The Liège Court of First Instance in Belgium has

Kerckhaert-Morres Revisited: ECJ to Reconsider Belgian Taxation of Inbound s by Marc Quaghebeur Marc Quaghebeur is with Vandendijk & Partners in Brussels. The Liège Court of First Instance in Belgium has sought a preliminary ruling from the European Court of Justice in the case of Jacques Damseaux v. Belgium. 1 Damseaux concerns the double taxation of inbound dividends from another member state, an issue the ECJ previously addressed in Mark Kerckhaert and Bernadette Morres v. Belgium (C-513/04). The Belgian court seeks to determine if the ECJ would maintain its judgment in Kerckhaert-Morres after an examination of the Belgium-France double tax treaty. Belgian Domestic Law Under Belgian law, a dividend received by a resident individual is liable to withholding tax at 25 percent. This withholding tax is the final tax. The taxpayer no longer has to declare the dividend on his tax return. If no tax has been withheld at source by the company distributing its profits or by the intermediary (usually a bank), the taxpayer must declare the dividend and pay income tax at a rate of 25 percent. Inbound dividends paid by a foreign company are taxed in the same way. Belgium grants (partial) unilateral tax relief for double taxation by applying the deduction method. The Belgian withholding tax (or alternatively the 25 percent income tax) is calculated on the net dividend (after deduction of the foreign withholding tax). Inbound dividends are effectively taxed twice, as Table 1 shows. (See columns 1 and 2.) Table 1. Taxation of Inbound Standards (1) Belgian- Source (2) Inbound 500 500 15 percent French withholding tax -75 425 25 percent Belgian dividend tax -125-106.25 Net dividend after tax 375 318.75 Kerckhaert-Morres In Kerckhaert-Morres, 2 two Belgian residents received dividends from a French company, which withheld 15 percent tax at source in accordance with article 15(2) of the Belgium-France tax treaty. Because they had received that dividend directly and no Belgian withholding tax was levied on this income, the taxpayers 1 Court of First Instance Liège, Mar. 28, 2008, Damseaux (not yet published). The case has number C-128/08 with the ECJ. 2 Case C-513/04, Kerckhaert-Morres v. Belgium, Nov. 14, 2006, [2006] ECR I-10967; see Doc 2006-23075 or 2006 WTD 220-10. TAX NOTES INTERNATIONAL SEPTEMBER 15, 2008 931

PRACTITIONERS CORNER declared the dividend but claimed a tax credit in accordance with article 19A(1) of the tax treaty, which provides for a tax credit against the French tax (quoted in note 11, infra). The treatment the taxpayers sought is shown in Table 2. Table 2. Taxpayers Claim in Kerckhaert-Morres 500 15 percent French withholding tax -75 French-Source Grossed up for Belgian tax purposes to 500 25 percent Belgian dividend tax 125 Less tax credit for French withholding tax To complicate things, the dividend that the taxpayers had declared and for which they claimed a tax credit was in fact an avoir fiscal. Avoir fiscal is a form of imputation credit that existed until 2004. It was calculated at 50 percent of the dividends paid as compensation for the French corporate income tax and reimbursed to the taxpayer. The Belgium-France tax treaty states that avoir fiscal granted to a Belgian resident shareholder constitutes a dividend. The tax authorities rejected the taxpayers demand because, despite the terms of the treaty, the credit for foreign withholding taxes had been withdrawn from Belgian domestic law in 1988. When the taxpayers challenged this position before the Ghent Court of First Instance, on the grounds, among others, that it infringed article 19A(1)(2) of the Belgium-France tax treaty, as well as article 73b(1) of the EC Treaty (now article 56(1) EC), the court stayed the proceedings to ask the ECJ for a preliminary ruling. The ECJ has dealt with the taxation of inbound dividends in several cases 3 and has usually found that national tax legislation that does not apply the same tax treatment to domestic and inbound dividend income is contrary to EU law. 3 Case C-35/98, Verkooijen, [2000] ECR I-4071; Case C-315/ 02, Lenz v. Landesfinanzdirektion Tirol, [2004] ECR I-7063; Case C-319/02, Manninen, [2004] ECR I-7477; Case C-292/04, Meilicke and Others v. Finanzamt Bonn-Innenstadt, [2007] ECR I-4871. -75 425 Net Belgian dividend tax -50 Net dividend after tax 375 However, the ECJ found Kerckhaert-Morres to be different. Belgium does not tax domestic and inbound dividends differently; both are taxed at 25 percent. 4 The different treatment is the result of the parallel exercise of fiscal sovereignty by two member states. What makes the difference is that France, the member state in which the dividends originate, exercises its fiscal sovereignty and withholds tax at source. A Belgian taxpayer does indeed pay more tax on foreign dividends, but that is the result of the French income tax system, not of the Belgian rules. The ECJ acknowledged that the coexistence of national tax systems may have negative effects on the functioning of the internal market, but noted that these need to be resolved by double taxation agreements. In this respect, the ECJ referred to article 293 EC, in which the member states agreed to enter into negotiations with each other with a view to securing the abolition of double taxation within the European Community for the benefit of its nationals. Apportioning fiscal sovereignty between member states to eliminate double taxation falls outside the ambit of Community law, except in the limited situation covered by the EC directives. 5 For the rest, member states must take the measures necessary to prevent such situations by applying, in particular, the apportionment criteria followed in international tax practice. The ECJ did not give any indication as to how this must be done. It merely stated that the Belgium-France tax treaty was signed to apportion fiscal sovereignty, but added that the treaty was not an issue in the case. Therefore, the ECJ could only conclude that Belgium does not have to offer its residents a tax credit to set off the French withholding tax. That the Belgian legislation does not offer resident taxpayers a tax credit for foreign withholding tax is not contrary to article 73b(1) of the EC Treaty (now article 56(1) EC). Damseaux Damseaux, a Belgian resident, received dividends and interim dividends from the French company Total 6 in 2005, 2006, and 2007. In accordance with article 15 of the Belgium-France tax treaty, 25 percent withholding tax was deducted in France. Subsequently, the Belgian bank withheld 15 percent withholding tax. 4 The ECJ rejected the argument that applying the same rule to different situations also constitutes a form of discrimination. A shareholder receiving domestic dividends is not in a different position than one receiving foreign dividends. 5 The EU mergers directive (90/434/EEC), EU parentsubsidiary directive (90/435/EEC), the EU savings tax directive (2003/48/EC), and the EU interest and royalty directive (2003/ 49/EC). 6 Total merged with the Belgian oil company Petrofina in 1999 to form TotalFina, and merged with Elf in 2000 to form Total- FinaElf. The company s current name is Total (since 2003). 932 SEPTEMBER 15, 2008 TAX NOTES INTERNATIONAL

The Liège Court of First Instance noted that for one of the dividend payments, Damseaux had claimed back the French withholding tax from the French tax authorities in accordance with the mutual agreement procedure in the tax treaty. However, before the court of first instance, the taxpayer contested the double taxation of the dividends he had received from Total. He argued that since Belgium had accepted that France withheld tax at source, it must accept the consequences and either let European law create the possibility for him to set off French tax against the Belgian tax or simply waive the Belgian tax to avoid double taxation. The court of first instance examined articles 14, 56, 58, and 293 of the EC Treaty and noted that the situation of taxpayers receiving dividends from companies established in another member state is not objectively different from that of taxpayers receiving dividends from companies established in the member state in which they are resident. However, those two categories of Belgian taxpayers are subject to a different tax regime. While Belgian dividends are taxed at 15 percent, inbound dividends are subject to 25 percent withholding tax in France and 15 percent withholding tax in Belgium. The court of first instance incorrectly 7 opined that this has been deemed an infringement of the free movement of capital before it extensively quoted the obiter dictum of the ECJ in Kerckhaert-Morres. The court noted that the 1964 Belgium-France tax treaty is part of Belgian tax law, and as such must comply with Community law. Because Belgium has not taken any measures to eliminate double taxation of inbound dividends, the court referred the following two questions to the ECJ: Must Article 56 of the EC Treaty be interpreted as meaning that it prohibits a restriction, arising from the France-Belgium Convention seeking to avoid double taxation and to establish mutual administrative and legal rules of assistance in the field of income tax, which allows partial double taxation of dividends from shares of companies established in France to subsist and which renders the taxation of those dividends more onerous than Belgian withholding tax alone applied to dividends distributed by a Belgian company to a Belgian resident shareholder?... Must Article 293 of the EC Treaty be interpreted as meaning that it renders wrongful Belgium s inaction in not renegotiating with France a new way of abolishing double taxation of dividends from shares of companies established in France? 7 The court refers to the commission s press release (see infra note 8), which is not established case law yet. PRACTITIONERS CORNER First Comments The ECJ s decision in Kerckhaert-Morres was a setback for the European Commission as it had provided Belgium with a reasoned opinion under article 226 of the EC Treaty. Nevertheless, the European Commission decided to start proceedings against Belgium using the same arguments as Mr. Kerckhaert and Ms. Morres. 8 We have expressed our doubts as to whether that is the correct approach. 9 Damseaux may put that question to the test. Fortunately, there is one less complication in Damseaux the dividends in question were paid after the 2004 repeal of avoir fiscal in France. Some commentators were indeed under the impression that in Kerckhaert- Morres, the ECJ let itself be influenced by the fact that a Belgian taxpayer received a higher net dividend when combining net dividend and net avoir fiscal (after deducting the French withholding tax and the Belgian tax). 10 Whether the payment relates to a dividend or to avoir fiscal, the principle should not change. And when the European Commission announced that it had started proceedings against Belgium, it mentioned that there was a difference between its own proceedings and those of Mr. Kerckhaert and Ms. Morres, since they had received a credit for French corporation tax paid by France, ultimately making it more attractive for Belgian investors to invest in France than in Belgium. Damseaux will also delight commentators who were disappointed that the ECJ had not taken the opportunity in Kerckhaert-Morres to examine whether the member states had exercised their fiscal sovereignty in a manner that was consistent with Community law. 11 It is regrettable that the ECJ did not address these questions, but it was simply abiding by its own rules when it limited its answer to the question referred and did not consider the effects of the treaty. 12 8 Press release IP/07/67 of Jan. 22, 2007; see Doc 2007-1681 or 2007 WTD 15-14. 9 M. Quaghebeur, Kerckhaert-Morres v. Belgian State: The Wrong Battle? British Tax Review 2007, pp. 121-132. 10 During the proceedings, the Belgian government gave an example: On a dividend of 1,000, the taxpayer also received payment of the (avoir fiscal) tax credit of 500. Both the dividend and the avoir fiscal would suffer French withholding tax at 15 percent, and the balance would be subject to Belgian tax of 25 percent, leaving the taxpayer with a net receipt of 956. That is a tax burden of 4.4 percent, compared with 25 percent for a Belgian-source dividend. 11 In taxation cases, the ECJ tends to start its analysis by stating, According to settled case-law, direct taxation falls within the competence of the Member States, but that the Member States must none the less exercise that competence in a manner consistent with Community law. 12 Conversely, in Bouanich and Denkavit II, the Court examined the double tax treaties that form part of the legal background to (Footnote continued on next page.) TAX NOTES INTERNATIONAL SEPTEMBER 15, 2008 933

PRACTITIONERS CORNER The First Question In Damseaux the ECJ will examine the question that we all wanted to see answered in Kerckhaert-Morres: Is the Belgium-France tax treaty compatible with EU law? This first question is the most important. However, the problem is that the question itself is incorrect. The Liège court states that the court denotes a restriction in the tax treaty that leaves some degree of double taxation, but it doesn t. Article 15(2) of the treaty allows France to withhold 15 percent tax at source (article 15), but article 19A(1) obliges Belgium to give a tax credit for that French withholding tax. 13 In fact, when Belgium signed the double tax treaty, individual shareholders were entitled to a foreign tax credit. 14 That was a tax credit for the withholding tax levied abroad on dividends or interest that was calculated on the assumption that the tax collected at source was 15 percent, regardless of the level of tax withheld abroad. However, that foreign tax credit was abolished in 1988. (For prior coverage, see Doc 2003-19342 or 2003 WTD 167-5.) When it examines the tax treaty, the ECJ will discover that Belgium and France have resolved the double taxation in the treaty. The problem lies in Belgian domestic tax law, which denies the taxpayer the tax credit to which he is entitled under the treaty. the main proceedings and has been presented as such by the national court and the Court had to take it into account in order to give an interpretation of Community law that is relevant to the national court. Case C-265/04, Bouanich v. Skatteverket, [2006] ECR I-923, para. 49. Case C-170/05, Denkavit Internationaal BV, Denkavit France SARL v. Ministre de l Économie, des Finances et de l Industrie, [2006] ECR I-11949, para. 45. 13 The Belgian tax due on the amount net of the (French) withholding tax will be reduced by (1) any withholding tax ( précompte mobilier ) imposed at the normal rate and (2) a fixed quota of foreign tax that is deductible in conditions fixed by Belgian law, provided that the quota may not be less than 15 percent of this net amount. 14 Quotient forfaitaire d impôt étranger or forfaitair gedeelte van buitenlandse belasting, article 187 para. 1 ITC 1964, which has become article 285 para. 1 ITC 1992. The Second Question The second question is unusual in that it suggests the ECJ would condemn Belgium for not negotiating another way of abolishing double taxation of French dividends. It is unlikely that the ECJ will be able to answer that question. First, it is settled case law that direct taxation falls within the competence of the member states. That means member states cannot be obliged to take any measures either to refrain from taxing or to avoid double taxation. It is only when a member state uses its powers to tax, or to take measures or negotiate agreements for the avoidance of double taxation, that it can be condemned by the ECJ if it exercises that competence in a manner that is not consistent with Community law. The Missing Question We have suggested that the referring judge in Kerckhaert-Morres refer for a preliminary ruling again with the question, What would be the answer if the convention was at issue in the preliminary reference at hand? 15 And that is what the Liège Court of First Instance is doing now. However, we had suggested a second question, which is missing here: Did Belgium restrict the free movement of capital when it repealed the foreign tax credit? It is not the treaty that restricts the free movement of capital, but Belgium s unilateral refusal to grant the foreign tax credit. It is, indeed, by repealing the foreign tax credit that Belgium is restricting the free movement of capital. It is not the treaty that restricts the free movement of capital, but Belgium s unilateral refusal to grant the foreign tax credit. The question that needs to be addressed is: Did Belgium exercise its powers in a manner consistent with Community law when it unilaterally repealed the foreign tax credit? The problem is that the ECJ is not going to address that issue, since Belgian domestic law is not an issue in the preliminary reference. Belgium s domestic courts have been asked a few times to rule on the compatibility of the 1988 withdrawal of tax credits with existing double tax treaties that contain a provision granting such a tax credit. In relation to the tax treaties with the Netherlands 16 and Germany, 17 the removal of the credit was regarded as legitimate under the specific terms of these treaties. The foreign tax credit was here granted under the Belgian conditions or in accordance with the Belgian rate. This prompted the Supreme Court to state that 15 See supra note 9. 16 Court of Appeal Antwerp, Nov. 25, 1997, Fiscale Jurisprudentie/Jurisprudence Fiscale, No. 98/34; confirmed by Cass., June 16, 2000, Fiscale Jurisprudentie/Jurisprudence Fiscale, No. 2000/213. 17 Court of Appeal Antwerp, Mar. 1, 1998, Fiscoloog. 657, p. 9. 934 SEPTEMBER 15, 2008 TAX NOTES INTERNATIONAL

the contracting parties intent was to leave it up to the competence of the Belgian legislator to decide on the extent of imputation, so that he is free to change the imputation system existing at the time of the signing of the convention. In contrast, the courts in Liège granted Belgian individual shareholders the benefit of the foreign tax credit under the Belgium-U.S. treaty. 18 Article 19(A)(1) of the Belgium-France convention contains similar terms to the corresponding articles in the Dutch and German treaties: It provides that the Belgian tax due on the net dividend amount net of the withholding tax will be reduced by...a fixed quota of foreign tax that is deductible in conditions fixed by Belgian law, but the major difference is that this treaty provides that the quota may not be less than 15 percent of this net amount. Remarkably, the Ghent Court of Appeal came to the conclusion that since Belgium put an end to the foreign tax credit, the taxpayer 18 Court of First Instance, Liège, Oct. 14, 2003, Fiscale Jurisprudentie/Jurisprudence Fiscale, No. 2004/285. Court of Appeal, Liège, Mar. 10, 2006, Tijdschrift voor Fiscaal Recht, 2006, p. 607. PRACTITIONERS CORNER was not entitled to such tax credit. 19 The Ghent Court of Appeal decided that even if the treaty grants the taxpayer a minimum foreign tax credit of 15 percent, the abolition of the foreign tax credit did have an effect at the level of the tax treaty because the minimum foreign tax credit of 15 percent can only apply insofar as the credit can be set off under the conditions laid down by Belgian law. The issue therefore remains far from settled. However, it would appear that even if Community law cannot oblige the member state of residence to grant a tax credit for a withholding tax in the member state of source whether or not they have signed a convention for the avoidance of double taxation it may well be that Community law may add an extra dimension to and settle this issue under Belgian law. We can only hope that the referring judge in Liège may find a hint in the ECJ s decision to help him decide that Belgium restricted the free movement of capital when it repealed the foreign tax credit in 1988. 19 Court of Appeal, Ghent, June 24, 1999, Fiscoloog Internationaal, 190, p. 3. TAX NOTES INTERNATIONAL SEPTEMBER 15, 2008 935