On 26 February 2019, the Court of Justice of the European Union (CJEU) issued its judgments in six cases which deal with the interpretation of the Parent-Subsidiary Directive (PSD) and the Interest & Royalties Directive (IRD, together the Directives).
The CJEU stated that the term beneficial owner in the IRD, required to be able to benefit from the exemption from tax under the IRD, should be interpreted as the entity which benefits economically from the interest received and accordingly has the power to freely determine the use to be given to that income. The CJEU also broadened the EU definition of tax avoidance, in which case no protection from the IRD or the PSD can be invoked, and provided indicia as to the elements that may constitute abuse when using intermediate holding companies. It also added the important statement that even in the absence of anti-abuse provisions in national law or tax treaties, Member States should apply a general EU law anti-abuse principle in order to refuse the benefits of the Directives.
In these six cases (the Danish cases N T Danmark (C-116/16) and Y Denmark (C-117/16) and cases Luxembourg 1 (C-115/16), X Denmark (C-118/16), C Danmark (C-119/16) and Z Denmark (C-29916)) the CJEU was asked multiple questions concerning the conditions under which a company paying dividends or interests to a related company can be denied an exemption from withholding tax pursuant to the PSD or the IRD. The questions were raised in connection with tax disputes in Denmark where the tax administration took the view that there was avoidance of Danish withholding tax through the use of intermediary holding companies controlled by entities that otherwise would not have access to the Directives’ benefits.
Meaning of beneficial ownership
In some of these cases, the CJEU was confronted with the interpretation of the beneficial owner requirement in Article 1(1) and Article 1(4) of the IRD. The CJEU considered that the concept of beneficial owner of interest must be interpreted as designating an entity which actually benefits from the interest that is paid to it and has the power to freely determine the use to be given to that income received. The CJEU further added that the concept of beneficial owner that appears in tax treaties based on the OECD Model Tax Convention and related commentaries is relevant when interpreting the IRD.
Broader definition of tax avoidance and constituent elements of abuse
In previous case law, an abusive practice would occur in case the arrangement was ‘wholly artificial’. In the Danish cases of today the CJEU referred to artificial arrangements in which the principal objective or one of the principal objectives is to obtain a tax advantage, suggesting that the CJEU has broadened the EU definition of tax avoidance.
The CJEU also provided some useful indicia in order to assess the existence of abuse in case of intermediary holding companies, stating that an arrangement may be considered as artificial in case the company receiving the interest or dividends passes all or almost all of such income very soon after its receipt to entities that do not fulfil the conditions for the application of the Directives. For the CJEU, the assessment of actual economic activity must be inferred from an analysis of all relevant factors relating, in particular, to the management of the company, to its balance sheet, to the structure of its costs and to the expenditure actually incurred, to the staff that it employs and to the premises and equipment that it has. Indications of an artificial arrangement may also be founded by the various contracts existing between the companies involved in the financial transactions at issue giving rise to intragroup flows of funds, by the way in which transactions are financed, by the valuation of the intermediary company’s equity and by the inability to have the economic use of the dividends or interest received.
General EU law anti-abuse principle
Finally the CJEU added the important statement that in the light of the general principle of EU law that abusive practices are prohibited, national authorities should refuse the entitlement to the Directives’ benefits even in the absence of anti-abuse provisions in national law or tax treaties.