An innovative new tax measure called the “notional interest deduction” is pushing Belgium to the top of the list for business investors looking to invest risk capital. The new measure, which comes into effect for the 2006 tax year, is designed to eliminate tax discrimination between debt financing and equity financing.

The NID is a “radical” tax measure, says Serge Bartholomé, head of the research department at the National Bank of Belgium: “We hope it will bring in a flow of investment.”

Belgians also hope the increased economic activity will offset the estimated 600 million euros that the NID will cost the Belgian treasury.

It’s a gamble the country seems capable of handling. Despite its small size (30,500 square kilometres), Belgium’s population of 10.5 million is so productive that the country is the 10th-largest exporting nation in the world. (Canada is ninth.) And its GDP ranked 15th out of 30 among Organization for Economic Co-operation and Development nations in 2005. (Canada was seventh.) Belgium’s recent federal budget proclaimed its eighth straight surplus. “With public financing in good shape, there is more fiscal room to try the NID,” says Bartholomé.

At the same time, Belgium needs to overcome some serious economic challenges. For example, it has immediate competition from one of the newest European Union members. The Czech Republic is using its low-wage environment to vie successfully for valuable auto-assembly contracts — one of Belgium’s largest export industries.

And at home, one of the key forces in Belgium’s economic success, its 220 business co-ordination centres, must be discontinued by the end of 2010 after the EU determined that the centres constitute “illegal state aid.”

Belgian officials hope the NID will help maintain the presence of corporations that were attracted to Belgium by the special tax regime that enabled the centres to flourish beginning in 1983.

The centres have allowed multinationals to set up Belgian subsidiaries to co-ordinate intragroup activities, such as financing and administration. The centres were given special tax status for 10 years, during which they would not be taxed on interest earned from intragroup financing. Instead, a tax would be applied on a small percentage — usually 8% — of revenue derived from a centre’s operations.

Belgium’s neighbours, particularly France, have not been happy with the economic drain created outside Belgium by the centres, says Jean-Yves Dopchie, secretary general of Forum 187, the federation of the Belgian centres. One-third of the centres are owned by U.S.-based parent companies, and federation members are responsible for 80% of foreign exchange coming into Belgium, he says.

With the advent of the EU’s Code of Conduct in 1997, the co-ordination centre regime was found by the EU council to be a harmful tax practice on the basis that it was not open to all companies. Only wealthy subsidiaries of multinationals could take advantage of the tax breaks.

In 2003, both Belgium and Forum 187 faced off against the EU in the European Court of Justice. In June, the ECJ ruled that existing centres can continue to take advantage of their preferential tax regime until the end of 2010.

In preparation for their demise, Dopchie has worked with industry colleagues to develop a new tax measure to enable broad deductibility of taxes on capital. The eventual result was the NID.

The new measure has received immediate support from Agoria, a 1,400-member technology industry employer organization, says Dopchie.

“Our members definitely will be taking advantage of the NID,” says Remi Boelaert, Agoria’s general counsel and chief economist.

The measure was also supported by the Belgian Federation of Employers.

Although Belgian finance ministry officials already had support from Belgium’s business community, they went to the EU to get approval for the NID before unveiling it. They wanted to overcome the bad reputation Belgium had earned with the co-ordination centres. The EU has approved the new tax break, because any company can use the new deduction.

Belgium also got the EU’s permission to give “legally binding” advance tax rulings to companies wishing to take advantage of the deduction, notes Bart Adams, an international tax expert with the Belgian Ministry of Finance.

As long as a company carries on business the way it describes in its tax ruling application, the ruling will stand for five years, says Véronique Tai, one of Belgium’s four advanced tax rulings commissioners. This gives the company the assurance that it won’t be bothered by the taxman.

@page_break@There are other key features connected with the NID. For example, if a company makes insufficient return on equity to make full use of the NID in a given tax year, the amount can be carried forward up to seven years.

Belgium does not have any “thin capitalization” rules that must be applied to the qualifying capital in order to obtain the deduction. This allows profits from a company’s operations in another country to be brought into a Belgian subsidiary, without requiring the Belgian company to invest in the foreign operations.

Finally, dividends paid out of a Belgian subsidiary to a parent company outside Belgium will not be subject to withholding taxes. Essentially, this allows a company with a Belgian subsidiary to “double dip.” For example, a Dutch parent company could provide an injection of capital designed to increase the shares of a Belgian subsidiary, taking advantage of the NID. Then the Belgian subsidiary pays the Dutch parent dividends that are not taxed.

Belgian officials tout other aspects of Belgium’s favourable corporate tax environment. For example, Belgium recently reduced its corporate tax rate on large companies to 33.99% from 40.17%, and its rate on small companies to 24.98% from 28.24%.

The country also offers tax incentives to employers of foreign workers, including resettlement costs, a housing allowance and reimbursement of school fees. IE