Portuguese law exempted dividends paid to domestic pension funds from corporation tax whilst taxing dividends paid to non- resident corporation tax. The European Commission issued infringement proceeding for breach of the provisions on free movement of capital (article 63 TFEU). The Portuguese Government agreed that the rule constituted a restriction of article 63 TFEU but considered that this restriction was justified for reasons of fiscal cohesion as domestically the dividends were subject to income tax in the hands of the pension beneficiaries, whereas this was not guaranteed in cross border situations. The rule was also justified for reasons of effective fiscal supervision as in Portugal the exemption was conditional on compliance with Portugal’s particularly strict investor protection rules. which would be impossible in cross-border situations.
In its judgment of 6 October 2011 the ECJ rejected the Portuguese Government’s submissions and held that the Portuguese rules breached article 63 TFEU. The rules were not justified for reasons of fiscal cohesion as the exemption applied domestically irrespective of the residence of the investor in the domestic pension fund and dividends paid to non- resident pension funds were taxed even if its shareholders were resident in Portugal. The attempt to justify the rule on grounds of effective fiscal supervision also failed, as the rule did not even provide foreign pension funds with the opportunity to prove compliance with Portuguese rules.