How Does the Netherlands US Tax Treaty Work?

A tax treaty is an agreement between two countries to resolve issues of how income earned in one country by a resident of the other is taxed. The primary goals of the U.S.-Netherlands tax treaty are to prevent the same income from being taxed by both jurisdictions, a concept known as double taxation, and to combat tax evasion. The treaty contains specific provisions that can override the standard domestic tax laws of each nation, creating a distinct set of regulations for cross-border operations. The U.S. taxes its citizens regardless of where they live, while the Netherlands bases taxation on residency, and the treaty assigns the right to tax specific types of income to one country or the other to reconcile these different approaches.

Determining Treaty Eligibility

A person’s ability to use the provisions of the U.S.-Netherlands tax treaty hinges on being a “resident of a Contracting State.” Under the treaty, this term refers to any person who, under the laws of either the United States or the Netherlands, is liable to tax therein by reason of their domicile, residence, citizenship, place of management, or any other criterion of a similar nature.

This definition can lead to a situation where an individual is considered a tax resident of both countries simultaneously, creating a “dual-resident” status. When this occurs, the treaty provides a series of sequential tie-breaker rules to assign a single country of residence for treaty purposes. If one test is inconclusive, you move to the next:

• Permanent home: Residency is assigned to the country where the individual has a permanent home available. This refers to any form of housing continuously available to the person, not just their primary residence.
• Center of vital interests: If a permanent home is available in both countries, this test determines to which country the individual’s personal and economic relations are closer. Factors include family, occupation, and place of business.
• Habitual abode: If the center of vital interests is indeterminate, residency is assigned to the country where the individual more frequently stays, regardless of the legal status of that location.
• Citizenship: If a habitual abode cannot be determined, the individual is considered a resident only of the country of which they are a citizen.

Taxation of Individual Income

The treaty establishes specific rules for how personal income is taxed, often reassigning the primary right to tax from what domestic law would otherwise dictate. For income from employment, the principle is that wages and salaries are taxed in the country where the work is physically performed. This means if a Dutch resident works in the U.S., the U.S. has the first right to tax that income.

An exception to this rule is the “183-day rule.” Under this provision, income from employment is exempt from tax in the host country if three specific conditions are met. First, the individual must be present in the host country for 183 days or less during any 12-month period. Second, the remuneration is paid by an employer who is not a resident of that host country. Third, the compensation cannot be borne by a permanent establishment, such as a branch or office, that the employer has in the host country.

The treatment of retirement income also receives special attention, distinguishing between private and government-service pensions. Private pensions and other similar remuneration are taxable only in the recipient’s country of residence. However, pensions paid for government service are taxable by the country that paid the pension. Social Security payments are taxable only by the country of residence of the recipient.

The “Saving Clause” is a provision that allows the United States to tax its citizens and certain former citizens as if the treaty did not exist. This preserves the U.S. system of citizenship-based taxation, meaning a U.S. citizen in the Netherlands is still subject to U.S. tax on their worldwide income. There are, however, exceptions where treaty benefits override the Saving Clause, preserving benefits related to Social Security payments and the ability to claim foreign tax credits for Dutch taxes paid.

Taxation of Investment and Business Income

The treaty provides guidelines for taxing income from investments. For dividends, the agreement limits the withholding tax that the source country can charge to 15%. This rate is further reduced to 5% if the beneficial owner is a company that owns at least 10% of the voting power of the company paying the dividend.

For interest income, the treaty provides for a 0% withholding rate at the source. This means that interest arising in one country and paid to a resident of the other is only taxable in the recipient’s country of residence.

For business profits, a company’s profits are only taxable in the other country if the enterprise carries on its business through a “Permanent Establishment” (PE) situated there. The treaty defines a PE as a fixed place of business through which the business of an enterprise is carried on. This includes a place of management, a branch, an office, a factory, or a workshop.

Key Treaty Provisions

A feature of the U.S.-Netherlands treaty is the “Limitation on Benefits” (LOB) article. The purpose of this provision is to prevent “treaty shopping,” a practice where residents of third countries try to gain access to treaty benefits by routing investments through a company established in either the U.S. or the Netherlands.

To qualify for benefits under the LOB article, a person or company must meet one of several objective tests. For example, publicly traded companies and their subsidiaries are considered qualified residents. Another test requires that more than 50% of the beneficial interest in an entity is owned by qualified residents and that less than 50% of the entity’s gross income is used to make deductible payments to non-qualified residents.

Another mechanism is the Mutual Agreement Procedure (MAP), which is available to taxpayers who believe they are being taxed in a manner not in accordance with the treaty. A taxpayer can present their case to the “competent authority” of their country of residence, which in the U.S. is the Secretary of the Treasury or his delegate. The competent authorities of both countries will then endeavor to resolve the issue by mutual agreement.

Claiming Treaty Benefits

A U.S. taxpayer claiming a treaty benefit must typically file IRS Form 8833, Treaty-Based Return Position Disclosure. This form notifies the IRS that you are taking a position that a treaty overrules or modifies the Internal Revenue Code. On the form, you must identify the treaty article being claimed, summarize the facts, and attach it to your annual tax return, such as Form 1040 or Form 1120.

There are exceptions to this filing requirement. Individuals are often not required to file Form 8833 to claim reduced withholding rates on dividends, interest, or royalties. In these cases, the withholding agent often handles the application of the treaty rate at the time of payment.