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Zero (in)tolerance (part 2)

April 28, 2017

Last time I talked a lot about zero taxation in the context of tax avoidance and evasion.

 

What I didn’t get round to dealing with was a recent EU Court of Justice decision about zero taxed Dutch investment funds (C-448/15). Now the Netherlands has come in for a lot of bad tax press in recent times, but in this case no one was saying it had done anything it shouldn’t have done. And tax avoidance and evasion were also not an issue. The Netherlands gives these investment vehicles special tax treatment for sound economic reasons, namely to provide a neutral tax basis for the collective investment of capital: by taxing the fund’s profits at a zero rate if they are distributed to its investors, the latter are effectively taxed as if they had directly invested in the underlying assets. So they get the economic benefit of collective investment without any adverse tax consequences. Other countries achieve the same result by giving special tax treatment to their own investment funds.

 

The problem with the zero tax in this case was that the Dutch fund wasn’t entitled to receive dividends from its Belgian investments free of Belgian withholding tax, at least not in the opinion of the Belgian tax authorities. If it had been a ‘normal’ Dutch company, subject to tax at the standard Dutch rate of 25% it would have got an exemption under the EU’s Parent-subsidiary Directive. The issue turned on the interpretation of the condition in the Directive for the exemption that required the parent to be subject to Dutch taxation (which it obviously was) “without the possibility of …being exempt”. The Court decided that in practical terms being taxed at zero percent was equivalent to being exempt and so it upheld the Belgian tax authorities’ position. On the face of it an understandable decision.

 

So what’s the problem? Well, what I have difficulty with is how the Court backed up its decision, by reference to the objective of the Directive (which it tends to have regard to when interpreting difficult terms in Directives). The objective of the Directive is, in short, to prevent double taxation of profits distributed between parents and subsidiaries in the EU. It does this by first requiring the parent to exempt or provide a credit for the underlying corporate tax and secondly by requiring the subsidiary to exempt the dividend payment from withholding tax. The Court argued that because the parent was subject to zero corporate income tax on the dividend it received “the risk of double taxation….is ruled out”. So levying the Belgian withholding tax was ok. That’s certainly correct as regards the risk of juridical double taxation, i.e. taxation of the dividend receipt twice in the hands of the parent, since there was only one tax levy, in the form of the Belgian withholding tax. However, it’s certainly not correct as regards the risk of economic double taxation, i.e. taxation of the profits first at the level of the subsidiary, in the form of corporate income tax and again in the hands of the parent, in the form of withholding tax. Since the objective of the Directive is clearly not limited to preventing juridical double taxation, I fail to follow the Court’s logic here. This is all the more apparent when you consider that even a ‘normal’ Dutch parent, i.e. subject to tax at the standard 25% rate, would not have been subject to Dutch tax on the dividend by virtue of the Dutch participation exemption. Following the Court’s logic such a company would also not be entitled to the withholding tax exemption.

 

My problem is perhaps more with the drafters of the Directive than with the Court: given the reference to “exemption” in the text there is little the Court could do but to find as it did. However, while there is obviously a need for this condition at the level of the subsidiary, the need is not to my mind apparent at the level of the parent.

 

But perhaps I’m becoming intolerant in my old age…..

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