Beneficial ownership, governance and substance trends across the EU

As a side note, the CJEU has also clarified in case C-504/16 the mere fact that the economic activity of an entity consists in the management of assets for the group or that the income of that company results only from such management cannot, per se, indicate the existence of a wholly artificial arrangement which does not reflect economic reality. Instead, in the CJEU’s view,

CJEU stated that a tax authority has the task of establishing the existence of the elements constituting the abuse, based on specific facts and circumstances. The CJEU further noted, specifically, that if tax authorities deny a benefit under an EU Directive because the company receiving the income is not its beneficial owner, such authorities are not required to identify the beneficial owners of the income. It is sufficient to establish that the alleged beneficial owner functions as a conduit company through which an abuse of rights has occurred.

The CJEU’s comments on beneficial ownership in the context of the IRD and the guidance on the constitutive elements of an abuse of rights under EU law provide some clarity on these concepts. These clarifications complement the Court’s previous case law, which noted that the mere fact that the economic activity of an entity consists in the management of assets for the group or that the income of that company results only from such management cannot, per se, indicate the existence of a wholly artificial arrangement which does not reflect economic reality^[6]. However, as the CJEU was only in a position to provide suggestions on the possible indications of abuse (it is up to national courts to decide on the specific circumstances of the case referred), the legacy of the Danish cases is nevertheless an increased scrutiny of intra-group dividend and interest payments, in particular where intermediate companies are present in the group’s EU structure, without clarity on the interpretation of the abovementioned concepts. The resulting unharmonized and inconsistent approach to the evaluation of potential abuse in the context of intra-group payments means that the evaluation of a taxpayer’s access to reduced withholding tax (WHT) rates (under domestic, EU or treaty law) has become increasingly volatile therefore leading to significant uncertainty and an increased volume of disputes between tax authorities and taxpayers.

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Against this backdrop, the European Commission is attempting to take steps towards establishing a common minimum standard on criteria for denying treaty or EU Directive benefits to companies lacking economic substance and which are at risk of being misused for the purpose gaining tax advantages through a proposal for an EU Directive commonly known as "Unshell”^[7]. The Unshell proposal sets out a list of features, referred to as gateways, to filter entities at risk of being misused for tax purposes. High-risk entities would then be required to report on a series of substance indicators through their annual tax return. Companies failing to meet a set of substance indicators would be deemed to be ‘shell’ entities, potentially triggering the denial of certain tax benefits that would have otherwise been available under double tax treaties and EU Directives.

Nearly two years since its introduction, the proposal is still under negotiation among EU Member States, with its final text and date of application remaining unclear. It could be inferred from the length of time during which discussions were held among Member States that the final text will differ from the initial proposal. Nonetheless, it's important to note that the original European Commission proposal is the only official position currently publicly available and has been used as a reference for the purposes of this article.

The totality of the anti-abuse framework, the broader concept of abuse of law, domestic substance requirements and anti-conduit rules, and the availability of certain WHT benefits only to the beneficial owner of the income are all pieces of the complex puzzle that needs to be solved by taxpayers claiming withholding tax relief. The present text intends to provide an overview of the disparities in approaches across Member States within these areas. Understanding these differences is key for taxpayers when assessing the withholding tax treatment for cross-border intra-group flows of dividends, interest, or royalties.

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With these developments in mind, in 2022 KPMG’s EU Tax Centre (the ETC) conducted an internal survey across the network of KPMG firms based in Europe to understand beneficial ownership (BO) trends across the EU and to collect key insights regarding the practice of local tax authorities in this area. We presented the outcome of our first survey in a previous blog post last year^[8].  

The ETC has continued to monitor developments in this area, most recently with a further internal survey, which was conducted in the Summer of 2023. Specifically, KPMG firms across Europe were asked to respond to an updated survey with an extended scope of queries. The objective of the survey was to identify common trends and key challenges for taxpayers in four main areas:

1.  beneficial ownership;
2.  substance;
3.  corporate governance;
4.  the wider anti-treaty shopping and anti-tax abuse frameworks applicable at a local level, with a particular focus on WHT-related measures; and
5.  the practice of the tax authorities in BO and substance matters, and level of certainty taxpayers can obtain.

The questions were asked in the context of intra-group transactions between associated companies, and do not necessarily reflect the tax treatment of income flows related to portfolio holdings.

The revised survey includes responses from 27 European jurisdictions^[9] and includes survey information valid as at September 2023. This article outlines key findings and trends identified as a result of the survey. Note that all information is valid as at September 2023. The information included below is of a general nature and does not represent tax advice based on entity-specific facts and circumstances. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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The surveyed revealed the difficulties faced by cross-border investors within the EU, in navigating the varying approaches to BO for WHT purposes.

The survey revealed that in a substantial number of responding jurisdictions, beneficial ownership, or similar concepts, hold significant relevance when it comes to the correct application of WHT rates. Specifically, this concept is applicable in 54 percent of jurisdictions applying WHT on dividend payments, and an even more significant 71 percent when it comes to interest and royalty payments. The difference is explained by the fact that certain jurisdictions (e.g.  Greece, Poland and Romania), rely on a legal ownership test rather than a BO test when testing ownership of shares and resulting income.

The graphics below illustrate the importance of the beneficial owner concept across the responding jurisdiction.

In certain instances, it is not entirely clear whether a beneficial ownership requirement exists. For instance, the Icelandic Tax Code does not refer to beneficial ownership as such; however, in order to apply for WHT benefits under a double tax treaty, an applicant must confirm their status as the beneficial owner on the application form. Similarly, in Ireland, when transposing the Parent-Subsidiary Directive, in line with the PSD an explicit reference to BO was not included. Nevertheless, the references to ownership in the relevant provision are generally understood to imply a beneficial ownership requirement. On the other hand, the local Irish dividend WHT exemption for outbound payments of dividends to treaty countries applies only to cases where, among others, the recipient is "beneficially entitled" to the dividend.

Interestingly, while the Parent-Subsidiary Directive does not test whether the recipient of the dividend is the beneficial owner of the income when providing relief from withholding tax , jurisdictions such as the Czech Republic have included this test in their domestic law when implementing the Directive.

Germany has also adopted a strict position whereby the local Tax Code incorporates an anti-treaty/directive shopping provision that denies the reduction of WHT if (i) the recipient is not the beneficial owner of the income and, (ii) if its shareholders (assuming they are the beneficial owners) would not be eligible for the treaty/directive benefits had they made the investment directly (additional conditions also apply).

Other jurisdictions, such as Norway and Sweden do not make any reference to the concept of BO in their domestic law, however, similar concepts apply. Norwegian jurisprudence suggests that there may be similarities in determining whether the direct recipient is entitled to treaty benefits, whereas, Swedish law restricts the applicability of WHT benefits to the party that holds “the right to the dividend income” (i.e. defined as the person who is entitled to withdraw a dividend for their own account at the time of the dividend payment).

In spite of a lack of harmonization of the beneficial ownership concept under the OECD Model Tax Convention or at the level of the European Union law, a small number of individual Member States have recognized the lack of clarity around this concept and have taken steps to address this issue for investors seeking to access reduced WHT rates in their jurisdictions.

A first example comes from Slovakia, where a BO definition has been included in the local Tax Code since January 2018. However, the definition did not initially provide guidance on how taxpayers could substantiate their BO status. This was resolved in August 2023, when the Financial Directorate of the Slovak Republic issued supplementary information on the method of substantiating the status of beneficial owner of the income. While this provided valuable guidance, it's worth noting that the information offered is framed as a recommendation and, therefore, not legally binding. Nevertheless, it represents a significant step towards establishing a framework for demonstrating BO status and hence for the application of double tax treaties.

Poland is another jurisdiction that has taken recent steps to provide more clarity. On September 28, 2023, the Polish Ministry of Finance issued draft clarifications on the interpretation of the beneficial owner concept, as well as establishing a framework for the due diligence requirements to be caried out by the income payor. 

In other jurisdictions, while an explicit definition is not available in their local Tax Codes, indicia can be drawn from local administrative guidance or jurisprudence. For example, in Belgium, local case-law and administrative commentaries provide a basis for the indicators that are taken into account when determining beneficial ownership^[10].  A similar situation exists in Iceland, where – regardless of the absence of a reference to beneficial ownership in the local Tax Code, in practice, BO is essential when seeking treaty WHT rates, and the application form for reduced rates includes an interpretation of the concept according to the Icelandic Director of Internal Revenue^[11].

Italy only defines beneficial ownership in the context of interest and royalty payments in its local Tax Code. Nonetheless, when it comes to dividend payments, the relevance of establishing the beneficial owner can be inferred from legal precedents and administrative practices, which also refer to the OECD principles and interpretations.

In the UK, although it is necessary to determine if the recipient of a payment is the "beneficial owner" for purposes of applying a double tax treaty WHT rate for interest and royalties payments, no explicit definition of this concept exists in UK domestic tax law. The interpretation of the term remains uncertain in the context of the UK's tax treaties as the responses did not reveal case-law specifically dealing with the meaning of beneficial ownership in this context. In principle, the OECD commentary should apply to the extent relevant to the interpretation of the treaty in question. However, in practice, HMRC have looked to economic tests (e.g. relying on the decision in case A3/2005/2497

Generally, in jurisdictions applying a BO concept, failing to meet this requirement would result in the denial of EU Directives or double tax treaty benefits. Denying the BO status can lead to additional tax consequences in several jurisdictions.

In the Czech Republic, Finland, Portugal, Romania (interest and royalties only) and Slovakia, an increased punitive WHT rate might apply. In the Czech Republic, if the immediate recipient is not considered the beneficial owner of the dividend, a 35 percent aggravated WHT may apply, rather than the domestic or treaty rate. The increased rate generally applies in cases when the direct recipient is not a resident of the EU or a treaty country (double tax treaty or exchange of information). However, it is likely that it would also apply if the taxpayer is unable to substantiate the tax residence of the beneficial owner in the EU or a treaty country. A similar increased 35 percent WHT rate could apply in Portugal, in specific situations. Slovakia also imposes an increased 35 percent WHT rate if the beneficial owner cannot be identified or is tax resident in a non-cooperative jurisdiction.

In Romania, a punitive WHT rate of 50 percent is applicable for royalty and interest payments if two conditions are met simultaneously: (i) the transaction is classified as artificial, according to the general anti-abuse rule specified in tax law, and (ii) the income is paid to a bank account from a state that has not established any information exchange treaty with Romania.

Denmark also applies an increased WHT for dividend payments if the beneficial owner is resident in a jurisdiction included on the EU list of non-cooperative jurisdictions for tax purposes.

The survey also revealed a further inconsistency in the EU regarding the application of the look-through approach. Specifically, in 19 percent of the jurisdictions, higher-tier group companies that qualify as the (ultimate) beneficial owners of dividend payments, would typically not be able to claim WHT benefits in the source state, even where they would have benefited from the same rate in the case of a direct investment. The percentage is slightly lower for interest and royalty payments (i.e. 17 percent of the jurisdictions would not allow a look-through approach). Further to this point, in several jurisdictions where the look-through approach is possible, the practices of the local tax authorities in applying the approach is not consistent.

As mentioned in our introductory comments, the CJEU held in the Danish cases that tax authorities that challenge beneficial ownership at the level of the recipient are not required to identify the actual beneficial owners of the income. In line with these judgments, taxpayers should not assume that a look-through approach will be automatically applied. Instead, they may attempt to present evidence to tax authorities to establish the identity of the beneficial owner and request the application of EU Directives or treaty benefits for this beneficial owner, where available. Several countries have indicated that, in this case, if presented with sufficient evidence, the tax authorities might consider a look-through approach. This is the case for example in Belgium, where this approach also represents a departure from the past practices of the local tax authority. In the case of France, case-law shows that the local courts have started to recognize the applicability of the tax treaties between the source state and the state where the beneficial owner of the payment (other than the direct recipient) is tax resident.

It is important to note that the look-through approach may not be available in the case of benefits granted under an EU Directive, even where such an approach is typically applied for double tax treaty benefits. This could be the case, for example, in Italy and Spain. In both cases, a look-through approach may be achieved based on a case-by-case assessment by local tax authorities or as a result of court proceedings. Consequently, WHT treaty relief could be extended up the ownership chain to the entity proven to be the beneficial owner. However, exemptions are generally not granted based on the Parent-Subsidiary Directive or the Interest and Royalties Directive. This is due to the absence of references to indirect shareholding in the local implementation of these Directives^[12].  

Similarly, a look-through approach could apply in the Netherlands, but only concerning the applicability of double tax treaties and not for the domestic WHT exemptions. The same approach is followed in Poland, where no look-through approach is available in the context of the Parent-Subsidiary Directive (but WHT relief could be granted based on the relevant double tax treaties).

The UK took a further step in reducing uncertainty and adopted guidance^[13] illustrating how the look-through approach would apply for interest flows, on which the UK levies withholding tax. As such, the guidance notes that treaty relief will not be denied merely because the immediate recipient is not the true beneficial owner of the payment. This remains valid as long as the actual beneficial owner would have been eligible for the gross payment (meaning no UK WHT would be applicable) under the relevant treaty.

In the aftermath of the Danish cases, the look-through approach is generally applied in Denmark where the direct recipient of the dividend, interest or royalty payments is deemed not to be the beneficial owner. In such instances, the payments would be subject to taxation as if they were made directly to the beneficial owner. The related WHT could be reduced based on the applicable EU Directives or the double tax treaty in force between Denmark and the jurisdiction where the beneficial owner is tax resident. This approach was confirmed by the Danish Supreme Court ruling^[14] on January 9, 2023, in two cases^[15] from the ”Danish cases” series on the WHT exemption under the EU Parent-Subsidiary Directive. The Danish Supreme Court concluded that the taxpayer proved that its US parent was the beneficial owner of the second dividend distribution and as a result, the benefits of the Denmark-US double tax treaty should be applied.

It is important to note that, based on the practice of the Danish courts, the burden of proof lies with the taxpayer to establish the identity of the beneficial owner of the payment. As such, in its May 4, 2023 ruling^[16] regarding two cases concerning WHT exemption under the Interest and Royalties Directive, the Danish Supreme Court concluded that it could not ascertain the beneficial owner due to the limited evidence presented by the taxpayers. Consequently, the payments were subject to domestic Danish WHT, and no double tax treaty benefits were granted.

On the topic of advanced certainty, survey results highlight that only half of the responding jurisdictions noted that taxpayers could obtain advance tax rulings in their jurisdictions to confirm the BO status of a taxpayer. This implies a significant degree of uncertainty for businesses operating globally and it also underscores the importance of a comprehensive understanding of each jurisdiction’s specific tax laws and regulations and the need for taxpayers to maintain appropriate records to meet the burden of proof placed upon them.

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Other relevant criteria in the majority of jurisdictions include (i) the physical presence of all board members at meetings held in that jurisdiction (63 percent of relevant surveyed jurisdictions) and (ii) the facts and circumstances of the company's directors. Other criteria that are widely used include the residence of directors (in 67 percent of relevant surveyed jurisdictions), and the skills and experience of directors (in 58 percent of the jurisdictions).

As a final point on this matter, it should be noted that the weight given to each criterion, such as the ones listed above, can vary depending on the jurisdiction. As such, understanding the relevance of each indicator remains essential for businesses operating internationally and typically requires a case by case analysis.