The meaning of “beneficial ownership,” a term imported into double tax treaties and tax legislation, is a frequent source of controversy in taxation practice. Two controversial judgments considering the meaning and application of the term “beneficial ownership,” and the European law concept of “abuse of rights,” were issued earlier this year by the Court of Justice of the European Union (the CJEU) in the combined cases commonly known as the Danish Cases.
The Danish Cases
The Danish Cases comprise two collections of CJEU decisions on related themes. The CJEU issued a judgment in relation to the Interest and Royalties Directive in the joined cases of N Luxembourg 1 (C-115/16), X Denmark A/S (C-118/16), C Danmark I (C-119/16) and Z Denmark ApS (C-299/16) (referred to below as the IRD Judgment). The CJEU also issued another judgment in relation to the Parent-Subsidiary Directive in the joined cases of T Danmark (C-116/16) and Y Denmark ApS (C-117/16) (referred to as the PSD Judgment).
By way of background, the Interest and Royalties Directive (2003/49/EC) provides that interest or royalty payments arising in a Member State will be exempt from any withholding taxes imposed by a source state, provided that the beneficial owner of the interest or royalties is a company of another Member State. The Parent-Subsidiary Directive (90/433/EC, now replaced by 2011/96/EU) exempts distributions of profits by companies of a Member State to parental companies in another Member State from withholding tax. It is important to note that, unlike the Interest and Royalties Directive, the Parent-Subsidiary Directive does not have a “beneficial ownership” condition as a requirement to accessing benefits under that Directive.
Despite some differences in the facts in the various decisions, each of the Danish Cases involved multinational companies utilising fairly commonplace transaction structures to implement private equity investment. Intermediate holding companies in the EU were established to acquire shares in Danish companies, thereby taking advantage of the Interest and Royalties Directive and/or the Parent-Subsidiary Directive to repatriate interest income (on back-to-back downstream loans and shareholder debt) or upstream dividends, respectively.
Key findings of the CJEU
The key findings of the CJEU were:
- (in the IRD Judgment only) the concept of “beneficial owner of the interest” within the Interest and Royalties Directive must be interpreted, having reference to economic reality, through identifying an entity which actually benefits from the interest that is paid to it. Article 11 of the OECD 1996 Model Tax Convention and the related commentaries are relevant when interpreting the Interest and Royalties Directive; and
- (in both the IRD Judgment and the PSD Judgment) the general principle of EU law – that EU law cannot be relied on for abusive or fraudulent ends – must be interpreted so that artificial financial arrangements would lead to a denial of exemption of withholding tax under the Interest and Royalties Directive or the Parent-Subsidiary Directive. This is the case even if domestic legislation or double tax treaties do not expressly provide for that denial.
The CJEU’s ruling on who is a “beneficial owner” under the Interest and Royalties Directive has left a wide scope for interpretation by national courts. The extent to which the OECD materials, in particular as regards conduit companies, are imported for the purposes of the interpretation of “beneficial owner” under the Interest and Royalties Directive has been left unclear. The CJEU held only that such OECD materials are “relevant.” Furthermore, without prescribing any specific guidance, the CJEU concluded that national courts should have reference to the “economic reality” of arrangements, leaving those courts with considerable latitude to decide whether (for example) back-to-back loans could be disregarded for the purposes of the Interest and Royalties Directive.
General EU law abuse of rights principle
In addition, the CJEU’s judgments also extend the general EU law concept of “abuse of rights” to direct tax matters. Previously, “abuse of rights” was limited to indirect tax matters (such as VAT) only. There are two elements of an abuse of rights: first, whether, viewed objectively, the purpose of the relevant rules has been achieved; and, second, whether there is a subjective intention to obtain an advantage from the relevant rule by artificially creating the conditions laid down for obtaining the advantage. An abuse of rights can now, following the CJEU judgments, be identified even if there are no domestic or agreement-based anti-abuse provisions applicable to a set of circumstances or a transaction.
Indicators of abuse of rights
The two legal themes – beneficial ownership and abuse of rights – were intertwined by the CJEU in the court’s decisions in the Danish Cases. Whereas the Parent-Subsidiary Directive does not include the concept of “beneficial owner,” the CJEU in the PSD judgment adopted the jurisprudence of abuse of rights to apply the concept of beneficial ownership in the IRD judgment. Indeed, the CJEU went further and laid down several guiding indicators for where an abuse of rights can be identified in comparable situations involving conduit companies.
- if the structure is purely one of form and one of its principal objectives is to obtain a tax advantage running counter to the aim or purpose of the applicable tax law;
- if all or almost all of the dividends or interest payments are, very soon after its receipt, passed on to entities which do not qualify for the benefits of the relevant Directive;
- if the consequence of the arrangement is such that a conduit company makes only an insignificant taxable profit in order to enable the flow of funds to the entity which is the beneficial owner of the sums paid;
- if the sole activity of the conduit company is the receipt of dividends or interest (being a fact-based test);
- if the recipient company is under a contractual or legal obligation (or in substance is required) to pay on the interest or dividends and has no right to use or enjoy them; and
- if there is a closeness in time of, on the one hand, the entry into force of new tax legislation and, on the other hand, the setting up of complex financial transactions and the grant of intragroup loans.
The decisions of the CJEU in the Danish Cases shine a light on the concepts of beneficial ownership and tax-themed abuse of rights but without providing complete illumination. To what extent these judgments will be applied by national courts or tax authorities (for example, in tax rulings and treaty interpretations) remains to be seen. In addition, the introduction of the general anti-abuse rule in the EU’s Anti-Tax Avoidance Directive (2016/1164/EU) potentially forestalls some applications of the Danish Cases in practice.
However, multinational groups with European intermediate holding companies will need to carefully watch developments in this area. The degree to which the parameters of beneficial ownership and abuse of rights have been broadened, and loosened, in the Danish Cases are indicative of an area of tax law which is likely to remain unsettled for some time to come.