Substance has become one of the least useful words in international tax. It appears in board packs as a box that has been ticked and in provider brochures as a service line with a monthly fee. What it means to an inspector, to a treaty partner or to a court is narrower and considerably more demanding: whether the company shown in the chart is the company that actually does what the chart says it does. That question is settled by evidence, not by declarations, and the evidence is usually already in the group’s own files.
What is actually being examined
No single Dutch statute defines substance. What exists is a set of indicators drawn from the corporate residence test, which article 4 of the Algemene wet inzake rijksbelastingen settles by reference to the circumstances rather than by a formula, from treaty and directive anti-abuse provisions, from the arm’s length principle in article 8b of the Wet op de vennootschapsbelasting 1969, and from the ruling policy that took effect on 1 July 2019. Read together, they point at the same facts.
They begin with where decisions are taken and by whom, which is not where a resolution is signed but where the commercial judgement behind it is exercised. Because that judgement is exercised by the directors, the composition and residence of the board follow immediately: whether the directors have the seniority, the mandate and the availability to run the company. The third indicator is the same question put to the record, namely where board meetings are held, how they are convened, and whether the minutes show deliberation or ratification. These three are one enquiry asked in three ways, and an entity that cannot show the commercial judgement in the first will not produce it in the other two. Their formal counterpart, for a Dutch company whose activity consists mainly of receiving and paying intra-group interest, royalties, rent or lease instalments, a test from which activity connected with the holding of participations is left out of account, so that a company that mainly holds shares but also lends and licenses can fall inside it, is article 3a, seventh paragraph, of the Uitvoeringsbesluit internationale bijstandsverlening bij de heffing van belastingen, which asks that at least half of the statutory and decision-competent directors live or are established in the Netherlands, that those Dutch-resident directors have the professional knowledge needed to decide on the transactions the company enters into and to see them properly settled, and that the board decisions are taken in the Netherlands.
The next four ask whether the company is equipped to reach such decisions and to act on them. Qualified personnel in the Netherlands, with a wage cost that is proportionate to the functions performed, are what allow a board to be informed rather than merely briefed. Premises at the company’s own disposal, used for the company’s activity, are where that work is done. Accounting kept in the Netherlands, with the primary records and the underlying documentation held there, is where the decisions leave their trace. Bank accounts operated from the Netherlands, with authority to move funds resting with the Dutch board, are where a decision becomes an act. Each is examined in the same way, by asking whether the arrangement serves the company’s own activity or has been assembled so that the indicator can be reported as met. The same provision states these four in their formal terms, requiring qualified personnel for the adequate execution and recording of the company’s transactions, an immovable property in the Netherlands at the company’s disposal for at least 24 months containing an office with the usual facilities in which the work is genuinely carried on, bookkeeping kept in the Netherlands, and the principal bank accounts held in the Netherlands.
The eighth indicator asks something different: whether the entity has the financial capacity to bear the risks the group attributes to it. Dutch law puts this as the last two requirements on the same list, which ask that the company run a real risk on the loans and legal relationships underlying what it receives and pays, and that it hold equity appropriate to that risk. For related loans article 8c of the Wet op de vennootschapsbelasting 1969 even puts a figure on it, deeming the risk to be real where the equity appropriate to cover it amounts to at least the lower of 1 per cent of the outstanding loans or 2 million euro, and leaving it to the company to show that the equity is genuinely there and would be eroded if the risk materialized. This is also the question the OECD placed at the centre of its 2015 final reports on Actions 8 to 10 of the BEPS project, which reallocate a contractually assumed risk to the party that does exercise control over it and does have the financial capacity to assume it. The first seven are conventional and well understood. The eighth is where most files fail, and it is the hardest to remedy retrospectively.
The board is the centre of the analysis
Dutch corporate residence is determined on the facts and circumstances, and the place from which the company is effectively managed carries the greatest weight. The Dutch policy statement on the transfer of a company’s seat adopts the Hoge Raad formulation without qualification: in assessing residence by reference to the circumstances it must generally be assumed that the real management of the entity rests with its board and that the place of establishment corresponds to the place where that board performs its managing task, but where it is plausible that the management is in fact exercised by someone other than the board, the place from which that other person manages may be treated as the place of establishment instead. Board practice is the primary evidence of it, and the relevant questions are practical. Are the resolutions drafted in the Netherlands, or received from the parent by email and signed as presented? Do the minutes show that alternatives were considered, that the directors asked for information, and that the information was provided in a form allowing a judgement? Is there correspondence in which a Dutch director declined, deferred or amended something?
A board that never disagrees with the shareholder is not evidence of harmony; it is evidence that the board is not the decision maker. The point is not that professional directors are unacceptable; it is that a director must have the time, the information and the standing to exercise the function attributed to the entity. The OECD Transfer Pricing Guidelines make the same point in the language of risk, stating that a mere formalising of the outcome of decision-making, in the form of meetings organised for formal approval of decisions that were made in other locations, minutes of a board meeting and the signing of the documents relating to the decision, does not qualify as the exercise of a decision-making function.
The residence of the directors matters for the same reason. A majority resident abroad, meeting abroad and taking advice abroad describes a company managed abroad, whatever the register says. Two states may then each claim residence, and the tie-breaker analysis under the applicable treaty will look at exactly the facts set out above. Where the treaty resolves dual residence by mutual agreement rather than by a rule, as the Dutch treaty with the United Kingdom does, the Dutch competent authority settles the question in consultation with its counterpart, the route the Dutch ruling policy describes as the corporate tie-breaker.
Treaty access and the anti-abuse layer
Substance and treaty access are separate tests that draw on the same facts. A Dutch entity may be resident for domestic purposes and still be denied the benefit of a treaty or of an EU directive, because the counterparty state applies a principal purpose test of the kind recommended by Action 6 of the BEPS project or a domestic anti-abuse rule to the arrangement. European case law on beneficial ownership and abuse has made conduit analysis routine for source states. The Court of Justice held in the Luxembourg interest cases that the exemption in the Interest and Royalties Directive reaches only the beneficial owners, meaning the entities that actually benefit economically from the interest and have the power freely to determine the use to which it is put, and in the Danish dividend cases that a member state must refuse the parent-subsidiary exemption where there is abuse even if no domestic or treaty provision says so, with the presence of conduit companies lacking economic justification among the indications on which that finding rests.
The practical consequence is that a Dutch holding company’s ability to receive dividends, interest or royalties at a reduced rate depends on what the source state concludes about the recipient, not on what the Dutch register records. The Dutch dividend withholding tax rate of 15 per cent, reduced under treaties and relieved at source in qualifying participation cases, among them those falling under the parent-subsidiary directive, is only one side of the flow; the more consequential decision is often taken in the paying jurisdiction. The conditional withholding tax on interest and royalties towards low-taxed and listed jurisdictions, in force since 2021 under the Wet bronbelasting 2021 and extended to certain intra-group dividends with effect from 1 January 2024, adds a further filter on outbound payments. A jurisdiction is caught only once it has been designated by ministerial regulation, the criteria for designation being that the state does not tax companies on their profits or does so at a rate below 9 per cent, or that it appears on the European list of non-cooperative jurisdictions for tax purposes.
The formal substance indicators, moreover, do not operate as a general safe harbour. Where Dutch law does attach a presumption to them, as article 2d of the Uitvoeringsbeschikking vennootschapsbelasting 1971 does for the substantial interest rule in article 17, third paragraph, letter b, of the Wet op de vennootschapsbelasting 1969, that presumption is expressly open to rebuttal by the inspector and reaches no further than the provision it serves. It is also measuring something else: that rule tests the foreign shareholder’s own substance in the shareholder’s own state of residence, which is why its wage floor is scaled by a country factor, and it says nothing about what a Dutch entity needs. Meeting these indicators does not conclude the enquiry, and the same facts are available to the states at the other end of the flow, so the file is read abroad as well as at home. That is not a figure of speech. A company on the Dutch list that fails one of the requirements must declare as much in its return and hand over the supporting data, including the states in which it claimed treaty or directive benefits, which is precisely the material the exchange of information regime exists to pass on.
Substance is not a threshold a company passes once. It is a description of where a business is run, and the file either reads as though that description is true or it does not.
Rulings require an economic nexus
The ruling policy applicable since July 2019 removed any ambiguity. Advance certainty is not available where the entity lacks sufficient economic nexus with the Netherlands, which the policy defines as the group carrying on real operating activities here and those activities being carried on for the account and risk of the applicant, with sufficient relevant personnel present in the Netherlands at group level; nor where the saving of Dutch or foreign tax is the sole or decisive motive for the acts or transactions; nor where the certainty sought concerns direct transactions with entities established in states on the Dutch register of low-tax and non-cooperative jurisdictions.
Substance work is therefore a precondition of advance certainty rather than a parallel workstream. An application filed by an entity with a thin functional profile will not simply be refused; it places on record a description of the structure that the tax authority can revisit. The interaction between substance and pricing certainty is set out further in our note on advance pricing agreements and rulings.
Why formal minimum substance no longer suffices
The older approach treated substance as a compliance list: a Dutch bank account, local bookkeeping, a resident majority on the board, an office available for a defined period, a wage cost above a stated floor. The floor for the Dutch entity is a wage cost of at least 100,000 euro, a flat amount that is not scaled by any country factor, and the period for the office is 24 months, during which premises in the Netherlands must be at the company’s disposal and its work must actually be done there. Those items remain relevant, but they are now read as indicators rather than as an answer. What changed is the arrival of the arm’s length principle as the operative test of who earns what.
Article 8b imposes the arm’s length principle and carries a documentation obligation with no monetary threshold, its third paragraph requiring the associated entities to keep in their records the material showing how the transfer prices were arrived at. It sits beneath the Master File and Local File requirements, which apply from 50 million euro of consolidated group revenue in the preceding reporting year, and country-by-country reporting, which applies from 750 million euro on the same measure. Under that principle, an entity is allocated the return on a risk only if it controls the risk and has the financial capacity to assume it. Control means the competence to decide whether to take the risk and how to respond when it materializes, and actually performing those functions. A company whose entire staff consists of two directors with no mandate to say no does not control anything.
Equity on the balance sheet is not by itself financial capacity. The question is whether the entity could absorb the downside of the risk it is said to bear without recourse to the parent. Where it could not, the return follows the party that could, and the Dutch entity is left with a service return. This is the mechanism that quietly converts a holding company into a cost-plus service provider, and it is described in more detail in our note on the article 8b documentation obligation.
A worked example
Consider a Dutch BV interposed between a European operating group and its shareholders. It holds the shares in four operating subsidiaries, lends working capital to two of them, and licenses a trade mark to all four. Its board consists of one group finance executive resident abroad and one local corporate service director. Minutes are prepared by the parent’s tax function and signed in circulation. The company has no employees, uses a registered address shared with a large number of other entities, and its accounting is performed by the group’s shared service centre abroad. Equity is nominal; the loans were funded by a back-to-back facility from the parent. The trade mark was contributed at book value and is developed and promoted entirely by the operating companies.
On examination, several conclusions follow more or less mechanically. The interest spread on the loans is unlikely to survive, because the entity neither controls the credit risk nor has the capacity to bear it; the analysis follows the treatment of intercompany financing arrangements, and the residual return migrates to the funder. The royalty is exposed on the grounds the OECD groups under the heading of development, enhancement, maintenance, protection and exploitation, since those functions all sit with the licensees. Withholding relief claimed by the subsidiaries in their own states is challenged, because the recipient does not look like a beneficial owner in any substantive sense. The place of effective management is questioned, since no decision of consequence is demonstrably taken in the Netherlands.
None of this depends on a novel legal theory. Each conclusion is drawn from facts the group itself created and documented.
What defensible substance looks like
The remedy is not a longer checklist. It is alignment between the functional narrative in the transfer pricing file, the legal agreements, the board record and the actual conduct of the business. Where the entity is a genuine holding and financing platform, it should be resourced as one: a board with real authority and the information to exercise it, personnel whose seniority matches the decisions attributed to them, premises and records in the Netherlands, and a balance sheet that can carry the risks allocated to it. Where the group is unwilling to fund that, the honest response is to reduce the functions attributed to the entity and price it accordingly. That choice is best made at establishment, when alignment is a matter of design rather than of restatement.
The cost is composed of the notarial deed by which article 175 of Book 2 of the Burgerlijk Wetboek requires a besloten vennootschap to be incorporated and the registration in the KVK Business Register that the civil-law notary arranges, the directors and their supporting infrastructure, premises, local bookkeeping and the annual filings, the transfer pricing documentation, and periodic review of whether the functional profile still matches reality. The weight of each item depends on the complexity of the group and on how much operating substance already exists in the Netherlands. What does not vary is the requirement that the description be true.
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This article is informational and does not constitute tax advice. Each engagement is subject to scope and applicable regulation.