Changes in the BOR scheme of the Dutch inheritance tax

Joep Schoenmakers - EMLA program at Warsaw School of Economy 

Will the recoding of real-estate equity as non-entrepreneurial equity have an influence on the raised revenue within the Dutch inheritance tax scheme?

Discussion in the Netherlands has recently arisen on the revenue raised by the inheritance tax in the Netherlands. One of the reasons for a decrease in revenue after a law change, is attributed to the use of a scheme exempting tax on entrepreneurial wealth (Van Denderen and Van Denderen, 2023). The use of this scheme has according to Van Denderen and Van Denderen more than doubled in value. 

The Dutch system of inheritance taxation and the BOR-scheme

The Netherlands has a system for inheritance taxation. Dutch inheritance tax is covered in the Dutch Successiewet 1956, or Succession Law 1956. The tax is levied on the wealth that a person leaves behind after he passes away. Stocks are also wealth. However, to not break up family businesses due to a tax burden, the system is known as the BOR, or Bedrijfsopvolingsregeling, or business succession scheme. With this scheme the inheritors are exempt from paying taxes under a certain amount (1.1 million euros). Above this threshold the exemption is 83%. The remaining amount is taxed. The BOR is meant to ensure the continuity of the business. The assets of the business or the inheritor might not be liquid enough to foot the tax bill. A determent or exemption then is possible under the BOR. However (CPB, 2022) showed that a majority of inheritors did possess the liquidity to pay the tax in full immediately. 

Requirements for the use of exempting capital under the BOR are the aanmerkelijk belang, or substantial interest in the company, which is set at minimum of 5% of stock. The inheritor also needs to have had an employment with the company for at least five years. The capital used in the enterprise needs to be of ‘entrepreneurial’ quality, and cannot just be ‘investment’. In other words, a holding company holding just securities does not qualify for the BOR-scheme. The wealth in these companies would not be exempt and inheritance tax needs to be paid on this amount. The difference between ‘entrepeneurial’ and ‘investment’ capital however is murky, especially when it comes to companies being involved in real estate. The law containing the definition of an enterprise is the Dutch Income Tax Law, or IB. 

The murkiness has led to Dutch High Court jurisprudence on these matters. The court has ruled on the 18^th of June 2021 that there are requirements on the other business of the company (such as real estate development), the effort required and the yield of the real estate holdings (ECLI:NL:HR:2021:955). In this case, the company was split into two where it came to ‘entrepreneurial capital’ – the development arm was seen as an enterprise, whereas the renting out of the developed properties was seen as ‘investment capital’. However, the court has not given the specifics of the requirements for when real estate companies would be seen as entrepreneurial. This has led to a lot of litigation, which the Minister of Finance dislikes (Spring Note 2023, p. 221).

This scheme erodes the tax base. Family wealth locked up in companies is easily protected from the paying of inheritance tax. Two channels are at work here. The wealth of the richest families (meaning the top 0,1% of the wealth distribution) is already mostly in significant interests in companies.  Their wealth is mostly characterized by the companies they held. An anecdotal evidence is the Heineken family holding shares in the Heineken Holding company. The second channel is tax planning: one recodes ‘normal’ wealth into entrepreneurial capital and is thus largely exempt for paying inheritance taxes.

Salience and (in)efficiency of inheritance taxes

Inheritance taxes are very salient. They are paid once, on a (usually) very emotional moment, after the passing of a loved one. Inheritance taxation will be hanging like a sword of Damocles over the heads of the inheritors, triggered by the death of the testator. Nevertheless, there is not a lot of empirical research into the effects of the salience of the inheritance tax. More salient taxes lead to a larger response to the taxes (Congdon et al. 2011). Complete tax avoidance here is impossible – one cannot escape death. However, aggressive tax planning or an disturbance of optimal consumption before death is possible. Goupille-Lebret and Infante estimated the behavioural responses to inheritance tax in France (Goupille-Lebret and Infante, 2018). They found that only in the immediate years before death, tax planning took place. They found only small effects, none which could be explained by tax salience. 

One way the tax planning works in the Netherlands is by using the yearly tax exempted gifts under the gift tax scheme. Another way is the aforementioned forming of a significant interest for your children (or other inheritors) in a corporation. The government wants to get of the latter. 

The reform as part of the governments financial Spring Note

In their annual Spring Note (Voorjaarsnota), the Dutch government revealed plans for the reform of the BOR-scheme. Two of the most significant changes (which are also relevant for this piece) are:

1. Real estate capital will no longer be seen as entrepreneurial capital;

2. The exempted threshold of capital is raised, while the nominal tax rate on the non-exempt part of capital also increases. 

The first reform is due to the Dutch tax authority noticing that these fiscal constructions with real estate capital are popular (Spring Note 2023, p. 221). However, it is unclear which proportion of inherited businesses consists of real-estate companies. What is clear according to the Minister of Finance is that the large amount of proceedings over whether or not various forms of real estate were entrepreneurial capital were putting a large burden on the Dutch tax authority (Spring Note 2023, p. 221). The proposed change in the Spring Note tries to close the ‘real-estate loophole’. Is that sufficient to increase the tax base and thereby raise the inheritance tax revenue?

Most of the entrepreneurial equity is in hands of the richest 10% of the Netherlands (IBO Vermogensverdeling^[1]). Of course, that does not necessarily mean that the entire wealth of the richest 10% is in entrepreneurial equity. Of that 10%, a majority of the value of entrepreneurial capital is with the 1% richest. That means that a significant portion of the wealth of the richest part of the Netherlands is in significant interests in entrepreneurial equity, which means it is largely tax exempt. 40% of the tax breaks due to the BOR are in hands of 2.2% of the inheritors (CPB, 2022). The consequence of this is that the big bulk of the capital inherited is not affected, because the value was not in real estate holdings to begin with. The affected groups by the change in real estate qualifications are mostly the 90-99% wealth bracket, with enough wealth to be able to plan their tax, but whose wealth is not necessarily already locked up in actual entrepreneurial capital. Unfortunately however for the Treasury, this will not solve the revenue problem. This problem lies with the significant interests actual entrepreneurial capital, after the reform still for a large part exempt via the BOR, in hands of the 99-100% wealth bracket. 

The discussion on significant interest taxation is broader than only the inheritance tax

An oft-heard argument (such as millionaire Henny de Haas in Quote, see [Wouda, 2022]) is that the inheritance tax endangers the continuity of family businesses. The CPB (the Dutch economic planning agency) finds that the BOR indeed serves this purpose (CPB, 2022). However, important to note is that the BOR starts its applicability at 5% of stock. This means that the company need not be a family company at all: a large stake in a company is already enough to qualify. Regular stocks (with a stake of below 5%) are not in the scheme. In this way the scheme benefits inheritors with large stakes in companies, which has a correlation with the wealthiest strata (CPB, 2022). The argument also rests on the assumption that the money to pay the inheritance tax needs to be paid from the companies equity, which is not necessarily true. Privately there is usually enough capital to pay the tax bill (CPB, 2022). The CPB concludes that the BOR is effective, but not efficient. 

The discussion about the fairness of the BOR-scheme for the inheritance tax relates to the system of Dutch income taxation. In this system, there are three boxes. Roughly speaking, the first is for labour income (box 1), the second for income deriving out a significant interest in a company  (box 2) and the third for income deriving from wealth (box 3). The requirements for the significant interest of the income taxation are the same as the requirements in the BOR. A disparity has grown in the severity of taxing between the significant interest income and the wealth income, or boxes 2 and 3 (Jacobs 2022) This has left to a recoding of personal assets held in a box-3-manner to equity in a held in a box-2 manner, which has reduced the individual tax liability on wealth. The ability to recode capital from box 3 to box 2 is an example of a possibility for tax arbitrage. 

Because of the BOR-scheme in the inheritance taxation, the previously detailed effect acts as a double-edged sword. There exists a double benefit in recoding normal assets, taxed via the regular scheme of the Dutch inheritance tax, to corporation assets, largely exempt via the BOR-scheme. Because this is also beneficial in the income tax system it has become a popular option. An upside is that a possible reform of either can also have a double-edged effect; repairing one of the two disparities can create an incentive to code the wealth in the type which actually reflects the nature of that wealth the best. 

In my view the normalization of the income tax schedule precludes the perverse incentives of recoding the equity to save on inheritance taxation. This is a yearly tax compared to a life-end tax, which adds to the tax bill. It will lead to a shift of box-2 wealth to box-3 wealth, which brings with it a decrease in ingenuous BOR-use. If this measure is combined with another reform in the BOR-schedule, being a requirement on the length of existing of the corporation used in the BOR-schedule, any ‘right-before-death’- recoding of capital is precluded. 

Bibliograpy

Congdon, William J., Kling, Jeffrey R., Mullainathan, Sendhil, Policy and Choice: Public Finance through the Lens of Behavioral Economics, 2011, Brookings Institution Press, Washington D.C., p. 180.

CPB, ‘Evaluatie van de fiscale regelingen gericht op bedrijfsoverdracht’, 2022

Denderen, M. van and M. van Denderen, ‘Inkomsten uit erfbelasting gedaald na mislukte poging om ontwijking te beperken’, 2023, ESB, 108(4820), 158-159.

Goupille-Lebret, J., & Infante, J. (2018). Behavioral responses to inheritance tax: Evidence from notches in France. Journal of Public Economics, 168, 21-34.

Jacobs, Bas, ‘Box 2: het vieze publieke geheim van het Nederlandse belastingstelsel’, Vrij Nederland, 18 mei 2022

Ministerie van Financien, ‘Voorjaarsnota’, 28 April 2023, https://tinyurl.com/linkvoorjaarsnota

Rijksoverheid, ‘Licht uit, spot aan: de vermogensverdeling’ (IBO Vermogensverdeling), 1 July 2022. https://tinyurl.com/ibovermogen

Wouda, Tom, ‘De Quote 500 over superrijkentaks: 'Jaagt mensen weg, maar het is armoe als ze op de vlucht slaan', 9 April 2023.