European Court of Justice interprets concept of beneficial ownership in EU directives
On 26 February 2019 the Court of Justice of the European Union (“CJEU”) published its decisions relating to the meaning of beneficial ownership for interest payments under the EU Interest and Royalties Directive (“EUIRD”) and the extent of the exemption from withholding tax on dividend payments falling under the EU Parent Subsidiary Directive (“EUPSD”).
Each case involved payments of either interest or dividends by Danish companies to other group companies established in another member state. The ultimate shareholders of the group were either widely-held private equity funds established as partnerships or a US company such that the ultimate shareholders were not established in a member state.
The CJEU held that EU member states should deny the tax relief provided in the directives in situations where taxpayers use the directives for abusive or fraudulent purposes, even when there is no domestic law targeting such abuse, and that it is up to the Danish courts to determine whether the arrangements in the cases involve abuse or fraud.
Beneficial Ownership Requirements
The EUIRD requires the recipient of an interest payment to be established in a member state and, amongst other things, to be the beneficial owner of the interest it receives. The EUPSD does not have a beneficial ownership test in relation to dividend payments. However, similar reasoning was put forward by the Danish tax authorities in determining that the group entities holding the shares of the Danish payers of both interest and dividends were established for abusive purposes such that the benefits of zero withholding tax under the directives should not be granted to the recipient member state companies.
The CJEU confirmed that “beneficial owner” for the purposes of the EUIRD means the entity which benefits economically from the payment, meaning the entity that in substance has the power to freely use the proceeds of the payment as it wishes.
Domestic Anti-Abuse Provisions
Another issue addressed in the cases was whether a member state, to combat abuse of the EUPSD or EUIRD, must have adopted a specific provision transposing that directive into its domestic law. The CJEU held that, even in the absence of domestic or treaty-based anti-abuse provisions, the general principle that EU law cannot be relied on for abusive or fraudulent ends means that a member state must deny the exemption from withholding tax where there is evidence of fraudulent or abusive practice. The CJEU stated that it is up to the national courts to determine whether an arrangement constitutes an abuse of rights.
Abuse of Rights
In determining whether there is an abuse of rights, the courts should consider all of the facts to determine whether the conditions required to benefit from the EU Directives have only been satisfied in form or artificially, without economic or commercial justification, in order to gain access to those benefits.
The CJEU set out the following circumstances that may indicate an abuse of rights:
- A group of companies has been established that does not reflect economic reality but instead the structure is established purely with the objective of obtaining a tax advantage contrary to the purpose of the directives e.g. where a conduit company is interposed between the payer of interest or dividends and the ultimate beneficiary with the aim of avoiding withholding tax.
- Dividends or interest received are paid-on to a company’s shareholder or group creditor shortly after receipt where that shareholder or creditor would not have benefited from an exemption from withholding tax under the EU Directives.
- A company may be considered a conduit where its sole activity is the receipt of dividends and / or interest which then pays those sums on (in whatever form) to the beneficial owner or other conduit companies.
- In assessing whether a company has an actual economic activity, all of the relevant facts should be considered including the management of the company, its balance sheet, its costs incurred, staff employed, premises and equipment used. Particular attention in these cases was given to the wider structure, contractual and financing arrangements giving rise to intragroup flows of funds.
- Whether some of the beneficial owners are resident in a third country which has concluded a double tax treaty with the source member state is immaterial in determining whether there is an artificial arrangement amounting to an abuse of rights.
- However, it is possible in a situation where interest or dividends would have been exempt had they been paid directly to a company in a third country that the aim of the group’s structure is unconnected with any abuse of rights.
The CJEU also confirmed that a tax authority is not required to identify who it thinks is the beneficial owners of the relevant interest or dividends to then demonstrate there has been an abuse of rights but rather that the supposed beneficial owner is merely a conduit company through which an abuse of rights has been committed.
In addition, the court also confirmed that the fundamental rights of free movement of capital and freedom of establishment cannot be relied upon to obtain the tax benefits of the EUPSD and EUIRD in fraudulent or abusive circumstances.
In general, the CJEU decisions provide specific guidance regarding the constituent elements of an abuse of rights in relation to the benefits under the EUPSD and EUIRD. In this connection, it should be noted that the CJEU requires the member states to deny rights where abuse is present.
The CJEU has referred the cases back to the Danish court for an interpretation on whether the six individual cases involve fraud or abuse. If an abusive nature can be established, the withholding tax exemption for dividends/interest paid is to be denied.