ECJ Ruling Opens Door To Withholding Tax Refunds

by Dechert LLP

The European Court of Justice (ECJ), in the case of Brisal, has determined on 13 July 2016 that national law which prohibits a non-resident taxpayer from deducting financing/operating costs from interest withholding tax infringes the EU fundamental freedom to provide services where resident taxpayers are able to deduct such costs.

As such, there may now be opportunities for taxpayers to reclaim withholding taxes already paid, and to argue that the manner in which certain withholding taxes apply within EU member states are in breach of EU law. Although Brisal concerned withholding tax on interest paid to a financial institution, the scope of the reasoning of the ECJ applies more broadly than interest withholding taxes and could extend to other lending vehicles (such as debt funds) and to other withholding taxes (such as withholding under royalty payments).

Brisal Summary

On the facts of the case, the main issue in dispute was the charging of Portuguese withholding tax on interest arising in Portugal and paid to a financial institution resident in Ireland. Portuguese law denied the Irish financial institution the possibility of deducting operating costs, whereas Portuguese taxpayers were allowed to deduct such costs in calculating their tax liability. 

The ECJ determined that such law infringes the fundamental freedom to provide services in the EU (which prevents an EU Member State from discriminating against nationals of different EU Member States without a justifiable reason). The ECJ reiterated that non-residents must be treated in the same way as residents and must be able to deduct the same expenses as those which residents are allowed to deduct (unless a restriction is justified by an overriding reason in the public interest but only to the extent that it does not go beyond what is necessary for that purpose). This applies notwithstanding the fact that the rate of withholding tax may be lower than the rate of domestic tax.

Withholding in a post-Brisal world

In practice, most cross-border loans by financial institutions are structured to avoid potential withholding taxes. As a consequence, if restricted in application to financial institutions, the practical application of Brisal may be limited. If extended to other lenders (such as debt funds), which do not benefit so widely as financial institutions from domestic and tax treaty exemptions from withholding, the application of Brisal may be more significant.

The ruling in Brisal will only apply to withholding taxes where a deduction for costs is disallowed for a taxpayer resident in a different EU Member State, but such costs are allowed for a resident taxpayer in the EU Member State where the withholding is being made.

Brisal poses practical and administrative difficulties for tax authorities and borrowers. In particular, it remains unclear how a borrower will determine the appropriate rate of withholding once the lender’s deductible expenses are taken into account. One possibility is that the borrower will be required to identify the operating costs of the lender. The tax authorities will likely in turn demand sufficient evidence from the borrower/lender of such costs in order to work out whether the appropriate withholding tax has been paid. Alternatively, withholding taxes could be applied on a gross basis and the lender could claim its operating costs subsequently against the tax authority. This will no doubt give rise to more extensive administrative costs for all parties involved, including the tax authority. Different EU Member States may take different approaches in order to comply, balancing different confidentiality and administrative concerns.


The UK is required to comply with all EU law until it formally secedes from the EU. Therefore, the Brisal decision will be relevant to the UK and UK taxpayers at least for the time being. Whether it will continue to be relevant post-Brexit remains to be seen as it would depend upon the nature of the UK’s subsequent arrangement with the EU.

Next Steps

Financial institutions who have suffered or are suffering withholding tax on EU cross-border interest or royalty payments should seek advice as to whether Brisal will reduce or remove the need for withholding on future payments or permit a reclaim to be made in respect of historic withholdings. This may include filing protective claims while the full practical impact of Brisal develops.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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