Pro memoria:
The cayman tax was introduced by the program law of August 10, 2015, and immediately retroactively corrected by the law of December 26, 2015. Subsequently, the December 25, 2017, program law introduced a whole series of adjustments to this system, which we have dubbed "cayman tax 2.0”. By introducing a transparency tax in the personal and legal entities income taxation, the income received through "legal constructions" is attributed for tax purposes to the "founders" as if they had directly obtained that income themselves. The second form of taxation under the cayman tax lies in the taxation of distributions to a beneficiary, whereby the distribution is taxed as a dividend, unless it can be shown that the distribution is composed of either a) income that has already been taxed or b) capital that has been contributed, and this within the restrictive application of the so-called "anteriority rule". Notwithstanding these principles appear to be quite simple, the concrete application of the current legislation has become a very complex matter.
The most relevant changes are included below.
CHAIN CONSTRUCTIONS
Briefly, to date, a "chain construction" is understood to be a set of legal constructions formed by a parent entity and all its subsidiaries. Crucially, each of the entities is to qualify as a legal construct in itself. To the extent that one entity in the chain does not qualify as a legal construction, qualification as a "chain construction" is not possible for all the underlying entities. Under the currently applicable regulation, chain constructions are thus subject to the cayman tax in cases where legal constructions are identified in a top-to-bottom approach. Thus, the application of the cayman tax is logically stopped in the case where the chain is broken by an entity that does not qualify as a legal construct in itself. The government sees this - quite unjustifiably - as a form of evasion, where, to the contrary, it is sheer logic.
The 'solution' currently proposed by the draft bill consists in the extension of the scope of the definition of 'founder' and the elimination of the term 'chain construction' which is replaced by the use of the term 'intermediate construction'. Whereas the currently applicable legal provision of Article 2, § 1, 14°, fourth indent of the BITC (Belgian Income Tax Code) limits the scope of application to holders 'of the legal rights of the shares', this draft bill proposes to extend the scope of application to those who 'directly or indirectly hold the legal or economic rights of the shares through a chain of intermediate constructions'. This would significantly expand the scope of application. In addition, the use of the term intermediate construction also makes it possible to target chains of legal constructions where not all entities of that chain are, in themselves, legal constructions.
Notwithstanding the theoretical possibility of introducing such measures, the practical feasibility of doing so is unrealistic. As is also already evident from discussions regarding the UBO register, obtaining sufficient information by an individual about a great-granddaughter entity through to the great-grandmother entity, regarding how this entity is controlled, in order to then make the tax analysis from a Belgian point of view, is not self-evident, read often "impossible". As a result, the cayman tax will simply become unenforceable in many cases.
The draft bill (ironically) emphasizes that - despite the aforementioned extension of the scope - the system still has limits. Among other things, it stipulates that the transparent tax only applies to legal constructions and cannot be applied to 'normally taxed' intermediate constructions. This is of course rather obvious, but still makes the whole system horribly complex, especially when distributions are made between the mother and granddaughter constructions. It is also emphasized that - despite the broad scope of application of intermediate constructions - this should not mean that the investment institutions or listed companies referred to in Article 2, § 1, 13°/1, first paragraph of the BITC could also be considered intermediate constructions (apart from so-called ‘dedicated funds’).
Finally, Article 5/1 BITC is supplemented by some new rules aimed at mitigating the transparent tax in the event that the legal arrangement is held through an intermediate construct, namely proportionately to the extent that the founder indirectly holds, through an intermediate construct or a chain of intermediate constructs, the legal or economic rights of the shares of the legal construct (which is a subsidiary). Again, this is sheer logic.
REALIZED CAPITAL GAINS ON SHARES
In order to avoid "advantageous" cayman tax situations, the condition of application of article 21, first paragraph 12°, BITC is made more stringent, by henceforth not allowing the exemption upon distribution of income, which has been subjected to their Belgian tax regime, in the event that the income is/was exempted in accordance with this Belgian regime, sufficiently called "exemption vaut impôt". This would have the effect that, for example, a realized capital gain on shares in an entity subject to cayman tax, would still constitute a taxable dividend upon distribution. Completely illogical, of course. At present such a distribution is - rightly - not a dividend and therefore tax-free. Whether such unequal treatment is compatible with the principle of equality, as well as with the right to free movement of capital and freedom of establishment, is highly questionable.
THE INTERACTION OF THE TRANSPARENCY SCHEME WITH BENEFITS IN THE SAME CALENDAR YEAR
According to the draft, there is currently discussion about the interaction of the transparency regime as provided for in article 5/1, §1, tenth tier of the BITC, namely which moment prevails: the moment of allocation to the legal entity resulting in transparent taxation, or the moment of effective distribution by the legal entity (in the same calendar year). The choice between the two moments is important from a tax point of view, in the way that, depending on which moment is chosen, certain income received by the legal entity is not taxed, while if the distribution were to be effective, it would be taxable as a dividend. Article 5/1, § 1 BITC is amended under the new draft law to clarify that the income obtained through the legal arrangement is always to be taxed transparently, even if it is redistributed in the same calendar year. This also corresponds to the existing ruling practice on this point.
This is the rather technical discussion of art. 5/1, §1, tenth paragraph BITC that was already discussed in the year 2017 and is now resurfacing. Indeed, the current Article 5/1, §1, tenth tier BITC reads, "This paragraph does not apply to income paid or granted by the legal construction." The statement accompanying the draft Program Law of December 25, 2017, shows that a legal arrangement is transparent on the part of the founder in terms of income received, but not transparent in terms of income distributed. More so, the explanatory statement literally states that the purpose of Article 5/1, §1, tenth tier BITC is to avoid that Article 5/1, §1 BITC would be invoked to prevent a qualification of income distributed in the same year by the legal arrangement as a dividend. However, with this particular provision, the system lost its character of perfect tax transparency, and the system would end up (by converting the nature of the income into a dividend) in a form of imperfect tax transparency. With the introduction of this new clarification, this situation is thus mitigated and the system - on this point - retains its perfect transparency, without conversion of the nature of income. Mind you, with the adaptation of art. 21, first paragraph, 12° BITC as explained above, this effect will then be fully compromised.
DEDICATED FUND SHAREHOLDING
The draft bill proposes to combat the "circumvention" of the dedicated fund shareholding application. Indeed, in practice, according to the Court of Audit, it happens that frontmen are sought to fill the position of unrelated person/shareholder - giving them a minimum participation - in order to shield the fund from the application of the cayman tax. Therefore, a minimum shareholding for unrelated persons of 50% is now provided for. This rule is supplemented in certain situations by a reversal of the burden of proof. Indeed, a legal presumption is established in case the asset manager of the relevant sub-fund receives specific instructions from the persons holding the rights to buy or sell certain financial instruments, or in case there is simply no independent asset manager. Thus, cayman tax would also become applicable in all these cases, which may lead to a far more broad of the field of application.
INCOME DUE TO SEAT TRANSFER
Article 5/1, § 2 BITC is amended in the draft bill to clarify the tax consequences of a transfer to Belgium. The proposed idea is to discourage the transfer of capital held in a legal entity to another legal entity and to encourage a transfer of such capital to Belgium. In order to correctly classify the income that then becomes taxable as a result of the transfer of the seat of a legal entity or the transfer of capital from one legal entity to another legal entity, this part of article 5/1 §2 BITC is transferred to a new article 18, first paragraph, 3°/1 BITC, which classifies this income as a (fictional) dividend. The precise impact of this new provision remains however unclear.
EXIT TAXATION
An "exit tax" is provided for in cases where the founder transfers his tax residence abroad. To mitigate the application of this (cf. Article 5 ATAD Directive), a staggered payment is provided for in Article 413/1 BITC 92. How all this fits into the whole of the BITC is nowhere mentioned in the draft bill.
THE "1" IN "3" RULE
In order to anticipate so-called "manipulations", whereby one waits until the taxable period in which the legal arrangement loses its qualification as a legal construct before making a distribution, the bill proposes that the special rules for distributions by legal constructions (i.e. the rules of art. 18, first paragraph, 3° in conjunction with art. 21, first paragraph, 12° in conjunction with art. 21, second paragraph BITC) should also be provided for the cases in which distributions are made by entities that have been qualified as a legal arrangement in at least one of the 3 previous taxable periods. So, this is actually a specific anti-abuse measure that targets a situation where the cayman tax would normally simply not apply. It remains to be seen how this complex rule will work out in practice.
SUBSTANCE EXEMPTION
Furthermore, it is proposed to tighten and rewrite the substance exemption. The founder can still provide evidence that the legal arrangement has sufficient substance and thus carries out a substantial 'economic activity' supported by personnel, equipment, assets and buildings. In order to avoid too broad and "too European" (sic) an interpretation of the concept of "economic activity," the new draft bill specifies its meaning. Specifically, the exercise of an economic activity is to be understood as the offering of goods or services on a given market. As a result, activities relating to the management of private or family assets cannot constitute an economic activity for the purposes of this provision.
Subsequently, the economic activity must also be substantial, meaning that the economic activity must not be a peripheral item within the overall activities of the legal arrangement, but must be a core activity. Finally, the concept also presupposes that the economic activity is supported by a set of personnel, equipment, assets, and buildings. However, it is not enough to meet this criterion by creating a minimum of substance by renting an office space and compensating a part-time paid employee. The set of personnel, equipment, assets, and buildings must be credible when measured against the turnover and economic activity that is supposed to be carried out.
According to the draft bill, it is not intended that this rewritten substance exclusion can be easily invoked by any legal construct that is not a letterbox company for the purpose of shielding it from the cayman tax. It remains necessary to examine whether all the conditions are met.
To inspire the aforementioned clarification, a similar clause provided for in the articles in the ATAD Directive related to the introduction of a CFC measure was considered. Reference is also made to the jurisprudence of the Court of Justice where the Cadbury Schweppes case is regularly cited in doctrine, from which the initial substance exclusion originated but which, according to the new draft bill, has evolved since then. Indeed, according to the new draft bill, the clause included in the ATAD Directive goes beyond the concept of "wholly artificial constructions", which strictly speaking limits the application of CFC measures to so-called letterbox companies.
EXTENSION OF DECLARATION REQUIREMENTS AND MANDATORY ATTACHMENT TO THE DECLARATION
According to the draft bill, the declaration of legal constructs should also be compulsorily and supplemented by a specific annex to the declaration, to facilitate administrative follow-up and make it easier to monitor the budgetary proceeds of the cayman tax. The draft law stipulates that all data which at present is to be reported must be included in the annex to the declaration, and that this annex must also mention the income obtained by each legal construction separately, as well as the dividends referred to in article 18, first paragraph, 3° and 3°/1 BITC, including those exempted in application of article 21, first paragraph, 12° BITC.
ENTRY INTO FORCE
This adjusted cayman tax 2.1 would take effect for distributions as of Jan. 1, 2024, on the one hand, and on the other hand, for income obtained through legal constructions as of Jan. 1, 2024. As for the appendix to the tax return, that already takes effect from tax year 2024.
Under the banner of "cayman tax 2.1", the cayman tax is being substantially amended. Certain of the proposed measures raise serious questions regarding equal treatment and proportionality of the measure. It remains to be seen what the initial verdict of the Council of State will be.
We are following these developments closely for you and will keep you informed as soon as there are any news/clarifications in this. To be continued.