the contrary, moving to the Netherlands—or just returning to the (beneficial) original situation, may be the only escapes.

An Often Overlooked Risk: Making Up with Foreign (Non-Dutch) Source Losses

There are risks once the taxpayer has chosen to opt for deemed resident status. An income change in the next year differing from the original situation can have a considerable negative impact. Additionally, a change in the resident state differing from the original starting point could also decrease the benefits of the deemed resident status.

This is caused by the fact that negative non-Dutch source income, which is offset against positive Dutch income, is more or less carried forward to the next year and/or subsequent years. Once in the future, the negative non-Dutch source income becomes positive, the negative income that has been carried forward over the years will not be subject to relief to avoid double taxation. Negative non-Dutch source income, in this situation, will be the negative income from one's foreign principal residence.

When Is Opting for Deemed Resident Status Beneficial?

As stated above, the benefit of the deemed resident status is that the taxpayer can claim certain tax deductions and credits on his or her Dutch source income, which the taxpayer may not claim in his or her resident state. However, the election will only be advantageous if the employee's worldwide income is, to a large extent, subject to Dutch income tax.

This is caused by the Dutch method of relief to avoid double taxation, determined by a fraction, which includes the foreign source income in the total taxable income and then reduces the Dutch income tax on this total income by that portion which is attributable to the foreign income. With deemed resident status, the final Dutch box 1 income tax is calculated as follows:

The result of this computation is deducted from Dutch income tax on one's worldwide income. The fraction must be positive (and is otherwise zero), so that no relief is granted in case of negative foreign source income.

Opting can be advantageous in a certain year, though that depends on the Dutch position (the level of Dutch positive income compared to the worldwide income). Thus, the benefits could be less in the first and the last years of making this choice, when the Dutch income is relatively smaller. Therefore, timing is critical and professional tax advice is highly recommended.

Examples

Basic examples will help demonstrate how this works out. The below-noted calculations for Dutch income and income taxes are for discussion purposes only and do not take into account social security and the taxes of the resident state.

Case: The taxpayer is resident of Germany. He owns and lives in his house in Germany and his annual mortgage interest is €20,000. The imputed rental income of the house is €2,975. The taxpayer works as an employee 100 percent in the Netherlands and gross employment income is €70,000, before application of the Dutch 30% ruling, the Dutch expatriate tax regime to which he is entitled, and which, simply said, reduces the taxable salary to 70 percent (€49,000) and adds 30 percent (€21,000) as a net allowance.

This results in a negative income from the German principal residence of €17,025, and positive Dutch taxable employment income of €49,000.

Example 1: Advantageous – if Employee's Worldwide Income Is, to a Large Extent, Subject to Dutch Income Tax

Example 2: Not Advantageous — if Employee's Worldwide Income Is Not, to a Large Extent, Subject to Dutch Income Tax

The same as under Example 1, only in this example the taxpayer is working 50 percent in the Netherlands and 50 percent in Germany.

As Examples 1 and 2 show, due to the progression clause in the Dutch method to relieve double taxation, opting for deemed resident status is only beneficial if the assignee's worldwide income is, to a large extent, subject to Dutch income tax.

Example 3: Claw-Back Clause by Not Making Choice

The same as under Example 1 has been applied for tax years 2001, 2002, 2003, and 2004. However, in this example, as of January 2005 and the rest of 2005, the taxpayer is working 50 percent in the Netherlands and 50 percent in Germany. As shown in Example 2, by choosing resident status, he would be, in principle, worse off than by not choosing in 2005.

If, assuming to avoid this loss, the taxpayer would decide not to choose deemed resident status in 2005, the claw-back clause would be applicable, and the 2004 income tax would be revised.

Although he received the benefits of four years €29,268 (4 x 7,317), now, in the end, the taxpayer suffers a loss. Since in 2004, the negative income regarding the German house of 2001, 2002, 2003, and 2004 is added to the taxable income (4 x €17,025 = €68,100)—this constitutes an extra Dutch income tax burden equal to €33,433.

Example 4: Avoiding Claw Back, Though Making Up with Foreign (Non-Dutch) Source Losses

Exactly the same situation as in Example 3 occurs in 2005; however, the taxpayer decides to avoid the claw-back clause by continuing to choose resident status again in 2005, and to take the relatively 'small' loss instead.

Thus, in this situation, avoiding the claw-back clause by continuing to choose resident status becomes more expensive due to the fact that the carried forward negative income must be credited first against any positive income, resulting in no relief to avoid double taxation. In future years, with positive German income, the rest of the carried forward negative German income of €50,125, will need to be credited against any positive income first to receive relief to avoid double taxation.

Conclusion: Opting Is Beneficial, Though Could Lock Taxpayer in a 'Golden Cage'

Nonresident taxpayers can opt to be treated as resident taxpayers of the Netherlands. Opting to be treated as a resident taxpayer in the Netherlands is beneficial if the nonresident taxpayer's income is to a large extent subject to Dutch income tax. It permits, for instance, the deduction of negative income related to one's non-Dutch principal residence (mortgage interest) from Dutch employment income. However, in the case where facts and circumstances change, the tax advantage may be (partly) taxed again in the Netherlands. This can be (partly) avoided by planning the dates, leaving the Netherlands (from a tax perspective), or moving to the Netherlands, or just returning to the (beneficial) original situation. Therefore, the choice to opt for deemed resident taxpayer status should be made only if the taxpayer is aware of all the consequences. Taxpayers that understand and accept that they could more or less lock themselves in a 'golden cage', or fail to consider the potential disadvantages, would be better off not spending any Dutch refunds, but rather, keeping these available for possible future Dutch tax liabilities.

Footnotes:

1 For further information, see R. van der Jagt, "Guidance Made Available on Dutch 30% Ruling," Flash International Executive Alert 2001-187, December 7, 2001.

2 For further analysis of Schumacker and other related cases, and the Dutch tax authorities' actions in light of the cases, see S. H.V. de Vries, "Considering Tax Methodology Options for Dutch Tax Authorities in Light of De Groot Case," The Expatriate Administrator, 2004-01, Spring 2004.