June 6, 2024
Despite the introduction of the 'Restoration Act' for Box 3, the Dutch Supreme Court has ruled that this transitionary legislation still fails to address the issues identified in its landmark ruling on December 24, 2021 (also known as the 'Christmas Decision'.
The current legislation on Dutch income tax in Box 3 continues to violate international anti-discrimination laws and property rights, especially when the assumed (deemed) return on investments is higher than the actual return. In today's rulings, the Supreme Court provided clearer guidelines on calculating actual returns and mandated corrective measures for affected taxpayers.
Background of the Box 3 Tax System
The original Box 3 tax system, effective from January 1, 2017, taxed income from savings and investments based on a fictitious return, ignoring the actual performance of taxpayers' assets. This system assumed a hypothetical investment mix and applied average returns, leading to either an over-payment or under-payment of tax based on the actual returns. The system did not account for the real composition of an individual's assets. Criticism increased through time, culminating into the supreme court ruling of 2021.
Supreme Court Ruling of December 24, 2021
On December 24, 2021, the Supreme Court ruled that the original Box 3 system violated the non-discrimination clause in the European Convention on Human Rights (ECHR). The Court highlighted that the system unfairly taxed those who chose low-risk investments at higher fictional returns than they actually earned. Additionally, it treated high-risk investors unfairly by applying an average return regardless of their actual success.
The Court emphasized that the original system imposed a disproportionate financial burden on taxpayers who opted for low-risk investments, taxing them on a higher fictional return than their actual earnings. Moreover, it created an unequal treatment within the group of high-risk investors by taxing them based on an average return, irrespective of their actual investment success. This inequality was deemed unacceptable under international law.
Introduction of the Restoration Act
In response to the 2021 ruling, the Restoration Act was introduced to retroactively adjust Box 3 income tax for the years 2017 to 2022 to comply with the Court's decision. The Act still uses a deemed return but tries to better approximate actual returns by considering the composition of taxpayers' assets, divided into three categories: bank deposits, other assets, and debts. Each category has its own deemed return percentage, which was 0.25% for bank deposits and 5.39% for other assets in 2017.
The Restoration Act aimed to address the discrepancies identified by the Supreme Court by more closely aligning the deemed return with the actual performance of different types of assets. However, it still did not fully resolve the issues for all taxpayers, particularly those with more complex asset portfolios. As stated above, the deemed return percentage of the old system was replaced by adding three deemed return percentages.
Examination of the Restoration Act
In today's rulings, the Supreme Court reviewed whether the Restoration Act adequately addressed the concerns raised in the 2021 decision. Some cases involved disputes over whether certain assets should be classified as bank deposits or other assets. Others questioned the definition of "actual return" and its relevance after the Restoration Act, and whether interest should be included in tax refunds.
The Court concluded that the Restoration Act's method of calculating the deemed return generally resolves issues for taxpayers with bank deposits, as it approximates actual returns. However, for those with other assets, the problem remains since the deemed return is calculated similarly to the original system, leading to unequal treatment based on investment success.
Persisting Issues with the Restoration Act
The Supreme Court found that the Restoration Act did not fully eliminate the problems identified in the original system. For taxpayers with assets other than bank deposits, the Act continued to apply a deemed return based on averages, which did not reflect their actual investment performance. This led to an unequal treatment of taxpayers based on their investment success, which the Court deemed discriminatory.
This unequal treatment is not justified by the Act's objectives, which are similar to those of the original system deemed insufficient by the Court in 2021. Thus, the Court ruled that the Restoration Act also violates anti-discrimination and property rights protections when the deemed return exceeds the actual return.
What are the 'actual returns'?
To address these ongoing issues, the Supreme Court provided guidelines for calculating actual returns, which include all assets in Box 3. Actual returns contain interest, dividends, rent, and both realized and unrealized gains or losses.
The Court emphasized that when the deemed return exceeds the actual return, legal reparations must be provided by reducing the tax assessment to include only the actual return. Taxpayers must demonstrate that their actual return is lower than the deemed return to qualify for this adjustment.
This ruling also applies to the Transition Act Box 3, effective January 1, 2023, which serves as an interim measure until a new system based on actual returns is implemented. The Transition Act, like the Restoration Act, aims to address the issues identified by the Supreme Court but still relies on deemed returns, which may not fully resolve the discrepancies for all taxpayers.
The future for Box 3
The Supreme Court's decision highlights the need for a more accurate and fair system for taxing income from savings and invstments in Box 3. The reliance on deemed returns can no longer be continued by the Dutch authorities.
Moving forward, policymakers will need to develop a system that accurately reflects actual returns, ensuring fairness and compliance with the ECHR and more explicitly the right to property. This may involve more complex calculations and reporting requirements.
Wrapping it up
The Dutch Supreme Court's ruling emphasizes the ongoing challenges in creating a fair tax system for income from savings and investments (a wealth tax in essence). Despite the efforts of the Restoration Act, significant issues remain, particularly for those with more complex asset portfolios. The decision calls for a reevaluation of the current approach and the development of a new system that accurately reflects actual returns.
If you are a taxpayer with assets in Box 3, this ruling can have significant implications for you. The decision means that if your actual return on investments is lower than the deemed return used for tax purposes, you may be entitled to a tax reduction. You will need to provide evidence of your actual returns to qualify for this adjustment. This can be particularly beneficial if you have been investing in low-risk assets, as the deemed returns are likely higher than what you actually earned.
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