Decision of CJEU on the application of the EU Parent-subsidiary directive and abuse of rights

On 26 February 2019, the Court of Justice of the European Union (CJEU) issued an important judgment about the abuse of rights. This judgment is important for the application of the EU Parent-subsidiary directive (PSD), which, subject to certain conditions, provides a tax exemption for dividend distributions by EU subsidiaries to EU parent companies.

Background

In the case concerned, a Danish subsidiary distributed a dividend to its shareholder, an intermediate holding company residing in Luxembourg. The question was whether this dividend distribution was exempt from dividend withholding tax based on the PSD.

On 26 February 2019, the CJEU also decided in a case relating to the application of the EU Interest and Royalty directive (IRD) and the explanation of the term ‘beneficial owner’. Based on the IRD, the source state is not allowed to levy any withholding tax on interest and royalties if the recipient can be considered the beneficial owner. The Netherlands do not (yet) levy any withholding taxes on interest and royalty payments by a Dutch company. Therefore, this news release does not further elaborate on the explanation of the term ‘beneficial owner’ as provided by the CJEU.

Obligation to deny benefits of PSD in case of abuse of rights

The CJEU ruled that an EU member state is obliged to deny the benefits of the PSD in cases of abuse of rights, even if the domestic law of the EU member state or the applicable tax treaty does not contain an anti-abuse provision.

Definition of abuse of rights

Abuse of rights occurs if an arrangement is considered to be ‘wholly artificial’. According to the CJEU, an arrangement is ‘wholly artificial’ if the arrangement cannot be considered to be in place for reasons that reflect economic reality, has solely formal purposes and if its main purpose or one of its main purposes is to obtain a tax benefit that undermines the purpose of the applicable legislation. According to the CJEU, this is the case if a conduit entity is added to the corporate structure. A conduit entity is an entity that exclusively carries out activities relating to receiving and paying on dividends to the beneficial owner or another conduit entity. The actual economic activity of an entity should be assessed based on all relevant factors, in particular the management of the entity, the structure of its costs, its balance sheet, its employees and its premises.

Consequences for exemption of Dutch dividend withholding tax

In principle, 15% Dutch dividend withholding tax (DWT) is due upon dividend distributions by a Dutch company. A dividend distribution to a Dutch company with a shareholding of at least 5% is exempt from DWT. A dividend distribution to a company with a shareholding of at least 5%, which resides in a country that has concluded a tax treaty with the Netherlands is also exempt from DWT unless it is part of a ‘wholly artificial’ arrangement. As a result of the decision of the CJEU, the Netherlands has to deny this exemption in cases of abuse of rights. To determine whether there is a ‘wholly artificial’ arrangement, it should be determined whether the recipient of the dividend actually carries out economic activities or can only be considered a conduit entity.

Consequences for the Dutch participation exemption

The decision of the CJEU concerns the exemption of withholding taxes at the level of the entity paying the dividends. In academic literature, the question has been raised whether this decision also affects the application of the participation exemption at the level of the recipient. Case law concerning this matter should be awaited.

Opinion of Secretary of State

On 8 May 2019, a large number of questions were asked to the Dutch Secretary of State about the scope of the decision of the CJEU of 26 February 2019. The answers to these questions are not known yet.

Conclusion

In its decision of 26 February 2019, the CJEU has provided a clearer definition of abuse of rights. To determine whether there is indeed abuse of rights, all relevant facts and circumstances should be taken into account. If the relevant entity has insufficient substance, there is a substantial risk there is indeed abuse of rights.

This news release, published on 20 May 2019, contains general information. No rights can be derived from this news release.