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Analysis

Withholding tax on net as opposed to gross interest

Judgment of the European Court of Justice of particular importance to financial institutions

Tax Alert 17/2016 | 4 August 2016

In its judgment of 13 July 2016 (case C-18/15 Brisal), the European Court of Justice decided on the method of calculating withholding tax on interest paid to non-residents being financial institutions.

Withholding tax and the freedom to provide services

Having considered the case from the perspective of the Portuguese corporate income tax regulations, the Court has taken a clear stand on inadmissibility of no possibility of deducting business expenses where interest paid to non-residents is subject to taxation if residents are allowed such a possibility. According to the Court, such a procedure for withholding tax constitutes an infringement of the principle of freedom to provide services.

In other words, if national financial institutions may, for purposes of determining their tax liability, deduct business expenses, withholding tax on interest paid to foreign financial institutions (whether its rate is lower than the standard tax rate or not) should take account of expenses relating directly to such income. As a result, tax should not be withheld on gross interest but on net interest, so after business expenses have been deducted.

Recoverability of tax which has already been withheld

The judgment in the Brisal case opens up an opportunity for taxable persons – financial institutions to recover withholding tax on gross interest, paid in the past in European Union/European Economic Area Member States. Recoverability of the said tax should be particularly important for taxable persons that have not deducted tax withheld in that way (whether in whole or in part) in the State of their residence (e.g. due to a tax loss or insufficient taxable income).

Please do not hesitate to contact us if you need any further information in this respect.

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