Netherlands Income Incentives Similar to ITC Are Not Treated As Foreign Taxes Paid and Are Not Eligible for Foreign Tax Credit

UIL Number(s) 0901.00-00

(2) Whether the WIR premium should be treated as reducing Netherlands income taxes paid if, pursuant to a change in Netherlands law, the premium may only be used to offset Netherlands income tax assessments and, to the extent the premium exceeds the tax liability, it may not be paid to the investor in cash but can be carried back 3 years and forward 8 years to reduce Netherlands income tax liability ("nonrefundable WIR premium").

(2) Where the Netherlands law has been changed so that the WIR premium can only be used to offset Netherlands income tax assessments, the WIR premium should be treated as a refund or credit which reduces Netherlands income taxes paid under Treas. Reg. 1.901- 2(e)(2) because the investor can only receive the benefit of the nonrefundable WIR premium as a reduction in income tax liability.

To be eligible for the premium an asset must be situated in the Netherlands and the minimum investment in qualified assets must be at least Dfl. 2800 (indexed) in any calendar year. The asset must be acquired from unrelated persons. The premium is not allowed on the cost of land, and personal use property is not eligible for the premium. Investments in buildings 70 percent or more of which will be rented to other persons are eligible for the WIR premium only if the building is new, the acquisition of the building is not part of a sale-leaseback transaction, the tenants of the building are subject to the corporate income tax, and the investor, if a corporation, is not held by 25 or fewer shareholders. Investments in buildings and other immovable property with a social, cultural or sports function are not eligible for the premium.

The amount of the WIR premium is not included in Netherlands taxable income and the premium does not reduce the Netherlands depreciable basis of the asset. The premium is effectively allowable in the year or years in which the expenditures to acquire the asset are made.

If an asset for which a WIR premium has been allowed is disposed of within 8 years, the premium is recaptured in the same proportion as the amount received for the asset bears to the original cost. Recaptured premiums are not deductible from Netherlands taxable income and do not affect the calculation of gain or loss on the disposition of the asset for Netherlands income tax purposes.

Under former Netherlands law, payment of the allowable WIR premiums by the government to the investor (and repayment of recaptured premiums to the government by the investor on the disposition of an asset) was effected through the tax assessment system, but the allowance of a premium was not a function of the investor's tax liability. The investor, whether a resident or a non- resident, would claim a credit or offset against the corporate or individual income tax assessment for the amount of WIR premiums due, and show an addition to tax for recaptured premiums. Under prior law however, if the amount of premiums due the investor exceeded the tax assessment (or if there is no tax liability) the excess was paid in cash to the investor by the Dutch government.

We understand that legislation enacted recently by the Netherlands Parliament eliminates the refundable feature of the WIR premium. Under the new legislation, an excess of current WIR premiums over the current year's income tax assessment is not paid in cash to the investor, but is allowed to be carried back 3 years and then carried forward 8 years (or carried forward without limitation in the case of start-up companies) until used against the investor's income tax liability. These are the same periods over which Dutch net operating losses may be carried. We do not know the effective date of the new islation. At one time it was reported as May 1, 1986; in another report it was the first day of the calendar month following the date of publication of the new legislation. We also do not have any information regarding transitional rules. ¹

In summary, the essential qualifications for the investment premiums under former Netherlands law appear to be twofold: a qualified asset must be placed in service in a trade or business in the Netherlands, and the investor must be potentially subject to the Netherlands corporation or individual income tax. The new legislation adds a third requirement that the premium may only be claimed as a credit against the Netherlands income tax liability.

REFUND OR CREDIT

Treas. Reg. 1.901-2(e)(2)(i) provides that an amount is not tax paid to a foreign country to the extent that it is reasonably certain that the amount will be refunded, credited, rebated, abated or forgiven. This rule is illustrated by example (2) of Treas. Reg. 1.901-2(e)(2)(ii), where an initial foreign income tax liability of 100u is reduced under foreign law by an investment credit of 15u and a charitable contributions credit of 5u. Example (2) holds that the amount of foreign income tax paid is 80u. Thus, the investment credit must be treated as reducing the amount of foreign income tax paid. The change in the Netherlands law eliminating the cash refund (negative assessment) feature brings WIR premiums subject to the new Dutch law squarely within Treas. Reg. 1.901-2(e)(2) and example (2) which require that "investment credits" reasonably certain to be creditable against a foreign income tax must be treated as a reduction in the amount of the income tax paid. Because the WIR premiums can only be taken against Netherlands income tax assessments under the new legislation, the WIR premium should be characterized as a refund or credit of Netherlands tax which reduces the amount of Netherlands income tax paid or accrued for purposes of the U.S. foreign tax credit.

Treas. Reg. 1.901-2(e)(2) and example (2), however, do not address a situation in which the amount of the investment credit is offset against the tax liability but would also be paid in cash to the taxpayer to the extent the taxpayer's income tax liability were less than the amount of the allowable investment credit. Under former Netherlands law, in contrast to the new legislation, the allowable WIR premium was paid to the taxpayer who invests in qualifying assets without regard to the taxpayer's Netherlands income tax liability; although the premiums first were used to reduce the current year's Netherlands income tax assessment, any excess of allowable premiums over the amount of the current year's income tax assessment was paid to the taxpayer in cash. Under the former law, because the taxpayer received the full amount of the WIR premium, either in cash or as an offset against the current income tax assessment, the crediting of WIR premiums against the tax assessment should be viewed as the means of payment of the premium, and not as a refund, credit, abatement or forgiveness of Netherlands income tax liability within the meaning of Treas. Reg. 1.901-2(e)(2).

Our conclusion that the WIR premium under prior Netherlands law is not a refund or credit of the foreign tax might be different if the premium were structured so as to be a refundable amount under Netherlands law, but, under the law as administered, no cash payments or only de minimis amounts of cash payments were ever granted by the government to investors. Further, our conclusion might be different if the present value of a WIR premium payable in cash were substantially less than the present value of a WIR premium received as a reduction in current tax assessments (as for example, if the law provided that payment of the cash portion of the WIR premium be deferred for a number of years). In addition, our conclusion might be different if the law or the practical administration of the law distinguished in any significant respect between resident and non- resident taxpayers in the avail-ability of a WIR premium in the form of cash.

SUBSIDY

The second provision of the section 901 regulations that must be considered in relation to the treatment of WIR premiums is Treas. Reg. 1.901-2(e)(3). That provision addresses whether subsidies provided to a taxpayer by a foreign government must be treated as a reduction in foreign income taxes paid. Our conclusion with respect to the treatment of WIR premiums under the former Netherlands law, (refundable WIR premium) is that the premiums are a subsidy, but under Treas. Reg. 1.901-2(e)(3) the premiums are not a form of subsidy that should be treated as reducing the amount of Netherlands income taxes paid for purposes of section 901. Because we have concluded that WIR premiums under the new legislation (nonrefundable WIR premiums) should be treated as a refund or credit of Netherlands income tax under Treas. Reg. 1.901-2(e)(2), we do not need to consider the application of Treas. Reg. 1.901-2(e)(3) or any other portion of Treas. Reg. 1.901-2 to the nonrefundable WIR premium under the new Netherlands legislation.

Treas. Reg. 1.901-2(e)(3)(i) provides that an amount is not an amount of income tax paid by a taxpayer to a foreign country to the extent that--

This provision of the regulations is consistent with earlier revenue rulings in which the Service has held that subsidies that are directly related to the amount of foreign tax liability reduce the amount of foreign income taxes for which a foreign tax credit may be claimed. In Rev. Rul. 69-433, 1962-2 CB 153, the Service held that a subsidy paid by the Virgin Islands government to a taxpayer in an amount equal to 75 percent of the taxpayer's Virgin Islands tax liability must be treated as a reduction in the amount of Virgin Islands taxes that the taxpayer's U.S. parent could claim as an indirect foreign tax credit under section 902. In Rev. Rul. 78-258, 1978-1 CB 239, the Service ruled that the amount of foreign taxes allowable as a foreign tax credit with respect to a 25 percent withholding tax imposed by Brazil on interest paid by Brazilian borrowers to foreign lenders must be reduced by the amount of a subsidy granted to the borrower by the Brazilian government. The amount of the subsidy to the borrower was equal to 85 percent of the withholding tax that the borrower deducted from the interest payment to the lender. Because the amount of the subsidy was directly related to the amount of the foreign tax in question, the Service considered the withholding tax to have been reduced as if the withholding tax had never been collected in full. The lender was allowed to credit the amount of the withholding tax in excess of the subsidy paid to the borrower. ³ The principles of Rev. Rul. 78-258 are also restated in the current regulations. Treas. Reg. 1.901-2(e)(3)(ii) and (iii).

Rev. Rul. 78-258 also modified an earlier ruling, Rev. Rul. 57-106, 1957-1 CB 242, which was inconsistent with the holdings in Rev. Rul. 69-433 and Rev. Rul. 78-258. In Rev. Rul. 57-106, a foreign corporation purchased the assets of two domestic affiliates of a domestic corporation. In addition to the stated purchase price of the assets, the foreign purchaser agreed to pay all foreign income taxes imposed on the seller in connection with the sale. The facts of the ruling state that the foreign purchaser was granted a subsidy by the foreign government equivalent to 100 percent of the foreign taxes imposed on the seller. Rev. Rul. 57-106 held that the foreign taxes assumed by the foreign purchaser were additional income to the seller and could be claimed as foreign income taxes paid by the seller. The ruling did not address what effect the subsidy to the purchaser had on this result. Rev. Rul. 78-258 noted that the existence of the subsidy in Rev. Rul. 57-106 was inconsistent with the holdings of the later rulings, and accordingly modified Rev. Rul. 57-106 to provide that the foreign purchaser was not granted a subsidy by the foreign government. Thus, under both the current section 901 regulations and prior revenue rulings, the Service holds that the amount of foreign income taxes for which a credit may be taken must be reduced by the amount of any subsidy directly or indirectly related to the amount of foreign income tax liability or the base of the income tax.

WIR premiums clearly are subsidies because the premiums reduce the economic cost of acquiring qualified assets, the premiums are not consideration for any goods or services provided by the taxpayer, and the government acquires no ownership interest in the qualifying assets. The important question under Treas. Reg. 1.901-2(e)(3) is whether the amount of the premium is directly or indirectly determined by reference to the amount of Netherlands income tax or the Netherlands income tax base. Under both the former Netherlands law and under the new legislation WIR premiums are not determined by reference to the Netherlands income tax base; rather, the premium is determined as a percentage of the cost of a qualified asset. Thus, the amount of the allowable premium is determined independently of the tax base rather than directly or indirectly as a function of the tax base, for example, as a percentage of Netherlands taxable income.

There does appear, however, to be some relationship between the WIR premium and the Netherlands income tax system. It is clear that the premiums are allowable only with respect to property used by a Netherlands taxpayer in an activity subject to the Netherlands income tax. For example, WIR premiums are not allowable on buildings or other immovable property with a social, cultural or sports function, and investments in buildings 70 percent or more of which will be rented to other persons are not eligible for the premium unless the tenants are subject to the corporation income tax. This "business use" requirement, however, does not guarantee the Netherlands government that the property upon which the premium is allowed will generate Netherlands income tax liability equal to or greater than the amount of the subsidy. Accordingly, we conclude that this "business use" requirement under the Netherlands law does not make the amount of the WIR premium indirectly determined by reference to the amount of Netherlands income tax or the base of the Netherlands income tax within the meaning of Treas. Reg. 1.901-2(e)(3)(i)(B).

Under former Netherlands law, the amount of the refundable WIR premium (subsidy) is also not determined directly or indirectly by reference to the amount of Netherlands income tax, because the full amount of this subsidy is paid to the taxpayer in the year the qualified asset is acquired without regard to the taxpayer's Netherlands tax liability. The taxpayer will receive the full amount of the premium either as a reduction in the income tax assessment, or in cash if the subsidy exceeds the current income tax assessment.

Accordingly, we conclude that the refundable WIR premium under former Netherlands law should not be treated as a subsidy which reduces the amount of foreign taxes paid. We express no opinion on the application of Treas. Reg. 1.901-2(e)(3) to the nonrefundable WIR premiums under the new legislation.

II

Because we have concluded that under the former Netherlands law WIR premiums do not reduce creditable foreign income taxes, it is necessary to determine how those premiums should be treated for U.S. purposes. ⁴ The economic effect of the premium is to reduce the cost of acquiring qualifying assets used in a trade or business. The WIR premium, as a subsidy, should therefore be treated for U.S. tax purposes either (1) in the case of a non-corporate U.S. person, as an item of gross income includable in full in taxable income for the year the subsidy is received or accrued under section 61, or (2) in the case of a domestic or foreign corporation, as a contribution to the capital of the corporation under section 118(a) with a corresponding reduction under section 362(c) in the basis of the qualified asset for which the premium was allowed. ⁵

Over the life of a qualified asset for which a premium has been allowed either of the above two treatments of the WIR premium will produce the same result (apart from present value considerations) for U.S. tax purposes; that is, the taxable income (earnings and profits in the case of a foreign corporation) is increased by the amount of the WIR premium allowed. Under the first (section 61) treatment, the increase is immediate and occurs in full in the taxable year in which the subsidy is received or accrued. Under the second (section 118- 362) treatment, the increase occurs over the depreciable life of the qualified asset for which the premium was allowed through a reduction in depreciation deductions for U.S. tax purposes.

The second (section 118-362) treatment is most compatible with the notion that the WIR premium is a subsidy which reduces the acquisition cost of a qualified asset. That treatment, however, is only available to corporations. Under section 118(a), only a corporation can receive a contribution to capital from a nonshareholder and exclude the amount from gross income. In the case of a non-corporate recipient of a WIR premium, section 118 by its own terms cannot apply, and no other Code provision provides an exclusion from gross income for a cash subsidy like the WIR premium. Under either treatment of the premium, if a premium is recaptured on the early disposition of a qualified asset, a deduction from gross income (reduction in earnings and profits in the case of a foreign corporation) should be allowed for the taxable year the recapture occurs to the extent of the portion of the recaptured premium that has previously been taken into account in computing taxable income (earnings and profits in the case of a foreign corporation) for U.S. tax purposes. In addition, if the basis of the qualified asset was reduced under the section 118-362 treatment in the case of a corporation, then for purposes of determining gain or loss for U.S. tax purposes on the disposition of the qualified asset, the asset's adjusted basis for U.S. tax purposes should be increased by the portion of the recaptured WIR premium that has not been taken into account (as reduced depreciation) in computing taxable income (earnings and profits in the case of a foreign corporation.)

² Under Articles I(1)(b)(i) and XIX(2) of the U.S.-Netherlands Income Tax Treaty, the corporation income tax and the individual income tax imposed by the Netherlands are creditable against U.S. income tax liability, and the Service has so held. Rev. Rul. 69-139, 1969-1 CB 375.

³Rev. Rul. 78-258 also stated that the Service would not follow a series of decisions dealing with subsidies paid by the government of Mexico to Mexican railroads (lessees) in connection with Mexican withholding taxes collected on rentals of railroad cars paid to nonresident U.S. lessors. Missouri Pacific R.R. Co. v. United States, 497 F.2d 1386 (Cl. Ct. 1974); Chicago, Burlington & Quincy R.R. Co. v. United States, 455 F. 2d 993 (Cl. Ct. 1972) rev'd on other grounds, 412 U.S. 401 (1973); Missouri Pacific R.R. Co. v. United States, 301 F. Supp. 839 (E.D. Mo. 1967) aff'd in part and rev'd on other grounds, 411 F.2d 327 (8th. Cir. 1969), cert denied, 396 U.S. 1037; Missouri-Illinois R.R. Co. v. United States, 381 F.2d 1001 (Cl. Ct. 1967). The courts held that the subsidies paid to the Mexican lessees in the amount of tax withheld on rental payments to the U.S. lessors were an internal Mexican affair and did not change the fact that the U.S. lessors paid creditable foreign taxes through the Mexican withholding tax system.

⁴ This discussion does not apply to the treatment of WIR premiums allowable under the new legislation because those WIR premiums must be treated as a reduction in Netherlands income taxes paid or accrued for the year in which the premium is allowed.

⁵ This basis adjustment applies only for U.S. tax purposes; for Netherlands tax purposes the premium does not reduce the cost basis of the qualified asset, i.e., for Netherlands depreciation deductions and for computing Netherlands gain or loss on disposition of the qualified asset.