Troubled Dutch

A proposed tax hike on carried interest in the Netherlands is bad enough – clumsy drafting is making things a whole lot worse, writes Andy Thomson.

Andy Thomson

With the focus now back on deal-related issues, it would be tempting to think that the bashing of private equity’s image – and political calls for more punitive treatment of the industry’s profits – were a thing of the past. Such temptation should be resisted. As arch-critic Poul Nyrup Rasmussen’s report to the European Parliament’s Committee on Economic and Monetary Affairs indicates, the battle between private equity sceptics and supporters continues to rage – and has a long way still to go.

In the Netherlands, no reminders of this are needed. The red faces of Dutch professionals currently hitting the beaches for their summer breaks may have little do with exposure to the sun – high blood pressure may be the cause. After all, with the threat of as much as 52 percent tax being levied on their carried interest, this is no time for relaxation. Indeed, tension has been ratcheted up a notch by the decision of the Dutch Parliament to postpone a decision on the bill that includes the proposal from last month to September.

Those close to the situation in the Netherlands say scrutiny of the industry began building in April 2007, when representatives of private equity and hedge funds were hauled before Parliament and given a thorough grilling. During the session, which had echoes of the Treasury Select Committee hearing in the UK but appears to have been more combative, Elly Blanksma, a senior MP for the ruling Christian Democrats, uttered the explosive words: “The ransacking of the country is not welcome.” It was clear that pressure was building for politicians to take some kind of populist action against investors perceived to be damaging the Dutch business world to further their own self interest.

Unsurprisingly, and as with any proposed legislation of a knee-jerk nature, some of the outcomes will not be entirely logical. While left-wing politicians have aimed at US and UK funds, it is GPs based in the Netherlands that find themselves in the firing line. Having traditionally seen their carry and sweet equity profits subject to an annual wealth tax (the so-called ‘box three’) at the nominal rate of 1.2 percent, from January 2009 they face the prospect of such benefits being relocated to ‘box 1’ for ordinary income tax at progressive rates of up to 52 percent. A Private Equity Comment from law firm SJ Berwin earlier this year noted that while the legislation applies to non-Dutch taxpayers “in principle”, “they will normally be protected against this Dutch domestic tax liability by double tax treaties”.

The reason for the domestic focus is informative. Despite the Blanksma remarks indicating that some of the ire has been trained specifically on private equity, the “lucrative interests” bill in which private equity has become entangled was initially designed to target large severance packages enjoyed by chief executives leaving listed companies/ Private equity, not for the first time, finds itself caught in a web spun by politicians playing to the gallery.

As one Dutch private equity lawyer puts its, however, even politicians are “not totally crazy”. He says they are well aware that if the Netherlands sets a tax rate out of line with international standards, threats by private equity firms to relocate to neighbouring jurisdictions would likely be more than the usual rhetoric. Hence, while the political message is of lucrative interests being charged at 52 percent, the pragmatic reality is that most GPs can escape to a 25 percent flat rate (‘box 2’) providing certain conditions are met. Such a carry tax level is broadly in line with most other European countries.

So, problem solved? Well, no. For one thing, critics say the proposed law has been poorly drafted, leaving many questions about how to qualify for the flat rate in certain circumstances (such as so-called ‘phantom income’ arising from recapitalisations and other scenarios too complex to detail here). There is also a retrospective element, meaning it will not only affect profits from funds from next year onwards, but also existing and past funds. Unsurprisingly, NVP (the Dutch private equity association) is lobbying hard for clarification – which may help to explain why the process has been delayed.

Fretful Dutch practitioners, some of whom have expressed their frustrations openly in the domestic press, would probably have a sharp reply to any suggestion that heavy-handed political intervention is no longer the main preoccupation for private equity. It can certainly be enough to spoil your holiday.