Cross-Border Dividend and Interest Payments
On 26 February 2019, the Court of Justice of the European Union (CJEU) issued two important decisions regarding the applicability of the Parent-Subsidiary Directive (joint cases C-116/16 and C-117/16) and the Interest and Royalties Directive (joint cases C-115/16, C-118/16, C-119/16 and C-299/16.). The question considered by the CJEU was when dividends and interest paid by Danish companies to related companies resident in other EU member states could be denied the exemption from withholding tax provided for in these two directives either on the grounds that the recipient is not the “beneficial owner” of the payment or on the basis of fraud or abuse.
The cases decided by the CJEC dealt with Danish companies that were owned by holding companies resident in other member states (Cyprus, Luxembourg and Sweden). These holding companies were in turn owned by corporations or private equity funds resident in countries outside EU or by companies that did not otherwise qualify for the benefits under the two directives. The Danish companies paid either interest or dividend to their direct EU parent companies and had claimed exemption from withholding tax under either the Parent-Subsidiary Directive or the Interest and Royalties Directive.
The Danish tax administration had argued that the direct EU parent companies were not the beneficial owners of the dividend and interest payments, they had been used to avoid Danish withholding tax on dividend and interest payments and, therefore, they should not benefit from the WHT exemption under the Directives. The Danish High Court referred the questions to the CJEU.
CJEU’s view on the concept of “Beneficial Ownership”
In the cases the CJEU discussed the concept of “beneficial ownership”. According to the CJEU the term “beneficial owner” concerns not a formally identified recipient but rather the entity which benefits economically from the income and has the power freely to determine how the income is used. The CJEU also confirms that the OECD Model Tax Convention, its successive amendments and the commentaries to the OECD model are relevant when interpreting the concept of “beneficial owner”.
The Abuse Doctrine under EU law
The CJEU judgments seem to have broadened the concept of what constitutes abuse under EU law. Under previous case law, arrangements were generally considered abusive when they were “wholly artificial”. In the judgments issued on 26 February, the CJEC refers to structures whose principal objective or one of their principal objectives is to obtain a tax advantage. Through this more stringent position on what constitutes abuse, the CJEU seems to have drawn influence from the principal purpose test (“PPT”) that will be adopted in the majority of bilateral tax treaties through the ratification of the Multilateral Instrument. The court also added that even in the absence of anti-abuse provisions in national law or tax treaties, EU member states should apply a general EU law anti-abuse principle to refuse the benefits of the Directives.
While the CJEU did not specifically address whether the use of intermediary EU holding companies in the cases in question amounted to abuse of rights under the directives, the CJEU provided useful guidance on the elements that may constitute abuse. The factors identified by the CJEU include among others:
- contractual, legal or “in substance” obligation to, very soon after the receipt, to pass on the income to entities which do not fulfil the conditions for the application of the Directives;
- lack of substance, which is 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;
- various contracts existing between the companies involved in the financial transactions at issue that result in flow of funds that transfer profits from a profit-making commercial company to shareholding entities;
- the way in which transactions are financed, the valuation of the intermediary company’s equity and the inability to have the economic use of the dividends or interest received; and
- the simultaneity or closeness in time of, on the one hand, the entry into force of major new tax legislation and, on the other hand, the setting up of complex financial transactions.
The CJEU also takes the position that the fact that the beneficial owner of the payment resides in a third country, with which a tax treaty has been concluded does not itself rule out the existence of abuse. The CJEU, however, acknowledges that in a situation where the dividends or interest would have been exempt had they been paid directly to the beneficial owner, that the aim of the group’s structure is unconnected with any abuse. Finally, as regards the burden of proof, the CJEU stated that the member state is not required to identify the entity which it regards as being the beneficial owner of the payment in order to refuse a company the status of beneficial owner or to establish the existence of an abuse of rights.
Key takeaways from these rulings
These rulings highlight the importance of careful planning of investments and group structures. As these cases could have an impact on existing group structures, it is important to review also existing structures and evaluate the need for restructuring. We are happy to tell you more about the cases and their possible effects on your group structure.
Our tax practitioners will discuss these cases and other topical tax issues in our annual tax seminar to be held on Tuesday 19 March 2019 at 11:30-14:00. For further information about the seminar and contact details, please navigate through this link.