The Court of Justice of the European Union (the “CJEU”) has held that EU-wide exemptions from withholding tax on dividends and interest may be disapplied by member states, where it can be shown that there has been an abuse of EU rights. The judgment is particularly relevant to EU holding company structures of the kind often used in private equity transactions. It is likely that cash repatriation out of some private equity investments will be less tax efficient as a result of the judgment.
Cases: C-115/16, C-116/16, C-117/16, C-118/16, C-119/16 and C-299/16.
The CJEU recently issued its decision in respect of six Danish cases on the application of Danish withholding tax, and the interpretation of the EU Interest & Royalties Directive and the EU Parent-Subsidiary Directive (together, the “Directives”). The cases concerned interest and dividends paid by Danish companies to parent companies in other EU member states, which were subsequently paid to other companies outside the EU.
The CJEU cited the principle established in EU caselaw that “EU law cannot be relied upon for abusive or fraudulent ends” as a valid basis for national tax authorities to refuse to allow a taxpayer the benefit of an exemption from withholding tax under the relevant Directive. Although the company claiming the relevant exemption must show that the necessary qualifying conditions have been fulfilled, it is for the national tax authority to establish the existence of an abusive practice where it seeks to refuse entitlement to the exemption on that basis.
In the CJEU’s opinion, an abusive practice requires both: (i) objective circumstances in which the taxpayer has formally complied with the necessary requirements of the relevant Directive without fulfilling the purpose of that Directive; and (ii) a subjective element consisting of an intention to obtain an advantage from the relevant Directive by artificially creating the conditions required for obtaining it.
The court considered that the following factors (amongst others) may be indicative of an abusive practice:
the absence of actual economic activity in the immediate recipient of the payment;
the lack of any economic justification for the given structure;
the lack of any right of the immediate recipient of the payment actually to use and enjoy it; and
close proximity in time between receipt of the payment by the immediate recipient and onward
payment to a third entity which does not itself fulfil the conditions for exemption in the relevant Directive.
According to the CJEU, the relevant exemption may be disapplied regardless of whether the beneficial
owner of the relevant payment is resident in a jurisdiction that has concluded a double tax treaty with the source jurisdiction or, indeed, has even been identified.
These cases have now been returned to the Danish courts for final determination. In the meantime, the decision will no doubt impact some structures that utilise EU holding companies. In many cases cash repatriated up a chain of companies will benefit from exemptions that lie outside the Directives (for example, double tax treaties or domestic rules like the UK’s “Quoted Eurobond” exemption), but that will not always be the case.