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Background

 

On February 26th, 2019, the Court of Justice of the European Union (the “CJEU”) released its decisions on “N Luxembourg 1” case (cases C-115/16; C-118/16, C-119/16 and C-299/16) and on “T Danmark” case (cases C-116/16 and C-117/16) regarding the application of the Danish withholding tax on interest and dividend paid by Danish companies to associated companies established in other EU Member States.

 

In particular, the Danish Tax Authorities denied the application of the withholding tax exemption regime provided for by the Council Directives 2003/49/CE (the “Interest & Royalty Directive”) and 90/435/CEE (the “Parent-Subsidiary Directive”, replaced by the EU Directive 2011/96/EU) respectively on interest and dividends paid to Luxembourg resident sub-holding companies, arguing that they acted as mere conduit and, therefore, could not qualify as the “beneficial owners” of the related items of income.

 

In the above-mentioned decisions, the CJEU pointed out several important principles concerning the application of the withholding tax exemption on interest and dividends granted by the EU Directives.

 

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The N Luxembourg 1 (on Interest & Royalty Directive)

 

This case deals with interest paid by Danish companies to EU companies ultimately owned by non-EU parent company or investors.

 

The Danish tax authorities denied the application of the withholding tax exemption provided for by the Interest & Royalty Directive arguing that the company receiving the income was a mere conduit and, therefore, could not be considered as the beneficial owner of the payment.

 

The findings of the CJEU

 

a) The concept of “beneficial owner”

 

The “beneficial owner” of the interest is the entity which actually benefits economically from that interest and accordingly has the power freely to determine the use to which it is put.

Moreover, the “beneficial ownership” clause, as provided by the Interest & Royalty Directive, can be interpreted according to the OECD Model Tax Convention on Income and on Capital – to which the Directive itself was inspired – and on the relating Commentary.

 

b) The legal basis to disregard the application of the Interest & Royalty Directive

 

In the CJEU’s view, the withholding tax exemption on interest shall be denied in case of financial arrangements whose sole aim is to benefit from the Interest & Royalty Directive.

 

The denial of the tax advantages provided for by EU laws shall be grounded on the general EU principle that abusive practices are not allowed.

 

Therefore, challenges on the abusive nature of an arrangement or transaction may be raised also in absence of a specific anti-abuse provision introduced by the domestic jurisdictions.

 

c) The “abuse” and its key features

 

An abusive behaviour occurs when both an objective and a subjective requirement are met.

 

The objective requirement is met when the purpose of the Interest & Royalty Directive has not been achieved, despite formal observance of the conditions laid down by the Directive itself. The subjective requirement consists in the intention to obtain an advantage from the Directive through the artificial creation of the conditions laid down to obtain such advantage.

 

The CJEU clarified that merely formal or artificial transactions lacking any economic and commercial reason and with the essential aim of benefiting from an improper advantage of the Interest & Royalty Directive shall be considered as abusive. Then, the CJEU enumerated a series of circumstances that may be expressive of an abusive transaction.

 

Namely:

  • the entity receiving the interest on its turn pays (simultaneously or in a short timeframe) such interest to entities that are not entitled to benefit from the Interest & Royalty Directive;
  • the group to which the entity receiving the interest belongs is structured in a way that the latter must itself pass the interest on to a third company with the consequence that it makes only an insignificant taxable profit in the jurisdiction where it acts;
  • the entity receiving the interest does not carry out a real economic activity; the lack of a real economic activity may be assessed based on the specific features of the activity carried out and taking into consideration the management of the company, its balance sheet, the structure of its costs and expenditure actually incurred, the staff that it employs and the premises and equipment that it has;
  • the various contracts existing between the companies involved in the financial transactions at issue give rise to intragroup flows of funds which may have the aim of transferring profits from a profit-making commercial company to shareholding entities in order to avoid the tax burden or reduce it as much as possible. The way in which the transactions are financed, the valuation of the intermediary companies’ equity and the conduit companies’ inability to have economic use of the interest received may also be used as indications of such an arrangement. In this connection, such indications are capable of being constituted not only by a contractual or legal obligation of the company receiving interest to pass it on to a third party but also by the fact that, ‘in substance’, that company, without being bound by such a contractual or legal obligation, does not have the right to use and enjoy those sums.

 

The CJEU also clarified that the existence of a double tax convention with the State of residence of the deemed beneficial owner of interest under which no tax would have been withheld on interest if they had been paid directly to the deemed beneficial owner does not itself rule out an abuse.

 

d) The burden of proving the abuse

 

The Interest & Royalty Directive requires taxpayers who intend to claim the withholding tax exemption on interest to prove by an attestation that they meet the formal requirements laid down by such Directive.

 

Though, the CJEU clarified that the burden of proving the existence of abusive arrangements or transactions is on the tax authorities if they intend to deny the application of the benefits granted by the Interest & Royalty Directive. Thus, tax authorities shall provide evidence that the supposed beneficial owner is merely a conduit company established to put in place an abusive arrangement or transaction. However, tax authorities shall not also identify the final beneficial owner of the income.

 

e) The “subject to tax” requirement

 

The CJEU clarified that an entity who is subject to corporate income tax in the State of residence but that is not actually subject to tax in relation to interest received cannot be regarded as being a “company of a Member State” within the meaning of the Interest & Royalty Directive. Therefore, it is not entitled to benefit from the withholding tax exemption laid down by the said Directive.

 

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The T Danmark case (on Parent-Subsidiaries Directive)

 

This case deals with dividend distributions made by a Danish resident company to intermediary holding companies resident in the EU which were ultimately owned by entities resident in non-EU Member States. The Danish tax authorities denied the application of the withholding tax exemption provided for by the Parent-Subsidiary Directive.

 

The findings of the CJEU

 

a) The legal basis to disregard the application of the Parent-Subsidiary Directive

 

As per the interest case, the CJEU stated that the general EU legal principle, whereby abusive practices are prohibited, prevents EU Member States to grant the benefits provided for by the EU law in case of abusive or fraudulent transactions.

 

Such a general principle applies in the context of the Parent-Subsidiary Directive even if national legislations have not introduced any specific anti-abuse measure.

 

b) The “abuse” and its key features

 

As regards the abuse, the CJEU provided the same clarifications as the interest case.

 

c) The burden of proving the abuse

 

Parent-Subsidiary Directive does not regulate the burden of prove. The CJEU clarified that, first, it’s up to the taxpayer to prove the fulfilment of the objective conditions imposed by the Parent-Subsidiary Directive to apply the withholding tax exemption regime.

 

However, if the tax authorities refuse to grant the exemption based on the existence of an abusive behaviour, then the burden of proving the abuse lies on them despite they are not required to identify the final beneficial owner of the income.

 

d) The granting of the EU freedoms

 

The fundamental freedoms provided for by EU law cannot be invoked in situations where the withholding tax exemption regime under the Parent-Subsidiary Directive have been denied since an abusive or fraudulent behaviour has been assessed.

 

 

If further information is required, please refer to your LED Taxand contact: eiascone@led-taxand.it or eprocopio@led-taxand.it

 

 

 

DISCLAIMER

The information provided in this newsletter cannot be regarded as legal advice. LED Taxand cannot accept any liability for the consequences of making use of this publication without their cooperation.

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