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Monday, 15 February 2021

Constitutional Court questions the application of the cayman tax to trusts

Previously, in its judgment of 11 March 2020 (A.R. no. 2018/4033/A unpublished)1, the Brussels court of first instance approved an agreement between the Belgium-resident founder of a Canadian trust and the Belgian tax authorities. In this judgement, the court recognised that any taxation of the founder’s income from that structure under the Belgian-cayman tax’s look-through principle was, while the trust income was subject to a 53.31% tax in Canada, in breach of the double tax treaty ("DTC") between Belgium and Canada.

 
 
 

In the same case, another beneficiary of this trust had gone to the Constitutional Court to present the case erga omnes. The Court handed down its judgment on 28 January 2021, annulling Article 89, 1°, of the Programme Law of 25 December 2017 (which was the law that introduced cayman tax 2.0), in so far as this article does not provide that the tax on distributions does not apply to the beneficiaries of income distributed by a legal arrangement (such as a trust) referred to in Article 2, § 1, 13°, a), WIB 1992, which, under the legislation of the State or jurisdiction in which it is established is subject to income tax equal to or in excess of 15% of the taxable income of that legal arrangement determined according to the rules applying to the establishment of Belgian tax on corresponding income (Judgment GWH 28/01/2021 no. 12/2021).

What the Constitutional Court says there, in summary, is that the 15% valuation rule of Article 5/1 §3, a) WIB that applies to type 2 legal arrangements (legal persons) should also apply to type 1 legal arrangements (legal relationships & trusts). The Court says nothing more. However, as the judgment establishes the existing legal arrangement’s unconstitutionality, the cayman tax is annulled erga omnes on that point. This means that a distribution made by a trust, that does comply with the 15% taxation rule, may not be a dividend. It is particularly interesting to note that the Constitutional Court did not rule on the transparent taxation (that is the look-through taxation) applying to trusts, which was also legally confirmed by the cayman tax in Article 5/1 §1 ITC. Such look-through taxation also only applies to type 2 legal arrangements if they do not comply with the 15% valuation rule.
In short, if we are to read the cayman tax now as corrected by the Constitutional Court's judgement of 28 January 2021, then a type 1 legal construction will continue to be subject to the look-through taxation, but the distributions will not be considered as dividends if and to the extent that the 15% taxation rule is achieved.

There are a number of critical comments to make. First, we must ask ourselves how the 15% tax rate should be calculated for a trust. Next, we must ask ourselves how this judgement should be applied within the EEA, where the Royal Decree of 21 November 2018 replaced the 15% rate with a 1% rate. Of course, the question arises as to the discrepancy with the valuation based on the look-through tax itself. Finally, it is very likely that the legislator will respond to this judgment very quickly with corrective legislation.

How should the 15% valuation be calculated for a trust?

The rule is then that, under the law of the State or jurisdiction in which the trust is established (the term 'established' not being a self-evident one to be applied to a trust), the type 1 legal arrangement in question must be subject to an income tax equal to or higher than 15% of the taxable income of that type 1 legal arrangement, as determined according to the rules applying for the establishment of the Belgian tax on the corresponding income. Since there are no trusts under Belgian law, there is no obvious basis for comparison possible for determining the hypothetical tax base. Therefore, it is not obvious to make a comparison with the corporate income tax’s taxable base, or the tax on legal entities as we are used to doing for the type 2 legal arrangements. On the other hand, prior to the introduction of the cayman tax, trusts, due to their lack of legal personality, were traditionally and partly taxed on the basis of the corresponding doctrine, but it was unclear on whose behalf the tax should be determined. This ambiguity was removed by the cayman tax, which introduced the concept of ‘founder’, with the Law of 10 August 2015.

Therefore, it is clear that one could look at the tax effectively levied in the relevant foreign country, whether on the entity itself, or the beneficiaries, or on the trustee. This will depend on the respective tax system that applies to the trust or the trust income under the foreign tax law. It seems to us that the cumulative amount of all these foreign levies, to the extent that they have the character of an income tax, can be taken into account for the calculation. It should be noted that any Belgian withholding tax that would have been withheld should also be included in this calculation.

However, a more pressing problem is deciding the reference tax base as determined under Belgian tax law. No element in the law allows us to give a conclusive answer to this point. One could argue that if the trustee is a legal entity, which will almost always be the case, then the corporate income tax or the tax on legal entities should be taken into account, by allowing for the economic activities carried out by the trustee. However, this argument is not really convincing. For the sake of convenience, one could even apply the rules of personal income tax, especially in those cases where, according to foreign law, the tax is levied on the beneficiaries themselves. However, it remains unclear. Perhaps it is advisable, in such a case, to make the three alternative calculations, i.e. corporate tax, legal entities tax and personal income tax, and apply the calculation that is most favourable to the taxpayer (in dubio contra fiscum). Of course, it is up to the legislator to adapt the law in such a way that it is sufficiently clear and legally certain for the taxpayers concerned.

How to apply this judgment within the EEA where the 15% rate has been replaced by a 1% rate by the Royal Decree of 21 November 2018?

The Constitutional Court does not express any opinion on the intra-EEA regulation of the 1% valuation threshold as determined by Article 1, paragraph 1, 3° RD 21 November 2018. However, trusts do exist within the EEA, namely in Liechtenstein. It seems to us that in the context of applying the principle of legality as confirmed by the Constitutional Court in this case, no justified distinction can be made between a Liechtenstein Stiftung on the one hand (1% valuation rule) and a Liechtenstein trust on the other hand (15% valuation rule). Here, too, it would be advisable for the legislator to intervene. However, the Constitutional Court's ruling of 28 January 2021 does not allow the 1% valuation rule to be applied to a Liechtenstein trust without such a legal provision. In such a case, the taxpayer in question will of course be able to apply to the Constitutional Court again to obtain a similar result with a probability bordering on certainty.

Regarding the question of the discrepancy with the valuation based on the look-through taxation.

As noted above, the Constitutional Court has said nothing about the application of the look-through tax for trusts subject to a rate of 15% or more abroad. The situation is thus reversed with this judgment. Trusts, whether taxed at 15% or not, will always be subject to the look-through tax but, as the case may be, distributions made by these trusts will not be dividends. This does not help the taxpayer in question at all, since the reading of the existing Article 18, paragraph 1, 3° ITC with the existing Article 21, paragraph 1, 12° ITC already provided for such a result, be it with the correction of the “anteriority rule” of Article 21, paragraph 2 ITC. It is interesting to note that this was one of the elements of defence that the Government had cited.

Quid corrective legislation?

It seems very likely that the legislature will respond fairly quickly with corrective legislation to bring the cayman tax text into line with the Constitutional Court's judgement. To this end, the judgment in Rn. B.24.2 provides the Belgian government with two different options.

"B.24.2 : In order to remedy this unconstitutionality, there are indeed several possibilities, including a designation of the taxpayers subject to the tax on benefits in identical terms for the legal arrangements of category a) and for the legal arrangements of category b), but also the preservation of the difference in treatment described in B.17 by means of a reasonable justification explained in the parliamentary preparation."

It is appropriate to quote the text of recital B.17 in full:

B.17. By extending the scope of the tax on benefits referred to in Article 18, paragraph 1, 3°, of the CIR 1992 to benefits paid by legal arrangements of category a), the legislator has taken a measure which is relevant in view of the objective mentioned in B.15.2, which is to put an end to the difference in treatment between legal arrangements of category a) and legal arrangements of category b) with regard to the tax regime applicable to their benefits. Benefits paid by both categories of legal arrangement will henceforth be subject to the tax on benefits.

However, it remains for the Court to determine whether, by putting an end to the abovementioned difference in treatment, the legislature has not created a difference in treatment, without reasonable justification, between, on the one hand, the recipients of income distributed by a legal arrangement falling within category (a) which, under the legislation of the State or the jurisdiction in which it is established subject to an income tax at a rate higher than or equal to 15% and, on the other hand, the beneficiaries of income distributed by an entity having legal personality which, under the legislation of the State or the jurisdiction in which it is established, is subject to an income tax at a rate higher than or equal to 15%. While the first category of beneficiaries is subject to the tax on distributions, the second category of beneficiaries is not. ”

Since the Constitutional Court, as already noted above, has made no finding on the look-through tax's application, it is to be expected that the legislator would aim to preserve the applicable distinction and would be content to include, in a new bill, an adequate justification that can then be used as an "explicit reasonable justification" through its inclusion in the parliamentary preparations. After all, the opposite would imply that the application of the look-through tax also needs to be repaired; and why would the legislature do that? After all, the Constitutional Court does not even say anything about it.

So we can expect, whether or not very soon, a draft bill of law that will contain an explicit justification of why trusts can continue to be subject to the look-through tax even if this "entity" is subject to a 15% or higher taxation in its home country (on a tax base, whether or not defined according to Belgian standards).

In doing so, it will also be necessary to ensure that the date of entry into force of such a repair law is determined. After all, it is to be expected that the Belgian government will attempt to minimise any possible "fiscal damage" that may arise for the period between 17 September 2017 and 31 December 2020.

However, the taxpayer in question who received a distribution from a trust during that period can certainly, in our opinion, rely on that judgment to consider that distribution as not taxable and therefore not to declare it for the assessment year 2021, and to file an objection or an ex officio application for exemption for the respective assessment years of 2018, 2019 and 2020.

In conclusion, the cayman tax’s complexity is increasing regarding trusts. The taxpayers concerned who use these structures will have to study this legislation with renewed determination in an attempt to estimate their tax liability. This implies a case-by-case analysis. The legal uncertainty in this area is rampant.

Please do not hesitate to contact us if you need assistance in this matter.

Gerd D. Goyvaerts - Partner (gerdd.goyvaerts@tiberghien.com)


1 For a reference to this judgment see Maufort, P., Taxe caïman: la taxation par transparence prévue à l'article 5/1 du C.I.R. 92 ne peut appliquer aux revenus perçus par une entité qualifiée de résident d'un État contractant par une CPDI, R.G.C.F., 2020/3, p. 141-145.

 
 
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