ECJ to Examine Belgian Withholding Rules

Transcription

1 Volume 48, Number 1 October 1, 2007 ECJ to Examine Belgian Withholding Rules by Marc Quaghebeur

2 taxanalysts ECJ to Examine Belgian Withholding Rules Belgium s Liège Court of Appeal, in Truck Center v. Belgian State, has asked the European Court of Justice for a preliminary ruling on the question of whether Belgium s tax regime, which requires a Belgian company to withhold tax on interest paid to a nonresident lender, is compatible with the EC Treaty. The case may result in an outcome similar to the one in Denkavit II (C-170/05) and extend the case law related to dividend payments to the payment of interest. (For the ECJ judgment in Denkavit II, see Doc or 2006 WTD ) The Case In the case at issue, the Belgian company Truck Center SA borrowed BEF 50 million (approximately 1,239,467 or $1,732,775) from its Luxembourg parent company. The Luxembourg parent s 48 percent shareholding in Truck Center SA, as well as the loan, have been assigned twice since then, but they are still held by Luxembourg companies. From 1994 to 1996, Truck Center SA did not pay any interest to its parent company; the interest accrued and was recorded as a liability in the Belgian company s accounts. The Belgian tax authorities discovered that the company had not withheld tax on the interest payments (that would have been due if the company had obtained the loan from another source). Consequently, the tax authorities assessed withholding tax at a rate of percent (for the years 1994 and 1995) and 15 percent (for 1996). Truck Center SA appealed that decision, and the Court of First Instance in Arlon decided that the Belgian rules are contrary to articles 56 and 58 of the EC Treaty (on the free movement of capital and the prohibition against arbitrary discrimination or any disguised restriction of that freedom) because they result in differing treatment of resident and nonresident lending companies. tax notes international by Marc Quaghebeur The Rules Under article 267 of the Belgian Income Tax Code, a Belgian company must withhold tax on interest when the interest is attributed or put up for payment. Interest registered in an account opened for the benefit of the beneficiary is considered to be attributed even if the account is inaccessible, provided that the inaccessibility results from the beneficiary s express or tacit agreement. Exemptions and waivers of that withholding tax are listed in the royal decree enforcing the Income Tax Code The royal decree lists several categories of beneficiaries. There is a general waiver of withholding tax on interest paid to professional investors in connection with ordinary loans. However, the category of professional investors is open only to resident companies. Belgium argued that the withholding tax had been charged in accordance with article 11(2) and (3) of the Belgium-Luxembourg income tax treaty. That article allows Belgium to charge withholding tax at a maximum rate of 15 percent. There is an exception in article 11(3) for cross-border payments of interest, but that exception does not apply when the beneficiary is a company resident in the other state that holds, directly or indirectly, 25 percent or more of the shares of the Belgian company. Moreover, Belgium argued that article 23 of the income tax treaty has a mechanism to impute the tax withheld in Belgium against the income tax due in Luxembourg. Because Luxembourg has to grant a credit for the Belgian withholding tax, there is no distortion of the competition between resident and nonresident companies, the Belgian state maintained. It should be noted that article 23 provides that Belgian withholding taxes on interest (paid or attributed) may be credited only against Luxembourg corporate income tax up to the rate of the Luxembourg withholding tax; the remaining part of the Tax Notes International 2

3 withholding tax will be deductible only as a business expense from the tax base. However, because Luxembourg withholding tax on interest from ordinary bonds is nil, the Belgian withholding tax cannot be imputed against the Luxembourg corporate income tax, but rather, must be deducted from Luxembourg taxable income. In other words, the Luxembourg company pays Luxembourg corporate income tax on the net income after deduction of the Belgian withholding tax, so the double taxation is not eliminated. The Question Referred On further appeal, the Court of Appeal in Liège concluded that the outcome depends on whether article 105(iii)(b) and article 107(2)(ix) of the royal decree apply, or whether they are contrary to articles 56 and 58 of the EC Treaty. However, it agreed with Truck Center SA that the ECJ should take into account the provisions of the Belgium-Luxembourg income tax treaty, because their effect is to resolve income tax issues that arise from the carrying out of an activity on an international level. The court referred the following question to the ECJ: Do Article 105(iii)(b) and Article 107(2)(ix) of the Royal Decree implementing the Income Tax Code 1992 adopted pursuant to Article 266 of the Income Tax Code 1992, read in conjunction with Article 23 of the Belgo-Luxembourg Double Taxation Treaty, infringe Article 73 (now Article 56) of the Treaty establishing the European Community, providing for free movement of capital, in that, by limiting the waiver in respect of withholding tax provided for in Article 107(2)(ix) exclusively to interest allocated to resident companies, they have, in particular, first, the effect of discouraging resident companies from borrowing capital from companies established in another Member State and, second, they constitute for companies established in another Member State an obstacle to investing capital, by way of loans, in companies having their seat in Belgium? Evolving Issues While the case started as a question about whether Belgium could impose a withholding tax on interest paid to a Luxembourg company, the Belgian tax authorities have managed to turn it into a question of whether Belgium could do that in the light of the income tax treaty, which has a mechanism for the elimination of double taxation. That question is new with respect to the payment (or attribution) of interest. The ECJ had, however, examined the issue in connection with the payment of dividends (in Denkavit II). It must be noted that the litigation relates to a period before Belgium implemented the EC interest and royalty directive (2003/49/EC of June 9, 2003). Today, Truck Center SA would not have to withhold tax at source on the payment of interest to a related EU company that holds a 15 percent participation for at least a year. The interest and royalty directive does not cover: interest paid before 2003; interest payments made to a parent company that does not have a sufficient level of participation (25 percent in 2003 and 2004; 20 percent in 2005 and 2006; 15 percent currently; and 10 percent as of January 1, 2009); or interest paid to a private lender. In recent years, though, shareholders who were not able to invoke the benefit of the EC parentsubsidiary directive (90/435/EEC of July 23, 1990, as amended by 2003/123/EC of Dec. 22, 2003) have taken their case to the ECJ and have been able to convince that court that the discrimination between nonresident and resident parent companies (where only the latter are entitled to a withholding tax exemption) is incompatible with article 43 of the EC Treaty (on freedom of establishment). Denkavit II is an example of a decision related to a dividend payment that predated the parentsubsidiary directive. Observers now are awaiting a decision in Amurta v. Inspecteur van de Belastingdienst (C-379/05), involving a situation that falls outside the ambit of the directive because the Portuguese parent company (Amurta SGPS) does not have a sufficient level of participation. Amurta SGPS owns a 14 percent equity stake in a Dutch resident company, well below the then-threshold of 25 percent under the parentsubsidiary directive. On June 7, Advocate General Paolo Mengozzi issued his opinion in that case, finding that the Dutch tax treatment of dividends distributed to Amurta SGPS is not compatible with the free movement of capital as set out in articles 56 and 58 of the EC Treaty. (For prior coverage, see Tax Notes Int l, June 25, 2007, p. 1287, Doc , or 2007 WTD ) There are no decisions related to the payment of dividends to a private shareholder. Kerckhaert- Morres (C-513/04) may have been a missed opportunity; the shareholders should have claimed the exemption of withholding tax in France. (For the ECJ judgment in Kerckhaert-Morres, see Doc or 2006 WTD ) If the ECJ follows the opinion of the advocate general in Amurta, as is likely, ECJ case law may well go in the direction of applying the parentsubsidiary directive to dividends paid before the directive entered into force, or paid to a parent 3 Tax Notes International

4 company with an insufficient equity stake. From there, it is only a small leap to apply the same principles to the payment of interest and royalties. Income Tax Treaties Whether the rules are applied to dividends or to interest, the question normally has to be considered in light of the provisions of the income tax treaty. The answer in Truck Center SA seems obvious: At first sight, Belgian tax law discriminates against nonresident companies. However, the appeals court is correct in looking at the issue on a higher level and asking the ECJ explicitly to read the legislation in conjunction with article 23 of the Belgium-Luxembourg income tax treaty. In Kerckhaert-Morres, the ECJ acknowledged that the beneficiary of a dividend payment was paying more tax as a result of the two member states exercising their fiscal sovereignty in parallel. However, it found that the negative effects of that situation have to be resolved by income tax treaties, and that the member states must take the necessary measures by applying, in particular, the apportionment criteria followed in international tax practice. It is ironic that this case brings to mind Kerckhaert-Morres, since in that case Belgium was in the opposite situation from the one it is in now. In Kerckhaert-Morres, Belgium was the member state of residence of a beneficiary receiving a dividend, and denied him a tax credit for the tax withheld at source on that dividend by the member state of source (France), although the taxpayer was entitled to the tax credit under the Belgium-France income tax treaty. In Truck Center SA, Belgium is defending the opposite position. Here, it is the member state of source, defending its right to withhold tax by referring to the obligation of the member state of residence (Luxembourg) to grant a tax credit for the withholding tax under the Belgium-Luxembourg income tax treaty. In Kerckhaert-Morres, Belgium was saved the disgrace of a condemnation, but only because the ECJ had not looked into the relevant provisions of the Belgium-France treaty. Instead, it decided that the tax treaty was not an issue, because the referring court had limited its question to the Belgian income tax legislation. However, the ECJ did examine the provisions of the income tax treaty in Denkavit II, and had a chance to answer the question that observers had hoped would be answered in Kerckhaert-Morres.Is it still discriminatory that France withholds tax on dividends paid to a Dutch company if one takes into account the income tax treaty between France and the Netherlands? That treaty allows France to withhold tax at source, and it grants the shareholder a credit for that tax that can be set off against the Dutch tax liability. When that question was submitted to the European Free Trade Association Court in relation to the European Economic Area Agreement (in Fokus Bank (E-1/04)), the EFTA Court decided that whether the state of residence has an obligation to grant credit for withholding tax under an income tax treaty and whether a credit is actually granted are of no legal significance. (For prior coverage of Fokus Bank (E-1/04), see Tax Notes Int l, Dec. 6, 2004, p. 840, Doc , or2004 WTD ) In line with the EFTA Court, the ECJ in Denkavit II decided that the member state of source cannot rely on the France-Netherlands income tax treaty to avoid its obligations under the EC Treaty, but it added the proviso whereas a parent company is unable to set off tax in that other Member State [the member state of residence] in the manner provided for by that convention. The decision in Truck Center SA may go in the same direction regarding the payment of interest. That means that the ECJ would decide that the member state cannot impose withholding tax on the interest, and that it cannot rely on the income tax treaty with the state of residence to impose the tax when the beneficiary is unable to set off the withholding tax in the manner provided for in that treaty. The conclusion then would be that the Belgian withholding tax on interest is contrary to the EC Treaty and that Belgian tax authorities cannot rely on the income tax treaty with Luxembourg to require Truck Center SA to withhold tax because the Luxembourg parent company cannot set off the withholding tax in the manner provided for by that treaty. It can set off the rest of the withholding tax against its tax base, but that does not eliminate the double taxation; the company pays corporate income tax on the net income after the deduction of the Belgian withholding tax. An Untenable Proviso While it works for the taxpayer here, it can be argued that the proviso in Denkavit II will prove untenable in practice. Legislators do not have sufficient trust in taxpayers to leave it to them to prove that a tax is due. And that is what this proviso would amount to. A withholding tax could only be introduced in situations in which the foreign parent company is entitled at home to a tax credit for that withholding tax, and is effectively able to set off that credit against its tax liability. That is something that cannot be defined objectively in the member state of Tax Notes International 4

5 source, so that state would have to effectively exempt all parent companies. Member states may consider resorting to an alternative test and continue to withhold tax at source to require parent companies to claim back the tax if they can prove that they have not been able to set off the tax at home. That may sound like a practical solution, but it risks creating a cash flow disadvantage, which the ECJ in Test Claimants in the Franked Investment Income (FII) Group Litigation v. Commissioners of Inland Revenue (C-446/04) has already condemned as contrary to the freedom to provide services and the free movement of capital. (For the ECJ decision in FII Group Litigation, see Doc or 2006 WTD ) Marc Quaghebeur, Vandendijk & Partners, Brussels 5 Tax Notes International