Box 3 tax has been a topic of political debate for some time now. Should there be higher taxation on growth, profits or the transfer of assets? And how can the system be made fairer? Aart Gerritsen, associate professor of economics specialising in optimal taxation, sheds some light on the matter.
Assets in shares, savings accounts or a second home: in the Netherlands, they are all taxed under Box 3. 'Since its introduction in 2001, this system has taxed people on the basis of a notional return. It was assumed, for example, that everyone earned 4 per cent on their investments or savings accounts, whilst in reality this could have been higher or lower. If you achieved much lower returns, you were out of luck,' explains Gerritsen.
Box 3 system criticised
Following rulings by the Dutch Supreme Court, the scheme is under fire. In 2021, the Court ruled that the scheme contravenes the law. It found that the estimated return used by the Tax and Customs Administration in its calculations was unfair.
Politicians therefore had no choice but to switch to a new system that actually taxes returns. The economist sees this as good news. “We are now moving to a system that is much fairer and in which we actually tax returns rather than a fictitious return.” However, there are still quite a few snags involved in that transition.
Capital Gains Tax versus Unrealized Capital Gains Tax
According to the economist, there are two options for adapting the system: Capital Gains Tax or Unrealized Capital Gains Tax. Gerritsen: 'In both systems, any interest or dividends you receive are taxed. The only way they differ is in how they treat the capital gains you make on your shares. Or how they treat the increase in value of your cryptocurrency or second home.'
Under Capital Gains Tax, you only pay tax on shares or cryptocurrencies once you have sold them. The downside is that owners can delay the sale, which, according to the economist, allows them to avoid paying tax.
Under an Unrealized Capital Gains Tax scheme, investors pay tax each year on the profits they make, even if those profits are still "tied up" in, for example, shares. As a result, if you have no savings, you may have to sell (some of) your shares or cryptocurrency to pay your tax.
Paying tax on capital gains?
How does that work? According to Gerritsen, the criticism is as follows: 'Suppose you tie up all your assets in a second home. That property suddenly increases in value, and you suddenly have to pay tax on it. That might mean you have to sell the property, because otherwise you won’t be able to pay the tax. We call that a liquidity problem. So you end up paying tax on the increase in value, using money you don’t actually have to hand. That can get you into trouble.'
To resolve this issue, Marnix van Rij (former State Secretary for Taxation and the Tax and Customs Administration) put forward a proposal in 2022 for a hybrid system: shares, bonds and cryptocurrencies that are easily tradable would be subject to Unrealized Capital Gains Tax. This means you would pay tax on the increase in value each year. Capital Gains Tax would then apply to property. You would only pay tax when you sell the house, as it is difficult to sell a house on a whim.
Criticism from the VVD supporters
However, Van Rij’s proposal attracted a great deal of criticism, particularly from the VVD’s supporters. Gerritsen: 'We were well on track to introduce a very reasonable compromise. There was a very comprehensive bill that had been passed by the House of Representatives in February. Then chaos broke out and the investors woke up.'
Even now, there is still no solution to the Box 3 problem. Gerritsen recognises that the government, and the VVD in particular, has put itself in a difficult position. 'The issue with Capital Gains Tax, which is what they’re all now aiming for, is that the revenue from it takes a little longer to materialise. This then creates a shortfall in the budget.'
Gerritsen argues that it is difficult to establish a system in which only the public interest is pursued: 'Lobby groups are everywhere. Wherever possible, they always want to get their own way. The only hope we have now is that the current plan falls through and that we end up with a Capital Gains Tax after all,' he concludes.
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