On November 11, 2010 the European Court of Justice’s Advocate General Kokott (AG) issued an important opinion in a case involving the Austrian rules for relieving economic double taxation on dividends paid to corporate shareholders (joined cases Haribo and Salinen (C-436/08 and C-437/08)). One of the issues in the case is the question whether it is contrary to EU law to grant only a conditional exemption with a switch-over to the credit method for EU/EEA dividends whereas domestic dividends are always exempt. The conditions in question include the requirement to provide details regarding the underlying taxation. The AG took the view that this different treatment in principle constitutes a restriction on the free movement of capital, but concluded that this was allowed because otherwise foreign dividends could be treated better than domestic ones. This is still the case, according to the AG, where it would be impossible or almost impossible to provide the necessary proof regarding the underlying tax.
Facts and legal background
Both cases concern Austrian companies that received portfolio dividends through domestic investment funds paid by companies in EU/EEA Member States and third countries. The Austrian corporate income tax rules contained provisions designed to prevent distributed corporate profits being subject to corporate income tax more than once. In the absence of such rules such double taxation would arise through first being taxed at the level of the distributing company and again at the level of the corporate shareholder. Such double taxation was avoided in the case of domestic dividends by exempting them in the hands of the shareholder. Whether foreign dividends were exempt, allowed a credit, or neither depended on the size of the shareholding, the underlying tax and the source of the dividends.
For portfolio dividends (that is, dividends from shareholdings of less than 10%) this resulted in the following:
- Dividends paid by Austrian companies were always exempt.
- Dividends paid by EU/EEA companies were exempt, provided various additional conditions were fulfilled. In practice, an exemption or credit was often not granted because the shareholder was not able to provide the relevant information as regards the underlying taxation. In such cases there was de facto double taxation.
- For dividends paid by EEA (not EU) companies there was an additional condition that there must be comprehensive arrangements for mutual assistance and cooperation.
- There were no provisions for relieving economic double taxation in respect of dividends paid from third countries.
The Austrian tax authorities refused to grant an exemption in respect of EU/EEA and third country dividends on the grounds that the statutory requirements had not been met, including an accurate account of the actual rate of corporate income tax that was payable by the distributing company. The Austrian companies accordingly appealed and the Austrian court stayed the proceedings and raised a number of preliminary questions concerning the different treatment of dividends according to their origin, as described above
AG’s Opinion
In her opinion, the AG addresses the question whether this treatment of foreign portfolio dividends is compatible with the free movement of capital.
Portfolio dividends from other EU/EEA Member States
Referring to previous case law of the ECJ, the AG noted that where a Member State relieves economic double taxation for domestic dividends, it must grant similar benefits for foreign dividends. In this regard, the ECJ considers the credit method equivalent to the exemption method provided the tax rate on foreign dividends is not higher than for domestic dividends and that a credit is given for the foreign tax up to the amount of the domestic tax. Although the credit method results in more administrative burdens than under an exemption method, given that it requires the shareholder to demonstrate the amount of underlying tax paid by the distributing company, the ECJ has held that this fact does not of itself result in a discriminatory treatment, as such administrative burdens are inherent to the tax credit system. The AG took the view that this is still the case, even where the required proof of the foreign tax is often in practice almost impossible.
However, since the conditions that applied to portfolio dividends from other EU/EEA Member States generally resulted in economic double taxation, the AG concluded that there was in principle a restriction of the free movement of capital. Notwithstanding this, an unconditional application of the exemption method to foreign dividends would not ensure single taxation up to at least the level of the Austrian tax, and could therefore ultimately lead to foreign dividends being more favorably treated that domestic dividends. Consequently the AG decided that the rules for EU/EER portfolio dividends were not in breach of the free movement of capital.
Portfolio dividends from an EEA (not EU) Member State
For portfolio dividends from an EEA Member State that is not a member of the EU, an additional condition applies, to the effect that there must be a comprehensive arrangement for mutual assistance and cooperation. This condition does not apply to non-portfolio dividends. In the AG’s view, based on the ECJ’s earlier case law, such an additional condition cannot be imposed if it is not imposed on non-portfolio dividends.
Portfolio dividends from third countries
Neither the exemption nor the credit method is available for this category of dividends. In the AG’s opinion this amounts to a unlawful restriction of the freedom of capital movement since it means Austria fully taxes such dividends even though the underlying profits may have already been subject to corporate income tax. The AG rejected in this context a number of arguments that had been put forward to justify the different treatment, notwithstanding indications in the ECJ’s earlier case law that justifications for restrictions in relation to non-EU countries may be more easily accepted because of the different legal context. The AG also addressed the question whether, in order to redress this infringement, Austria should apply the exemption or the credit method. She concluded that the required approach should be coherent with the treatment of dividends from EU/EEA Member States, and that accordingly a conditional exemption should apply with switch-over to the credit method, subject to the same conditions as for dividends from EU/EEA Member States. She added that the condition of reciprocal mutual assistance could not be imposed in this case.
KPMG Meijburg & Co comment
Dutch corporate income tax law also provides a dual system of double tax relief with regard to profits derived from shareholdings (participations), consisting of an exemption in the case of an active or sufficiently taxed participation and a credit in the case of a passive investment participation. However, in contrast to the Austrian regime, the Dutch rules are generally structured in a neutral way, at least the conditions that apply to domestic and EU situations are the same. As the AG sees it, it is not relevant that in the case of foreign participations it is more difficult to satisfy the ‘subject to tax’ test, that requires taxation that results in real taxation when judged by Dutch standards.
One aspect where there is a difference in the case of passive investment participations relates to the amount of credit. If a company generates profits from a low-taxed passive investment participation, the shareholder can credit the underlying corporate income tax relating to the dividend. The main rule is a fixed credit of 5%, whereby the dividend is first grossed up by 95/100. 5% of the grossed up dividend can then be credited against the tax due. However, for dividends distributed by low-taxed passive investment participations that are resident in an EU Member State and satisfy the conditions of the Parent-subsidiary directive, there is an option to credit the actual underlying tax.
This credit mechanism can result in dividends from third countries not being able to fully credit underlying tax, whereas that would be possible for EU or Dutch dividends. In this respect the Netherlands would not be able to justify the different treatment based on the need to supervise the collection of taxes in situations where information exchange arrangements are in place with the country in which the distributing company is based.
It is now a question of waiting to see if and to what extent the Court of Justice follows the AG’s opinion.