CJEU decisions provide important guidance on beneficial ownership and tax avoidance

Introduction
Based on the Parent-Subsidiary Directive (PSD), dividend payments from EU entities to qualifying EU entities may be exempt from dividend withholding tax provided that certain anti-abuse rules do not apply including a general anti-abuse rule (GAAR) which is applicable in case of tax avoidance. Under the Interest & Royalty directive (IRD), interest and royalty payments from EU entities to qualifying EU entities which are considered the beneficial owner should be exempt from withholding tax provided that certain anti-abuse rules do not apply including a GAAR.

On 26 February 2019, the Court of Justice of the European Union (CJEU) issued its judgments in six cases (the Danish cases T Danmark (C-116/16) and Y Denmark (C-117/16), Luxembourg 1 (C-115/16), X Denmark (C-118/16), C Danmark (C-119/16) and Z Denmark (C-29916)). In these cases, the CJEU answered various questions on the concepts of beneficial ownership (pursuant to the IRD) and tax avoidance (pursuant to the IRD and PSD) in case EU entities receiving interest, royalties and/or dividend partially or fully on-paid the funds to non-EU entities as interest and/or dividend. The decision of the CJEU is in particular relevant for non-EU investors which invest in the EU through EU intermediate financing, licensing and/or holding companies.

Beneficial ownership
In some of the above-mentioned cases, the CJEU answered questions on how the term beneficial owner as referred to in Article 1(1) and Article 1(4) of the IRD should be interpreted.

According to the CJEU, the concept of ‘beneficial owner of the interest’ must be interpreted as designating an entity which actually benefits from the interest that is paid to it. The term ‘beneficial owner’ does not concern a formally identified recipient but rather the entity which benefits economically from the interest received and accordingly has the power freely to determine the use to which it is put.

In addition, the CJEU clarified that the concept of ‘beneficial owner’ as included in tax treaties based on the OECD Model Tax Convention, and the successive amendments of that model and of the commentaries relating thereto are relevant when interpreting the concept of ‘beneficial owner’ included in the IRD.

Tax avoidance
In previous case law, the CJEU clarified that tax avoidance is present only in ‘wholly artificial structures’ (resulting in the denial of the benefits of the PSD directive under the application of the GAAR). In the above-mentioned cases, the CJEU interpreted the term tax avoidance as artificial arrangements in which the principal objective or one of the principal objectives is to obtain a tax advantage. Therefore, it seems that the CJEU has broadened its concept of tax avoidance.

In addition, the ECJ provided the following indications in which an artificial arrangement or transaction exists involving an intermediary holding company receiving a dividend:

• All or almost all of the dividends received by the intermediary holding company are, very soon after their receipt, passed on to entities which do not fulfil the conditions of the DWT exemption.
• The sole activity of the intermediary holding company is the receipt of dividends and their transmission to the beneficial owner or to other conduit companies. The absence of actual economic activity must, in the light of the specific features of the economic activity in question, be inferred from an analysis of all the relevant factors relating, and in particular, to:

      (i) the management of the company;

      (ii) its balance sheet;

      (iii) the structure of its costs and to expenditure actually incurred;  

      (iv) the staff that it employs; and

      (v) the premises and equipment that it has.

• The existence of various contracts between the companies involved in the financial transactions, by the way in which the transactions are financed, by the valuation of the intermediary companies’ equity and by the conduit companies’ inability (legally or in fact) to have economic use of the dividends received.
• Dividend withholding tax is avoided due to the interposition of the intermediary holding company between the company that pays dividends and the company in the group which is their beneficial owner.
• The existence of conduit companies which are without economic justification and the purely formal nature of the structure of the group of companies, the financial arrangements and the loans.

General EU law anti-abuse principle
The CJEU ruled that a general EU anti-abuse principle should be taken into account by national authorities and courts based on which the benefits of the PSD and IRD directive should be denied in case of abusive practice, even in the absence of anti-abuse provisions in national law or tax treaties.

Reaction Dutch Ministry of Finance
The Dutch state secretary of Finance has announced that his Ministry is studying the implications of the CJEU decisions and that these will be included in proposed legislation to be announced on Budget Day (i.e. 17 September 2019).

Take away
Although the CJEU provided some guidance on the concept of beneficial ownership and tax avoidance, it is not clear under which circumstances the benefits of the PSD and IRD exactly can be denied.

Taking into account these important CJEU decisions (and other significant major changes impacting the tax efficiency of international corporate structures 1)), we recommend to assess whether your investment structure meets the current and future requirements.


 1) i.e. the recommendations under the BEPS Project, the introduction of the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent BEPS (MLI), implementation of the EU anti-tax avoidance directives and other changes in Dutch tax legislation