CJEU rules in Danish cases on beneficial ownership and treaty abuse
On February 26, 2019, the Court of Justice of the European Union (CJEU) issued its landmark judgements in six cases (C-115/16, C-118/16, C-119/16 & C-299/16 and C-116/16 & C-117/16) dealing with withholding tax on dividends and interest paid by Danish companies to entities in other Member States. The majority (5 out of 6) of the cases involved holding and financing structures involving non-EU investors that utilized a Luxembourg or Cypriot holding and financing structure to invest in Danish companies, whereby withholding tax savings on dividends and interest materialized.
26 Apr. '19 8 min. Patrick T.F. Schrievers
The joined cases (two dividend cases and four interest cases) revolve around Danish companies owned by a parent company in another EU Member State (Luxembourg, Cyprus and Sweden). Subsequently, these EU parent companies were all owned by companies resident outside the EU (such as Bermuda and the Cayman Islands) or by funds with investors in unknown jurisdictions. The key question of the cases was whether dividend and interest payments were exempt from withholding tax, while the payments were made from a Danish company to a company resident within the EU and these payments were fully or partially passed on to an ultimate parent company outside the EU.
On the dividend and interest payments, the Danish companies claimed an exemption of withholding tax based on the EC Parent-Subsidiary Directive or the EC Interest and Royalty Directive (EC Directives). The claim was challenged by the Danish Tax Authorities, arguing that the recipients in the EU were not the beneficial owners of the payments. The case ended up in the Danish High Court, which then referred questions to the CJEU. The CJEU ultimately agreed with the Danish Tax Authorities and concluded that an abusive situation can be evidenced in the combined presence of objective (the purpose of the EC Directives is circumvented) and subjective elements (existence of a wholly artificial arrangement, as well as an intention to obtain a (tax) advantage).
In more detail the CJEU stated that proof of an abusive practice requires, first, a combination of objective circumstances in which, despite formal observance of the conditions laid down by the EU rules, the purpose of those rules has not been achieved. Secondly, a subjective element consisting of the intention to obtain an advantage from the EU rules by artificially creating the conditions laid down for obtaining it. A group of companies may be regarded as being an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principal objective or one of its principal objectives is to obtain a tax advantage that is in contradiction with the aim or purpose of the applicable tax law.
Hence, if one of its principal objectives is to obtain a tax advantage that is in contradiction with the aim or purpose of the applicable tax law, abuse of law could be proven (subject to a number of other provisions that have to be satisfied; see before). Conceptually, if there are valid economic arguments for a transaction but one of the transactions’ principal objectives is to obtain a tax advantage, the tax objectives may outweigh the valid economic arguments and abuse of law may apply. Although the CJEU decisions were in the context of payments to beneficial owners on interest and dividend amounts, it is expected that these cases will result in Tax Authorities invoking the EU abuse of law concept on a more frequent basis in any other case.
Broadened EU concept of tax avoidance?
We are not completely certain whether the Danish cases actually mean that the EU abuse of law concept is broadened. In for instance the CJEU Cadbury Schweppes and Cadbury Schweppes Overseas cases (C-196/04) abuse of law would occur in purely artificial economical transactions. In the Danish cases the CJEU referred to artificial arrangements in which the principal objective or one of the principal objectives is to obtain a tax advantage, suggesting (at least) that the CJEU has broadened the EU abuse of law concept.
In Cadbury Schweppes and Cadbury Schweppes Overseas the CJEU tackled only purely artificial economic transactions designed to circumvent the application of the legislation of the Member State concerned by means of the EU abuse of law concept. The CJEU accepted ‘jurisdiction shopping’, as long as the structuring of its financing operations via controlled subsidiaries was not ‘wholly artificial’, meaning that both the establishment of the subsidiaries and their financing activities had to be real (had to show economic substance). This means that a financial structuring is considered artificial within the meaning of the Cadbury Schweppes and Cadbury Schweppes Overseas cases insofar as it is not set up for business reasons related to economic reality. The CJEU emphasizes that an essential objective of saving taxation is sufficient and that it does therefore not have to be the sole purpose of transactions.
To this extent it could be argued that the CJEU has broadened the EU abuse of law concept. On the opposite however the Danish cases seem to be in line with the judgements in the Cussens (C-251/16) and Foggia (C-126/10) cases. In Cussens, a completely artificial construction is assumed if there are circumstances that may indicate that a transactions principle objective is to obtain a tax advantage. It is crucial that tax legislation is circumvented, which can also be achieved in case the transactions have been carried out for ‘valid commercial reasons’. In Foggia, the CJEU again refines the concept of purely artificial economic transactions defined in the Cadbury Schweppes and Cadbury Schweppes Overseas cases. The CJEU ruled that the concept is broader than the mere pursuit of purely a tax benefit. The CJEU emphasizes that each specific case must be investigated separately and therefore it is not sufficient to apply general criteria. With this judgement the artificiality has apparently been less emphasized and the CJEU has focused more on the valid commercial reasons.
The reasoning of the CJEU in Cussens and Foggia cases shows that the CJEU has, prior to the Danish cases, already given a more nuanced or broadened view on the abuse of law concept as defined in the Cadbury Schweppes cases. To this extent it is not completely certain whether the Danish cases indeed do reflect a broadened EU abuse of law concept.
But why are the Danish cases important?
We expect that the CJEU as well as any Tax Authority, as a corollary to the Danish cases, will adhere (more) attention to the intention to obtain a (tax) advantage in close cooperation with an arrangement or a set of arrangements involving companies with limited economic substance. In this respect an intention to obtain a tax advantage despite a number of business-like motives may trigger discussions involving treaty or EC Directive entitlements.
It should also be noted that in the Danish cases the CJEU listed the following indicia in order to assess the existence of abuse in case of intermediary holding companies:
- For the CJEU, the assessment of actual economic activity must be inferred from an analysis of all relevant factors relating, in particular, to the management of the company, to its balance sheet, to the structure of its costs and to the expenditure actually incurred, to the staff that it employs and to the premises and equipment that are available.
- An arrangement may be considered as artificial in case the company receiving the interest or dividends passes all or almost all of such income very soon after its receipt to entities that do not satisfy the conditions for the application of the EC Parent-Subsidiary Directive and the EC Interest and Royalty Directive.
- Indications of an artificial arrangement may also be founded by the various contracts existing between the companies involved in the financial transactions at issue giving rise to intragroup flows of funds, by the way in which transactions are financed, by the valuation of the intermediary company’s equity and by the inability to have the economic use of the dividends or interest received.
We expect that these parts of the CJEU case will be used by Tax Authorities in close connection with the applicable substance in the (six) private equity holding and financing structures that were scrutinized by the Danish Tax Authorities in the joined cases. Tax Authorities could look at the applicable substance and governance model of the underlying Danish cases (that serve as a base mark) and argue that abuse of law applies. Reference is made to our Blog on this matter in which we depicted the holding and financing structure of the six cases.
- The CJEU judgements are important for the application of the EC Parent-Subsidiary Directive and the EC Interest and Royalty Directive and more generally for the interpretation of terms such as “beneficial ownership” and “abuse of law”. The cases could have a significant impact on international group structures, particularly in the situation of funds flowing from EU subsidiaries to parent companies residing outside the EU. In case of dividend and interest payments, taxpayers will be required to show that payments to intermediary companies are not part of a fraudulent or abusive arrangement. Taxpayers must also show that the recipient of the interest income is actually the beneficial owner, taking into account the OECD interpretation of this concept. The CJEU seems to have lowered the threshold for Tax Authorities to challenge arrangements and to consider it as fraudulent or abusive (even in case no specific anti-abuse provision is implemented in domestic law).
- The detailed CJEU cases give the opportunity to perform a “sanity check” and to identify potential red flags. From the cases it becomes clear that it is key that intermediary companies are economically embedded within the structure and are equipped with sufficient functions/activities. The case law aligns with international developments and given the increased transparency, companies are strongly recommended to make changes within the structure if there are facts/circumstances present that may point towards an “abusive arrangement” or a mismatch with the concept of “beneficial ownership”.
- The interpretation of “abuse of law” and “artificial arrangements” seems to have shifted, although this is not completely certain. Based on the Danish cases Tax Authorities could interpret an arrangement or transaction as “abuse of law” and deny certain benefits. The CJEU explicitly noted that a group of companies may be regarded as being an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principle objective is to obtain a tax advantage running counter to purpose of the applicable tax law. Such may be the case if a conduit entity is interposed to avoid withholding tax.
- The CJEU closely examines all facts and provides a list of circumstances that may indicate the existence of an arrangement intended to obtain improper entitlement of the EC Parent-Subsidiary Directive and / or the EC Interest and Royalty Directive. In relation to the “conduit company”, the CJEU looked amongst others at how quickly payments were passed on, its functions/activities, its ability to have economic use of the funds received and any legal/contractual obligations it has.
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