On 10 January 2020, the Dutch Supreme Court ruled on an important case whereby a dividend distribution by a Dutch holding company to its Luxembourg corporate shareholder was subject to Dutch corporate income tax based on the Dutch substantial interest rules1. The taxpayer was in this case not successful in relying on either the EU Parent – Subsidiary Directive (the “PSD”) or the argument that such taxation was an infringement of EU law. In this Tax Alert we provide you with a summary of the case and some preliminary observations.
1. Key legal considerations
Shares in a Dutch BV (“Dutchco”) were held by a Dutch legal entity, which was as of 2010 effectively managed from Luxembourg (“Luxco”). Dutchco was through certain subsidiaries mainly engaged in insurance businesses. Luxco was ultimately owned by an individual residing in Switzerland. Luxco was managed by a trust service provider, who was in essence solely responsible for administrative activities. Luxco neither had an office nor any employees in Luxembourg. Its only expenses related to legal and administrative costs.
Dutchco had sold part of the shares in its subsidiaries to a third party and as a result in 2012 Luxco received a dividend distribution from Dutchco. The Dutch tax authorities stated that this distribution fell within the scope of the Dutch substantial interest rules and was subject to Dutch corporate income tax at the reduced Dutch/Luxembourg tax treaty rate of 2.5%. In this respect it should be noted that these rules only apply in “abusive” situations, which according to the rules applicable in 2012 was – in short - the case if (i) the primary objective, or one of the primary objectives, for holding the substantial interest was to evade personal income tax or dividend withholding tax (“subjective criterion”) and (ii) the interest could not be allocated to the active business enterprise of the foreign shareholder (“objective criterion”). The tax authorities were of the view that this was a passive investment structure that amounted to an abusive situation as described above.
2. Supreme Court ruling
The Lower Court did not agree with the approach of the Dutch tax authorities. However, the Court of Appeal ruled that the dividend distribution did fall within the scope of the abusive situations described above, as - in essence - Luxco did not fulfill a relevant function within the structure (due to a lack of substance and a lack of economic activity), which made this a wholly artificial construction. The shares in Dutchco could not be allocated to the business enterprise of the foreign shareholder. Hence the Court of Appeal ruled that this taxation was not contrary to the PSD and the EU freedom of establishment. The Advocate General’s opinion was generally in line with the ruling of the Court of Appeal. The Supreme Court is of the view that the ruling of the Court of Appeal holds up under scrutiny. A direct dividend distribution by Dutchco to the ultimate individual owner would have been subject to a higher Dutch tax burden than through the Luxco and hence the subjective criterion referred to above is met. Also the Supreme Court refers to parliamentary history where it is laid down that to determine whether a substantial interest is allocable to a business enterprise, the purpose of the investment should be considered. In case the substantial interest is held as a passive investment (i.e. the return on investment was not expected to exceed standard portfolio management) the above referred to objective criterion will be met as the substantial interest is then not attributed to an active business enterprise. According to the Supreme Court, the objective criterion would not have been met (and substantial interest taxation would not apply) in case:
I. the substantial interest’s business is in line with the business of the taxpayer;
II. the taxpayer is a holding company that has a significant function for business operations of the group; or
III. the taxpayer invests as a private equity firm, without functioning as a holding company within the group.
According to the Supreme Court none of the above situations are applicable in the case at hand and hence the objection criterion is also met.
With respect to the arguments made by Luxco that such the substantial interest taxation is an infringement of EU-law, as in domestic cases the Dutch participation exemption would apply to such dividend income, the Supreme Court notes the following:
(a) Freedom of establishment
Whether the subjective criterion is met, is reviewed at the moment income is derived from the substantial interest. The purpose of this test is derived from the aim to avoid abuse. Under EU law a restriction is only justified in case this is to limit conduct which is artificial and does not reflect economic reality (wholly artificial arrangements).
From the recent Danish beneficial ownership case law, it follows that an EU member state is obliged to refuse to grant entitlement to the rights provided for by the PSD where they are invoked for fraudulent or abusive situations. A member state may, however, not refuse rights based on predetermined general criteria. All relevant facts and circumstances must be determined on a case-by-case basis. If the rule allows the tax authorities to deny a right under the PSD based on limited evidence (or a presumed criterion), the authorities must allow a non-resident parent company to provide evidence demonstrating the existence of economic reasons.
The subjective criterion reflects a presumption. The taxpayer can counter this by providing evidence to the contrary. A structure with an ultimate beneficial owner outside the EU can be considered wholly artificial in case an EU entity has been interposed to avoid Dutch personal income tax or Dutch dividend withholding tax. The Court of Appeal did acknowledge this and therefore the Supreme Court is of the view that in the case at hand taxing the dividend distribution is not contrary to EU law.
3. Preliminary observations
The case at hand related to the year 2012. In 2016, 2018 and as of 1 January 2020 several amendments to the substantial interest rules (and Dutch dividend withholding tax rules) have been adopted (mainly to align European case law). In the ruling, the Dutch Supreme Court takes into account case law of the European Court of Justice, notably Cadbury Schweppes Overseas Ltd (C-196/04), Eqiom SAS and Enka SA (C‑6/16), Deister Holding AG and Juhler Holding A/S, (joined cases C‑504/16 and C‑613/16) and T Danmark and Y Denmark (joined cases C-116/16 and C-117/16) and considers that the substantial interest regime applicable in 2012 is in line with it.
The Luxco in the case at hand that received the dividend had very limited substance and no economic activities. The ruling demonstrates the development that in such cases international tax planning is increasingly less tolerated by judiciaries.
Under the current law, having been lastly amended as per 1 January 2020 to align it with T Danmark and Y Denmark (joined cases C-116/16 and C-117/16), a shareholder of a Dutch company meeting certain substance requirements leads to the presumption of ‘non-abuse’ which is respected unless the tax authorities provide evidence to the contrary. Furthermore, if the substance requirements are not met, the taxpayer is still allowed to provide other proof that the structure at hand is not abusive. See this Tax Alert and this Tax Alert for futher details on this latest amendment.
1 In short, under Dutch domestic tax law a foreign corporate shareholder holding 5% of the shares (or 5% of a class of shares) of a Dutch company is considered to have a substantial interest. Dividend/interest income received and capital gains realized with respect to such shareholding are at the level of the shareholder under certain circumstances subject to Dutch corporate income tax at the domestic rate of 25% (potentially to be reduced under the PSD/EU Interest and Royalty Directive or the relevant tax treaty).