Netherlands Supreme Court finds Box 3 Incompatible with EU Law

In a decision of 24 December 2021, the Dutch Supreme Court (Hoge Raad der Nederlanden) decided that the Dutch tax regime for the income from savings and investments (the so-called box 3 income) is incompatible with EU Law.

Box 3

In the Netherlands, investment income and capital gains are taxed at a flat rate in box 3 calculated on a notional yield on net assets. Investment income is all income from savings and investments: dividends (other than those on substantial shareholdings), interest and royalties and capital gains. Until 2016, the notional yield was a fixed 4% of the value of the taxpayer’s wealth at a rate of 30% which was effectively a wealth tax of 1.2%. However, a return of 4% is far from realistic.

In 2017, the Dutch legislator attempted to tax the real return rather than a fixed fictitious return and adjusted the tax regime to tax a 'deemed asset mix'. A weighted notional yield is assigned to a fictional "savings" portion of the assets and a fictional "investment" portion of the assets. This deemed yield was taxed at a rate of 30% from 2021.

In the case before the Supreme Court, the taxpayer had savings of about €1 million, consisting of about 80% bank savings and 20% other investments. However, he was taxed as if he had only invested 21% in bank savings. The tax due under box 3 for 2017 and 2018 amounted to €12,705 and €11,969 while the taxpayer had received an actual return of €6,612 and €3,528.

The taxpayer argued that his taxation is incompatible with article 14 of the European Convention on Human rights (ECHR) and article 1 of the First Protocol to this Convention.

European Convention on Human Rights

Article 14 ECHR states that "The enjoyment of the rights and freedoms set forth in [the] Convention shall be secured without discrimination on any ground such as sex, race, colour, language, religion, political or other opinion, national or social origin, association with a national minority, property, birth or other status.”

Article 1 of the First Protocol provides that “Every natural or legal person is entitled to the peaceful enjoyment of his possessions. No one shall be deprived of his possessions except in the public interest and subject to the conditions provided for by law and by the general principles of international law.”

The taxpayer did not manage to convince the District Court of Gelderland. That court found that by using average yields as a starting point the legislator had created a link with reality. The court did not find a problem in the fact that this system is based on various fictions.

The Supreme Court overturned that decision and held that the system of the deemed asset fix is incompatible with the right of procession and the equality right.

The Supreme Court reasons that no sufficient justification can be found for the deemed asset mix system. This system restricts the right of undisturbed enjoyment of possessions as guaranteed by 1 §1 of the FP ECHR as it attaches a relatively heavy financial burden to the choice of saving.

With the flat-rate system with the deemed asset mix that has been in place since 2017, the legislator aims to match the returns achieved by taxpayers on average in the previous years. However, by basing the levying of income tax partly on the average return on risky investments, the system creates an inequality based on a circumstance outside the taxpayer's control.

Therefore, it cannot reasonably be said that the asset mix meets the proportionality test of article 1 FP ECHR. There is no reasonable proportion between the intended aim of the legislature to tax a deemed weighted yield derived from savings and investments and the inequality caused by the design, consisting of a deemed asset mix chosen by the legislature because it does not take into consideration that individual investors may not want to invest with risk.

The Supreme Court now rules that the flat-rate system that has been in place since 2017 is not proportional and violates the taxpayer's right to property.

The Supreme Court settles the matter itself
and offers legal redress
by limiting the tax to the actual return.

In principle, the court must assess whether and in what way it can provide effective legal protection against these violations of the law. The legislator has indicated that it is working on a 'speedy' introduction of a levy based on actual returns, but that the introduction cannot be expected before 2025.

Therefore, the Supreme Court itself makes up for the resulting legal shortfall by including only the actual returns in the taxpayer's levy.