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New Double Tax Convention between Bulgaria and The Netherlands

July 12, 2021

New Double Tax Convention between Bulgaria and The Netherlands

In State Gazette, issue 55 of 2 July 2021, the have been promulgated the new Convention between the Republic of Bulgaria and the Kingdom of the Netherlands for the Elimination of Double Taxation with Respect to Taxes on Income and Prevention of Tax Evasion and Avoidance, as well as a protocol thereto (hereinafter referred to as “the new DTC” or “DTC”). The new DTC will replace the currently effective DTC signed in 1990 г. (“the former DTC“).

The new DTC shall be applicable:

  • with respect to withholding tax – for amounts paid or accrued on or after 1 January 2022;

  • with respect to other taxes – for tax years commencing on or after 1 January 2022. An exception is provided for pension income and other similar payments, for which the former DTC may continue to be applicable in specific circumstances.

The new DTC contains provisions according to the Model Tax Convention of the Organisation for Economic Cooperation and Development (OECD) of 2017, which have been developed and approved as part of the actions under the Action Plan on Base Erosion and Profit Shifting (BEPS). Such texts and provisions of the new DTC are:

  • the heading and preamble, which clarify the purpose of DTC to eliminate double taxation while not creating opportunities for non-taxation or tax evasion or avoidance. These additions are part of the minimal standard under Action 6 (Preventing the Granting of Treaty Benefits in Inappropriate Circumstances) of the BEPS Plan, i.e. they are compulsory for all jurisdictions (already over 130) participating in the BEPS Inclusive Framework;

  • a provision regarding entitlement to benefits under the DTC (Art. 23), containing the so-called Principal Purpose Test, which is also part of the BEPS Action 6 and provides for the possibility of denying a DTC benefit, if obtaining the respective benefit was one of the principal purposes of any arrangement or transaction;

  • other provisions under BEPS Action 6, which are not part of the minimal standard, include:

    • with respect to dividend income (Art. 10 of the DTC). In contrast to the former DTC, the new DTC provides for hypotheses whereunder dividend income may be exempt from tax in the state of source. One of the hypotheses is for the dividend beneficiary to be a pension fund. The other hypothesis requires minimal (10%) direct participation of the dividend beneficiary in the capital of the dividend distributing entity while also imposing an additional condition under BEPS Action 6, namely the minimal capital participation to has been held for a period of not less than 365 days, including the day of the payment of the dividend where for the purpose of computing that period, no account shall be taken of changes of ownership resulting directly from a corporate reorganisation, such as a merger or divisive reorganisation, of the company that holds the shares or that pays the dividends;
    • with respect to gains from alienation of shares or participations in arrangements deriving their value mainly from immovable property (Art. 13, para 4 of the DTC). The provision aims at preventing the use of companies or other arrangements for carrying out transfers in immovable property and avoiding taxation in the state where the immovable property is situated. The reason is that as a matter of principle, gains from transfers of shares and other similar participations are taxable only in the state of residence, in contrast to gains from transfers of immovable property. Therefore, additional conditions have been imposed in accordance with BEPS Action 6 regarding: (i) the period throughout the participation is held (minimum 365 days) and (ii) the maximum part (75%), up to which the value of alienated shares/participations may derive their value from immovable property situated in the other contracting state, subject to specific conditions;
    • a rule to prevent abuse in case of permanent establishments situated in third jurisdictions (Art. 23, para 4 of the DTC) – the state of source shall not allow a benefit with respect to income attributable to a permanent establishment (PE) in a third jurisdiction, if the income is subject to reduced taxation in the third jurisdiction (less than 60% of the tax that would have been imposed in the state of residence) and the PE’s profits are exempt from taxation in the state of residence;
  • provisions under BEPS Action 2 “Neutralising the Effects of Hybrid Mismatches” regarding:

    • transparent entities (Art. 1, para 2 and para 3 of the DTC). They refer to cases where income is derived by an entity or arrangement that is treated as fiscally transparent for tax purposes in one or both of the contracting states. In such cases, benefits under the DTC shall be allowed only if the respective income is considered for tax purposes to be income of a resident of one or both contracting states;
    • persons that are not individuals and that are tax resident of both of the contracting states (Art. 4, para 5 of DTC). In such cases, the tax status under the DTC of the respective person shall be determined according to the mutual agreement procedure;
    • application of the methods for the elimination of double taxation (Art. 22 of the DTC). According to the new DTC, Bulgarian tax residents shall have the right to an ordinary tax credit for the purpose of elimination of double taxation regarding all types of income that The Netherlands have the right to tax under the DTC. According to the former DTC, the said method is applicable only with respect to dividend income, royalties (being exempt from withholding tax according to a provision in the protocol to the former DTC) and income from alienation of shares in particular circumstances. Regarding all other types of income, the exemption with progression method is applicable under the former DTC;
  • provisions under BEPS Action 7 “Preventing the Artificial Avoidance of PE Status“ in order to:

    • prevent the possibility of artificial avoidance of PE formation through splitting of a cohesive business operation into numerous smaller, complementary functions or activities in order to claim that they are of a preparatory or auxiliary character and hence, do not form a PE Art. 5, para 8 of the new DTC;
    • prevent the possibility of splitting activities related to a buildings site or a construction or installation project into numerous separate activities (contracts), in order not to exceed the time threshold specified in the DTC for formation of a PE (Art. 5, para 6 of the new DTC). The time threshold is 12 months instead of 9 months under the former DTC, except for the cases of offshore activities (see below);
  • a supplemented, according to BEPS Action 14 “Making Dispute Resolution Mechanisms More Effective“ (minimal standard), provision regarding the mutual agreement procedure with an option for activation of an arbitration clause – Art. 25 of the new DTC and s. XIII of the protocol thereto.

Other changes compared to the former DTC include:

  • a tax residence definition for Bulgarian individuals under the new DTS, which is in line with the tax residence criteria according to the Bulgarian effective domestic legislation (the Individuals’ Income Taxation Act) (Art. 4, para 1 of the DTC). According to the former DTC, only Bulgarian citizens qualify as tax residents for the purposes of application of the treaty;

  • a detailed “tie breaker rule“ provision applicable in case an individual is a tax resident of both contracting states under their domestic laws (Art. 4, para 4 of the DTC). According to the former DTC, only the “centre of vital interests” was the decisive criterion in the said case;

  • a new PE hypothesis (Art. 5, para 4 of the DTC) – where an enterprise of one of the contracting states carries out activities in the territorial sea of the other contracting state or in any space beyond and immediately adjacent to the territorial sea over which the other contracting state exercises jurisdiction or sovereign rights in accordance with international law – the so-called “offshore activities“, in case they continue for a total of 30 or more days in any 12-month period;

  • a provision regarding corresponding transfer pricing adjustments (Art. 9, para 2 of the DTC) for the purpose of elimination of economic double taxation where one of the contracting states increases the taxable profit of its enterprise because of non-arm’s length conditions of a transaction with an enterprise of the other contracting state;

  • a right, according to the new DTC (Art. 11, para 2), of the state of source to tax interest income with tax not exceeding 5% of the gross income, except in expressly defined hypotheses (e.g. if the interest beneficiary is a pension fund, or where interest are paid in connection with a loan provided by a bank or an insurance company, and other – Art. 11, para 3 of the DTC).

According to the former DTC, interest income shall be taxable only in the state of tax residence of the beneficial owner of the income;

  • a right, according to the new DTC (Art. 12, para 2), of the state of source to tax royalties with tax not exceeding 5% of the gross income. A similar provision is contained also in the former DTC but it is amended by a clause in the protocol thereto, according to which taxation in the state of source shall not take place until The Netherlands introduces in its domestic legislation withholding tax on royalties (which was introduced as from 1 January 2021 only regarding cases involving certain jurisdictions or tax evasion).

The protocol to the new DTC does not include an exemption clause, which means that as from 1 January 2022 royalties accrued by a Bulgarian tax resident or a PE in Bulgaria, to the account of which the income is charged, shall be taxable with 5% withholdings tax in Bulgaria under the DTC, where an obligation for such a tax arises under the domestic legislation (the Corporate Income Taxation Act or the Individuals’ Income Taxation Act);

  • regarding income from professional services or other freelance activities, the provisions regarding PE (Art. 5) and business profits (Art. 7) of the new DTC shall be applicable;

  • in contrast to the former DTC, the new DTC entitles the state of source to tax in all cases pension income and other similar payments and annuities (Art. 17 of the DTC);

  • the new DTC contains the most recent, according to the OECD Model Tax Convention, information exchange provision (Art. 26) and assistance in the collection of taxes provision (Art. 27).

This material is not exhaustive and is of general informative character and shall not be considered as individual advice or consultation. Should questions arise or if you need further information, please do not hesitate to contact us at email: office@afa.bg, tel.:+359 2 9433700, address: 38, Oborishte Street, 1504 Sofia.

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