Domestic withholding tax imposed by EU Member States on dividend payments made to non-resident investment vehicles has been an on-going issue for some time now, due to the argument that such taxes may restrict the free movement of capital within the EU. The European Court of Justice (ECJ) recently handed down a major decision in the Santander case regarding this matter, finding that the French withholding tax (WHT) — levied on dividend payments by French-resident companies to non-resident investment vehicles — is not compatible with EU law.
This decision not only relates to the right to a refund of WHT from French company dividends, but also provides a basis for seeking refunds of WHT from other EU-based companies, where the WHT has been imposed on a basis similar to that employed by France.
The French Tax Code imposes a 30% withholding tax on dividend payments made by French-resident companies to non-resident investment vehicles. Prior to 1 January 2012, this tax was levied at the rate of 25%.
In the instant case, Belgian, German, Spanish and U.S. investment vehicles that were subject to the WHT brought a claim before a French administrative court, arguing that the tax was not compatible with EU regulations, since French investment vehicles were not subject to either corporate income tax or the WHT. The French court referred this to the ECJ.
The ECJ held that the difference in treatment with respect to imposition of the WHT upon resident and non-resident investment vehicles constituted a restriction of the free movement of capital, insofar as it could discourage non-resident investment vehicles from investing in French companies and French investors from investing in non-resident investment vehicles.
The ECJ concluded that non-resident and resident investment vehicles should be considered as comparable and that the difference in the WHT treatment could not be supported. Further, the ECJ stated that its decision had retroactive effect. As a consequence, the French tax authorities were not entitled to withhold any tax, and comparable nonresident investment vehicles can make a claim for the refund of the French tax previously withheld.
This decision has very broad scope, as it applies to investment vehicles, including those incorporated in the form of mutual funds, and whether located within or outside the EU. While the ECJ did not provide clear guidance on what type of funds were “comparable” to French funds, it is possible that the decision also extends to private funds.
As the ECJ ruling is broadly applicable to dividends paid to investment vehicles resident in foreign countries, without regard to whether or not such countries have established tax treaties with France, it is our belief that an entity located in a tax haven jurisdiction could seek to obtain a refund of the tax withheld, unless the entity is located in a noncooperative Territory or State, provided that the entity can demonstrate that it has the status of an investment fund that is “comparable” to a French investment vehicle.
Although the ECJ decision involved French WHT, the ruling should be applicable to other EU Member States as well. Accordingly, EU Member States that impose a WHT with respect to dividend payments made to non-resident investment vehicles — but not to resident investment vehicles — presumably will soon take steps to amend their legislation so as to be in conformity with EU law.
Implementation of an Additional Tax for the Corporate Income Tax
The French parliament approved a new financial bill, effective 16 August 2012, which provides an exemption from the imposition of WHT for dividend payments made to certain investment vehicles.
The exemption applies to investment vehicles that:
are resident in another EU Member State or in a country that has entered into a tax treaty with France which provides for an exchange of information, or that has entered into an exchange of information agreement with France (for instance, Cayman Islands, Jersey, Guernsey and the British Virgin Islands);
have similar characteristics to French organismes de placements collectives (UCITS) pursuant to sections 1, 5 or 6 of article I of L. 214-1 of the Monetary and Financial Code;
raise funds in accordance with the interests of their investors and the vehicle’s defined investment policy;
are not located in a non-cooperative jurisdiction, as listed by the French Tax authorities.
In order to fill the gap in tax revenues resulting from the implementation of the WHT exemption, an additional tax upon corporations has been implemented in France. Pursuant to this new regime, each French resident company that pays a dividend is required to pay a tax of an amount equal to 3% of the dividends paid.
France, as well as the EU, is trying to discourage tax avoidance and treaty-shopping schemes. The WHT was initially enacted to prevent tax avoidance schemes whereby investments might be made through vehicles located in tax havens but the investor would not be taxed in its country of residence upon the dividends received. Since the 3% contribution will be made by the dividend-paying company and not by the recipient, the new tax regime might not serve as a deterrent to the use of tax avoidance schemes.
The contribution requirement should be considered as a temporary remedy to make up for tax revenue lost as a result of the exemption from the WHT. The French government may try to implement a more permanent regime that could more effectively prevent the use of tax avoidance schemes.
France, together with other EU countries, is waiting to see how the U.S. FATCA legislation will be implemented. It is likely that comparable legislation may be enacted, either on a Member State-by-Member State basis or at the EU level, in order to discourage the use of tax avoidance and treaty-shopping schemes through foreign investment vehicles.