CJEU Rules on Parent-Subsidiary & Interest and Royalties Directives Anti-Abuse Clauses
On February 26, 2019 the Court of Justice of the European Union (CJEU) issued the long-awaited judgments on the cases concerning the Danish government withholding tax on dividends and interest paid by Danish companies to companies in other EU Member States. More specifically, the cases dealt with the interpretation of the anti-abuse clauses laid down under Art. 1, para. 2 of the Parent-Subsidiary Directive (2011/96/EU, PSD) and Art. 5 of the Interest and Royalties Directive (2003/49/EC, IRD).
An in-depth analysis of the judgments will be published in the coming weeks, setting out the implications of the CJEU judgments in a number of EU jurisdictions. This case-based note will be published from the perspective of all main European jurisdictions.
The most relevant statements of the CJEU judgements can be summarized as follows:
- Even in the absence of domestic or agreement-based anti-abuse provisions implementing the anti-abuse clauses laid down under the PSD and IRD, national authorities and courts are to refuse a taxpayer the exemption from withholding tax on dividend and interest payments, based on the general principle of EU law that EU law cannot be relied on for abusive or fraudulent ends. Therefore, for the purposes of the PSD, there is no need to interpret the notion of beneficial owner
- In the context of the IRD, the beneficial ownership clause – which is expressly provided under Art. 1, para. 1 and 4, IRD – should be interpreted as designating an entity which actually benefits from the interest or royalty that is paid to it. Namely, an entity will qualify as the beneficial owner of any interest or royalties only if it receives those payments for its own benefit and not as an intermediary, such as an agent, trustee or authorized signatory, for some other person. Furthermore, as the beneficial ownership clause included in the IRD draws upon Art. 11 of the Organization for Economic Cooperation and Development (OECD) Model Tax Convention and pursues the same objective, the concept of beneficial ownership which appears in the bilateral conventions based on that model and on the commentaries relating thereto is relevant when interpreting the provisions of the IRD
- Whilst the national court will ultimately determine whether the arrangement of a specific case amounts to an abuse of law, the CJEU has provided the Court a few indicia in order to provide guidance in the assessment of the cases. In this sense, indications of the existence of an arrangement intended to obtain improper entitlement to the exemption laid down under the PSD or the IRD can be identified
- in the case that all or almost all of the dividends or interest/royalties are, very soon after their receipt, passed on by the company that has received them to entities which do not fulfil the conditions for the application of the PSD/IRD, either because they are not established in any Member State, or because they are not incorporated in one of the forms covered by the PSD/IRD, or because they are not subject to one of the taxes listed in the PSD/IRD, or because they do not have the status of ‘parent company’
- If the sole activity of the company is the receipt of the dividends or interest/royalties, and their transmission to the beneficial owner or to other conduit companies. The absence of actual economic activity must, in the light of the specific features of the economic activity in question, be inferred from an analysis of all the relevant factors relating, in particular, to the management of the company, to its balance sheet, to the structure of its costs and to expenditure actually incurred, to the staff that it employs and to the premises and equipment that it has
- In the existence of various contracts between the companies involved in the relevant financial transactions giving rise to intragroup flows of funds or in how the transactions are financed, in the valuation of the intermediary companies’ equity and in the conduit companies’ inability to have economic use of the dividends received. Such indications are capable of being constituted not only by a contractual or legal obligation of the parent company receiving the dividends or interest/royalties to pass them on to a third party, but also by the fact that, ‘in substance’ the receiving company, without being bound by such a contractual or legal obligation, does not have the right to use and enjoy those dividends or interest/royalties
- When the beneficial owner of the dividends is resident in a non-EU State, refusal of the withholding tax exemption regime provided under the PSD is not in any way subject to fraud or an abuse of rights being found
- In respect of the burden of proving the abuse of rights, while it is in principle for the companies which seek entitlement to the exemption to establish that they fulfil the objective conditions imposed by the PSD or IRD, the burden to specifically prove the existence of an abusive practice lies with the tax authority of the source Member State. In this context the tax authority has the task not of identifying the beneficial owners of dividends or interest/royalties but of establishing that the supposed beneficial owner is merely a conduit company through which an abuse of rights has been committed
- In respect of the ‘subject-to-tax clause’ of the IRD, the CJEU held that this requirement cannot be considered as being met by a company that, although being liable to corporate income tax in its Member State of establishment, is effectively not subject to such tax on the interest received
- With specific regard to the IRD, where no fraud or abuse is found, the provisions regarding the free movement of capital do not preclude national legislation under which a resident company which pays interest to a non-resident company is required to withhold tax on that interest at source, whilst such an obligation is not owed by that resident company when the company which receives the interest is also a resident company
- Those provisions on the free movement of capital preclude, however, a national legislation which prescribes such withholding of tax at source if interest is paid by a resident company to a non-resident company whilst a resident company that receives interest from another resident company is not subject to the obligation to make an advance payment of corporation tax during the first two tax years and is therefore not required to pay corporation tax relating to that interest until a date appreciably later than the date for payment of the tax withheld at source
- Furthermore, the free movement of capital precludes national legislation providing that, where a resident company is subject to an obligation to withhold tax at source on the interest which it pays to a non-resident company, account is not taken of the expenditure in the form of interest, directly related to the lending at issue, which the latter company has incurred, whereas, under that national legislation, such expenditure may be deducted by a resident company which receives interest from another resident company for the purpose of establishing its taxable income
We are dealing with groundbreaking judgments and some time is required to outline all their implications and to consolidate the interpretation of all the principles affirmed therein. As of today, it is only possible to provide some initial commentary.
The CJEU judgments largely support the arguments of the tax authorities, whereas the Opinion of the Advocate General Kokott delivered on March 1, 2018 was in favor of taxpayers;
On one hand the CJEU attributes no relevance to the beneficial ownership clause in the context of the PSD, whilst on the other the CJEU makes reference to the requisite of beneficial owner in the context of the indications of existence of abusive practices, without clarifying the relevant concept and scope. Furthermore, where a non-EU beneficial owner is involved, it seems that the application of the beneficial owner concept prevents any relevance of the general anti-abuse principle affirmed at EU level, thus almost looking as a prerequisite.
It is our understanding that where a holding company has not a merely passive role and is involved in comprehensive activities aimed at the coordination and support of subsidiaries, at the management of the relationships among unrelated shareholders or investment protection the mere fact that the dividends it receives are passed on to other entities in a short timeframe should not result in the qualification as an abusive practice based on the overall assessment of the holding company’s role within the group. In this sense, it cannot be ignored that one of the natural purposes of a company – including a holding company – is the distribution of dividends to its shareholders.
A careful and balanced interpretation of all the principles affirmed in the judgments will be required by both taxpayers and tax authorities in order not to contradict the purposes of the PSD and IRD. In particular, the goal of the PSD to eliminate double taxation should be considered. A withholding tax on dividends must be very carefully considered as it ultimately frustrates the objective of eliminating double taxation, whilst a withholding tax on interest or royalties may not result in an additional charge, as the Member State where the recipient is resident would generally eliminate double taxation through exemption or, more commonly, credit method.