On September 7, 2017, the Court of Justice of the European Union (CJEU) rendered its decision in the Eqiom and Enka case (C-6/16).
On September 7, 2017, the Court of Justice of the European Union (CJEU) rendered its decision in the Eqiom and Enka case (C-6/16). The case concerned the refusal by France to grant an exemption from withholding tax on dividend distributions by a resident subsidiary to its parent company located in the EU, which is controlled by shareholders in third States.
The exemption was refused on the grounds of preventing tax evasion or abuse.
The Court ruled that the French rules were contrary to Article 1(2) of the Parent-Subsidiary Directive and the EU freedom of establishment.
Article 5 of the Parent-Subsidiary Directive provides for an exemption from withholding tax on distributions of dividends by a resident subsidiary to its non-resident parent company located in the EU. However, under Article 1(2) of the Parent-Subsidiary Directive, in the version applying at the time, the withholding tax exemption can be refused under domestic or treaty provisions for preventing fraud or abuse.
In the present case, the French tax authorities refused to exempt dividends distributed in 2005 and 2006 by a French resident company to its Luxembourg parent company which was, in turn, indirectly controlled by a company resident in Switzerland.
This refusal was based on a French provision that attempts to avoid ‘directive shopping’ by requiring the taxpayer parent − if it is controlled by non-EU residents – to prove that the principal purpose or one of the principal purposes behind the structure is not to take advantage of the exemption.
The questions referred to the CJEU addressed in particular whether the French rules were compatible with, on the one hand, Article 1(2) of the Parent-Subsidiary Directive and, on the other, the EU fundamental freedoms.
The CJEU decision
In principle, any national measure in an area which has been the subject of exhaustive harmonization at the level of the European Union must be assessed in the light of the provisions of that harmonizing measure, and not in the light of the provisions of primary EU law.
However, referring to its earlier case law, the Court noted that Article 1(2) of the Parent-Subsidiary Directive is not intended to achieve exhaustive harmonization since it recognizes only the right of Member States to apply domestic or treaty provisions required to prevent fraud or abuse. It therefore follows that the French rules under examination have to be assessed in the light of Article 1(2) of the Parent- Subsidiary Directive as well as the relevant provisions of primary EU law i.e. the fundamental freedoms.
Referring to its earlier case law, the Court noted that this derogation from the withholding tax exemption rule must be interpreted strictly. The Court also noted that Article 1(2) only allowed such a derogation if ‘required’ to prevent fraud or abuse. Recalling its earlier case law, the Court noted that in order for domestic legislation to be justified by the need to avoid tax evasion and abuse, its specific objective must be to prevent conduct consisting of the creation of wholly artificial arrangements which do not reflect economic reality, with a view to unduly obtaining a tax advantage.
Thus a general presumption of fraud or abuse cannot justify a tax rule that conflicts with a directive.
In the present case, the Court concluded that the French rules generally covered all situations in which a parent company located outside France is controlled directly or indirectly by shareholders in third States, and were not specifically designed to exclude from the withholding tax exemption purely artificial arrangements designed to benefit from that exemption. The Court mentioned that the tax authorities may not confine themselves to applying predetermined general criteria, but must carry out an individual examination of the whole operation in order to determine whether an operation pursues an objective of fraud and abuse.
The Court thus ruled that the French rules were contrary to Article 1(2) of the Parent-Subsidiary Directive.
As regards the freedom of establishment and whether this was restricted, the Court ruled that adopting an initial presumption of abuse where the EU parent company is controlled by shareholders in third States, while the withholding tax exemption is granted automatically to a French parent company even though it is controlled by shareholders in third States, constitutes a restriction on the freedom of establishment.
The Court noted that the objective of combating fraud and tax evasion could potentially justify such a restriction, but reached a similar conclusion regarding the proportionality of the rules to that mentioned above for Article 1(2) of the Directive, i.e. that the rules went further than necessary.
KPMG Luxembourg comment
The CJEU decision is in line with the AG’s Opinion (please see ETF 312) and with previous CJEU decisions in cases dealing with the circumstances in which a Member State may refuse a tax advantage provided by virtue of an EU Directive on grounds of preventing tax evasion or abuse.
This case should be seen as a positive change for investors interested in investing in the EU. Indeed, there should be no general presumption that implementing an EU intermediary company to benefit from the provisions of the EU parent-subsidiary regime constitutes an artificial arrangement only aiming at obtaining a tax advantage.
The decision is likely to impact the application of the new GAAR clause of the Parent-Subsidiary Directive, which took effect as of January 1, 2016. While the Parent-Subsidiary Directive still contains a provision similar to that of Article 1(2) of the Directive as it applied at the time of this case, the new provisions explicitly require Member States to deny its benefits to arrangements whose main purpose or one of its main purposes is to obtain an advantage contrary to the object of the Directive and without valid commercial reasons reflecting economic reality. It will be interesting to follow the practical implementation of this judgment by tax authorities in tax audits, in particular as regards the evidence required to justify an initial refusal of the withholding tax exemption.
Indeed, the burden of proof should firstly lie with the tax authorities, who will have to determine on a case-by-case basis whether companies that are interposed between the EU distributing company and the ultimate non-EU shareholder are genuine or not, based on an analysis of all relevant facts and circumstances in the case under review.
In our view, the assessment of the existence of the right “economic substance” must be made in light of the criteria set forth in the Cadbury Schweppes decision in terms of premises, staff, and equipment (e.g., criteria such as the real activity of the EU company, the existence of a separate office space and phone number, the fact that the day-to-day management of the company is performed from the registered office of the company, as well as the place where board meetings take place).
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