On 17 March 2022, the European Court of Justice (“ECJ”) has issued a preliminary ruling on Case C-545/19 (AllianzGI-Fonds AEVN), confirming that the free movement of capital (article 63 of the TFEU) “must be interpreted as opposing to the legislation of a Member State under which dividends distributed by resident companies to a non-resident collective investment vehicle (CIV) are subject to withholding tax, whereas dividends distributed to a resident CIV are exempt from such withholding”.
The case was filed in Portugal by AllianzGI-Fonds AEVN (“AllianzGI”), which is an open-ended regulated collective investment scheme established in Germany (Alternative Investment Fund - “AIF”). The AIF received investment income (dividends) paid by companies resident in Portugal. AllianzGI filed a full withholding tax refund claim in Portugal, on the grounds that the Portuguese withholding tax was incompatible with EU Law, taking into consideration that a Portuguese CIV (incl. UCITS and AIF) performing a similar investment in Portuguese companies would benefit from a withholding tax exemption – since Portuguese CIVs are exempt from CIT on investment income.
The claim was made on the basis that a situation where domestic legislation of a Member State provides for a withholding tax levied on the dividends paid to non-resident CIV, while giving only resident CIVs the possibility of obtaining exemption from that tax constitutes a restriction on the free movement of capital.
On the contrary, Portuguese Tax Authorities (“PTA”) argued that Portuguese CIVs are not in a comparable position to AllianzGI, sustaining that such CIVs are subject to different tax provisions, which comprise an “autonomous taxation” on certain dividends and also a different tax – stamp duty – levied on the net asset value of the Portuguese CIV. PTA argued that Portuguese CIVs are merely subject to a different taxation mechanism, which should not be regarded as being in breach of EU Law. This understanding was later on adopted in the opinion of Advocate General Kokott.
In our view, the position advocated by PTA and by AG Kokott is clearly flawed by the fact that the comparability analysis was performed on the basis of completely different types of taxes, taking into account that CIT/withholding tax would be levied on income (dividends), whereas stamp duty is levied on the net asset value of the CIV. This conceptual difference of taxation techniques was highlighted in their final pleadings submitted to the ECJ.
In this regard, the ECJ clearly states that the case at hand should be assessed in light of ECJ case Fidelity Funds, reiterating that by levying a withholding tax on dividends paid to non-resident CIVs while granting an exemption to resident CIVs, “the national legislation at issue in the main proceedings treats the dividends paid to non-resident CIVs unfavorably” constituting a restriction on the free movement of capital – referring directly to Fidelity Funds Case (§44 and §45). Moreover, the ECJ clarifies that under the established case law, different taxing techniques could be admissible only when a “difference in treatment relates to situations which are not objectively comparable”. Said reasoning was followed in ECJ case Pensioenfonds Metaal en Techniek, given that the court recognizes that the difference in treatment resulted from a “difference in the situation between those two categories of taxpayers in the light of the objective pursued by the national legislation at issue in that case and their subject-matter and their content”. In this regard, the ECJ underlines that the stamp duty levied on Portuguese CIVs is irrelevant for the comparability analysis between Portuguese and non-resident CIVs. As stressed by AllianzGI – and confirmed by PTA in the clarifications provided to the ECJ – “stamp duty is a property tax, which cannot be equated with a corporation tax”. This is further evidenced by the fact that the stamp duty would be levied on accumulated income, but not on income immediately distributed – “That aspect alone is sufficient to distinguish that case from that which gave rise to [Pensioenfonds Metaal en Techniek]”, so stated the ECJ.
The ECJ also refuses the claim from the Portuguese Government that Portuguese CIVs are subject to an autonomous taxation on certain types of dividends. Under the Portuguese CIT Code, dividends paid to exempt entities are subject to income tax provided the shareholding is not maintained for a minimum period of 1 year. In the court’s opinion, this provision has only a limited reach and is not deemed relevant for the comparability assessment which should be based on the general tax framework applicable to resident and non-resident CIVs.
Lastly, the ECJ considers an argument put forward by the Portuguese Government regarding the purpose of the Portuguese legislation to eliminate economic double taxation. This argument was challenged by AllianzGI in the national court proceedings and was rebutted again in the pleadings to the ECJ, given that the Portuguese legislation does not take into consideration (at all) the position of the investors in the CIV. AllianzGI illustrated this by referring to a situation where a Portuguese resident investor holds shares in a foreign CIV, which in turn invests in Portuguese companies. Whilst dividends paid to the foreign CIV are subject to withholding tax, upon receiving a distribution from the foreign CIV, the Portuguese investor is not entitled to claim any (indirect) tax credit for the withholding tax levied in Portugal.
The ECJ recognizes this point and establishes that, to the extent “the criterion of distinction referred to in the national legislation at issue in the main proceedings, which relates solely to the place of residence of the CIV, does not make it possible to conclude that there is an objective difference in situations between resident and non-resident entities” and therefore resident and non-resident CIVs should be deemed comparable.
The existence of an overriding reason in the public interest
The ECJ refuses the claim from the Portuguese Government that this different treatment could be justified by the need to preserve the coherence of the Portuguese tax system. The fact that the Portuguese dividend taxation model is a “composite” one – as suggested by the Portuguese Government – has no bearing on the assessment of its conformity with EU Law.
In this regard, the ECJ states that there needs to be evidence of a direct link between the tax advantage given (the CIT exemption applicable to resident CIVs) and the compensating of that advantage by the disadvantage of a particular tax levy10. However, as pointed out by the ECJ, the exemption from withholding tax applicable to resident CIVs is not conditional on redistribution of dividends received by it and on the taxation applicable to the investors in the CIV. These circumstances are, in fact, disregarded by the Portuguese regime. “Therefore, the need to preserve the coherence of the national tax system cannot be relied on to justify the restriction on free movement of capital introduced by the Portuguese legislation”, states the ECJ.
The balanced allocation of taxation powers between Member States
With regards to the preservation of the balanced allocation of taxation powers between Member States, the ECJ refers to previous cases to clarify that such a justification may only be accepted where, inter alia, the rules at issue are intended to prevent behaviors capable of jeopardizing the right of a Member State to exercise its powers of taxation in relation to activities carried on in its territory. However, as ruled out in Fidelity Funds Case, the option of applying a full CIT exemption on investment income received by Portuguese CIVs while non-resident CIVs are subject to withholding tax on the same type of income cannot be justified by the need to ensure the balanced allocation of taxation powers between Member States.
Comments and takeaways form this decision
- This ECJ decision has a relevant harmonizing effect on previous case-law. The position of the Portuguese Government, seconded by AG Kokott, was to rule on this case on the basis of Pensioenfonds Metaal en Techniek (C-252/14). In our view, AG Kokott’s opinion was hindered by the misleading information provided by PTA and the Portuguese Government in the court pleadings, as well as in some incorrect assumptions on the national provisions (which has already been highlighted in academic publications which followed the AG Opinion, see: Stoeber, European Taxation, 2022 (Vol. 62). In this respect, the ECJ clearly overturns AG Kokott’s opinion, reiterating that the comparability analysis may only be performed by reference to taxes similar in nature, thus rejecting the comparability between withholding tax (tax on income) and stamp duty (tax on property).
- This decision also clarifies that the comparability analysis should be made on the basis of the general national tax framework applicable to resident and non-resident entities. A special tax on dividends that is applicable only on short-term holdings (as it was argued by PTA) “cannot be equated with the general tax of which the national-sourced dividends received by non-resident CIVs are concerned”.
- The court underlines that the transparent nature of foreign funds is not of importance, where the relevant national provisions do not take into consideration the position of the ultimate investors. In order to claim that a difference in treatment serves the purpose of avoiding tax abuse and/or eliminating economic double taxation, it is necessary thatsuch purpose is effectively pursued by the applicable provisions and not only intended. In the case at hand, the ECJ refuses to consider even the potential application of a foreign tax credit at the level of the non-resident (ultimate) investor, as it is clear that this effect has no bearing in the application of the different tax provisions at stake.
- The fact that the ECJ ruling is made on the basis of the free movement of capital allows for non-EU CIVs to also pursue the recovery of withholding taxes.
- Moreover, the fact that the regime applicable to CIVs in Portugal grants an exemption for all investment income, allows for a similar litigation strategy for withholding tax applied on interest payments.
Please note that the recent ECJ decision opens the opportunity for WHT reclaims in Portugal for the previous 4 years, as an exception to the general period of limitation of 2 years.
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