Summary of the facts
All of the six cases concern Danish companies either paying interest or distributing dividends to affiliated companies. The Danish tax authorities argue that withholding taxes were abusively avoided by interposing an intermediary EU- company between the payer, on the one hand, and a controlling entity not having access to the benefits of the EU-directives on the other hand. Denmark therefore refuses to grant a withholding tax exemption on the interest and dividend payments.
The withholding tax exemption, provided in Article 1 (1) of the IRD, can only be applied if the ”beneficial owner” of the interest (or royalty) payment is a qualifying EU company (or PE). The referring court asks some guidance as to how this notion of “beneficial ownership” should be interpreted. As the “beneficial ownership”- requirement does not appear in the parent-subsidiary directive (PSD), the ECJ only answers this question in the cases concerning interest payments.
According to the Court, the “beneficial owner” of an interest payment is the entity which actually benefits economically from the payment and accordingly has the power to freely determine the use to be given to the received interest.
Remarkably, the ECJ adds that Member States can (or are obliged to?) rely on the OECD Model Tax Convention and its commentaries when interpreting the concept of “beneficial ownership”. Later amendments to the OECD Model and its commentaries (i.e., dating from after the entry into force of the IRD) also have to be taken into account. The ECJ seems to come to this conclusion by referring to the text of a Commission Proposal regarding the Directive of March 1998.
Relying on non-EU law sources for the interpretation of EU law is, however, debatable. The fact that the Commission stated in an old proposal that some aspects of the directive are inspired by the then applicable OECD Model (and its Commentaries), does not mean, in our view, that the EU-law definitions lose their autonomous nature. Important to note that the ECJ disagrees with the opinion of the Advocate General on this point.
According to the Court, interpreting the beneficial ownership- concept in line with the OECD Model (commentaries) means that it “must be understood not in a narrow technical sense but as having a meaning that enables double taxation to be avoided and tax evasion and avoidance to be prevented.” The ECJ thus intrinsically links the notion of “beneficial ownership” with the notion of “tax abuse (or evasion)”. However, as the ECJ explains a bit further in its decision, proof of an abusive practice requires an objective and a subjective element. Determining whether a person or entity is the “beneficial owner” of a payment, does not necessarily involve an analysis of the subjective background of the structure. To put it simply: often a person (or entity) can be considered the beneficial owner, whether the person (or entity) wants it or not.
Prohibition of abusive practices: general principle with “direct effect”
Apart from the “beneficial ownership”- concept, Danish law did not implement a domestic or agreement based anti-abuse provision in its tax legislation (as is allowed by article 5 (1) of the IRD and the former article 1(2) PSD). The referring court seeks to ascertain whether such a domestic provision is required in order to challenge an abusive application of the IRD or PSD.
The ECJ starts by submitting that the prohibition of abusive practices constitutes a general principle of EU-law. This general principle is not – as opposed to the directives themselves – subject to a requirement of transposition in national law. The ECJ states that the principle can therefore be directly relied upon by a Member State against a taxpayer. The Court goes even further: a Member State is not only allowed, but obliged to refuse any benefits under the directives obtained abusively (or fraudulently).
Of course, in the case at hand the ECJ invokes this “general principle” in order to prevent any abusive reliance on EU-law benefits. One could wonder whether such a “general principle of prohibition of abuse” can also be relied upon by Member States in a non-EU law context: e.g. in order to refuse tax treaty-benefits.
The notion of abuse: constituent elements
At the request of the referring court, the ECJ also lists the constituent elements (and the required evidence) of an abuse of rights.
The ECJ no longer seems to require that the transaction or structure is “wholly artificial”. A group of companies may already be regarded as being an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principal objective or one of its principal objectives is to obtain a tax advantage running counter to the aim or purpose of the applicable tax law.
The abusive use of intermediary companies can further be determined taking into account the following indicia:
- the company receiving the income is obliged to pass the income (very soon after its receipt) on to other entities which do not fall within the scope of the IRD or PSD;
- the company receiving the income lacks an economic substance and carries out limited activities. The Court also lists a number of helpful indicia for determining whether there is any substance;
- the company receiving the income does not have the right to use and enjoy the received sums based on the various contracts existing between the companies involved.
- the structure is set up simultaneously or closely to the entry into force of major new tax legislation.
The Member State has to prove the existence of these elements, in particular the fact that the company to which the interest is formally paid is not its beneficial owner. However, as opposed to the opinion of the Advocate General, the Court stated that the Member States are not required to identify the beneficial owner of the income. It is sufficient to provide evidence indicating that the recipient is a conduit company.
Finally, the referring court also asks whether there can be an abuse of rights if the beneficial owner is located in a third state and the third state has concluded a tax convention with the source state. According to the ECJ, the existence of such a convention cannot in itself rule out an abuse of rights. Nonetheless, the ECJ adds that, in a situation where the interest would have been exempt under the tax convention had it been paid directly to the company having its seat in a third State, the taxpayer can prove that the aim of the group’s structure is unconnected with any abuse of rights.
Luxembourg Sicar cannot rely on the benefits of the interest royalty- directive
In one of these cases (C-118/16), the beneficial owner was a Luxembourg Sicar. Such an entity is subject to corporate income tax in Luxembourg, but exempt on some of its income (relating to risk-bearing capital).
Although the literal wording of the IRD only requires the company to be subject to Luxembourg corporate income tax (which it is!), the Court states that the directive has to be interpreted in the light of its objective : i.e. “ensuring that interest payments are subject to tax once in a single Member State”. For that reason, the ECJ decides that a Sicar is not “a company of Member State” within the meaning of the IRD, if its interest income is exempted from Luxembourg corporate income tax. The Sicar can, therefore, not benefit from the withholding tax exemption. We assume that the refusal of this exemption only relates to the exempted part of the Sicar’s interest income. This would require the parties to examine the Sicar’s tax regime – on a case-by-case basis – for each interest payment.
Violation of freedom of establishment and free movement of capital
The Danish court also requested the ECJ to examine whether some aspects of the Danish withholding tax regime were discriminatory and in violation with EU-primary law. Before going into further detail on the domestic law, the ECJ distinguishes two situations:
- The first situation is where the withholding tax exemption of the IRD (or the PSD) was denied because the transaction or structure is abusive. In that case, the taxpayer cannot invoke primary EU-law in order to claim that he has been discriminated against.
- The second situation is where the withholding tax exemption of the IRD (or the PSD) is not applicable because the scope of application is not fulfilled. In that case, the taxpayer can rely on EU primary law, and challenge the discriminatory character of the domestic rules.
The ECJ further investigated the conformity of Danish withholding taxes with the freedom of establishment and the free movement of capital (in the cases C-115/16, C118/16, C-119/16 and C-299/16). Three questions were submitted by the referring court:
- The first question centered around the fact that domestic interest payments (on loans) between Danish companies were exempted from withholding tax, whereas interest payments to non-resident taxpayers were subject to withholding tax. While this is not per se discriminatory, the Danish legislation also provided that a resident company receiving 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. It is, apparently, also 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 where interest is paid by a resident company to a non-resident company. This cash-flow disadvantage constitutes an unjustifiable restriction of the free movement of capital.
- Secondly, the Danish default interest rate in case of late payment of withholding tax due on interest paid by a resident company to a non-resident company, is higher than the interest rate applied in case of late payment of corporation tax due on interest received by a resident company. This also constitutes a restriction on the free movement of capital.
- Thirdly, and in line with the Brisal- case law (C-18/15), Denmark has to allow a non-resident to deduct from the interest withholding tax base any expenses directly related to the lending at issue. In casu, it concerned interest payments incurred by the non-resident.
Do not hesitate to contact your trusted adviser at Tiberghien in case you have any queries.
Koen Morbée – Partner (email@example.com)
Matthias Vekeman – Associate (firstname.lastname@example.org)