The most common complaint I hear about the Dutch tax system is the way that they tax income from savings and investments (e.g. interest, dividends and capital gains). This taxation occurs in “Box 3” of a Dutch tax return (“Box 1” covers wages, pensions, etc. and “Box 2” covers dividends and sales of corporate entities with 5% or more ownership by the taxpayer.)
The Netherlands is the only country I am aware of that taxes this kind of income on a “deemed return” basis, meaning that they assume your assets will have a certain return and you pay tax based on this assumed return, regardless of the actual return. It works and feels a lot like a wealth tax, with the important distinction of being seen by the US tax authorities as a “creditable” income tax (as opposed to a non-creditable wealth tax). This means you can use the Dutch Box 3 tax as a credit to offset your US tax on Form 1116.
For 2021, the deemed return for Dutch tax purposes is based on your total assets as follows:
|From €0 to €50,000
|0% deemed return (tax free amount)
|From €50,000 to €100,000
|1.898% deemed return
|From €100,000 to € 1,000,000
|4.501% deemed return
|Above € 1,000,000
|5.69% deemed return
This income is then taxed at a 31% flat tax. So, for example, on assets over € 1M, this works out to a 1.7639% tax (€ 17,639 per € 1M of assets). For married couples or other fiscal partners, the assets can be allocated in the most optimal way (regardless of actual ownership), so the rate is effectively reduced on the first € 2M of assets in this case. This also means that a couple with €100K or less of assets would not pay any tax on the income from these assets.
When assets are located in other countries it gets more complicated because you need to look at the treaty (if applicable) for each respective country to see who has the “first” right to tax the income. The country with the “second” right generally has to allow for an exemption or a tax credit, in order to avoid double taxation. I will only discuss the US-NL Treaty here, but many countries work in a similar way.
Tax Treaty Treatment of various types of income when the person is resident of The Netherlands, but the assets are located in the US:
US Interest (Article 12): Interest is generally allocated to the Netherlands, so the Netherlands has the “first” right to tax the assets that produce interest. The US will allow a foreign tax credit to offset the US tax on the interest, using a method called “treaty resourcing” which allows you to consider US interest as foreign for the purposes of calculating your foreign tax credit.
US Dividends (Article 10): This is a tricky one because the US tax can be anywhere from 0% to 37%, depending if the dividend income is “qualified” and depending on the marginal tax rate for the individual. In general the Netherlands is allowed to tax the assets that produce dividends, but they also must allow for a credit of (up to) 15%, depending on the actual US tax paid. On the US side, you are allowed to “treaty resource” just enough US dividends to bring your tax rate down to 15% on your US tax return. For example, if you have an investment account worth €1M (resulting in roughly €17K of tax in NL before credits) and it produces €50K of dividends with US tax of €10K (20%), you would take a credit on your Dutch tax return of 15% of €50K or €7.5K, resulting in a “net” Dutch tax of €9.5K. On your US tax return you would “treaty resource” €12.5K of the dividend income, which would allow for a credit of €2.5K on your US tax return (to bring the rate down to 15% on €50K, or €7.5K). So the “worldwide” tax on this investment account would be €17K (€9.5K paid in NL and €7.5K paid in the US). The remaining €7K of NL tax (€9.5K paid less the €2.5K credit taken = €7K of unused foreign tax credits) can potentially be used later when you sell the shares, to offset the capital gain tax in the US.
US Capital Gains (Article 14): Capital Gains are generally allocated to the Netherlands, so the Netherlands has the “first” right to tax the assets that produce capital gains. The US will allow a foreign tax credit to offset the US tax on the capital gains (by using “treaty resourcing” to consider US capital gains as foreign for the purposes of calculating your foreign tax credit).
US Real Estate (Article 6 and/or Article 14): Taxation of US Real Estate (whether a second home or a rental property) is generally allocated to the United States. These assets are first included in the Dutch Box 3 Tax calculation, but then the corresponding tax is deducted as a credit. For example, if your only assets were € 1M of cash and € 1M of US Real Estate, you would calculate the tax on € 2M and then 50% of this tax would be credited on the Dutch return.
Note about NIIT: For taxpayers with higher income and subject to the Net Investment Income Tax (NIIT) of 3.8% in the US, you cannot use foreign tax credits to offset this tax. (February 2024 update – due to the 2023 Christensen v. United States court case it may be possible to claim Foreign Tax Credits against NIIT. The case is currently under appeal by the IRS).