Monday, June 13, 2005

Withholding tax on outbound dividends and the freedom of establishment

Some weeks ago, I reported a case submitted by the French Conseil d'Etat on the compatibility of French withholding tax on outbound dividends with the freedom of establishment. Now the questions submitted to the ECJ are available in the ECJ website.

In this case, two French companies distributed dividends to their Netherlands parent company (Denkavit BV) from 1987 to 1989. The dividend withholding tax was reduced to 5% on application of Art. 10(2)(a) of the France-Netherlands tax treaty. The French and the Netherlands companies brought a procedure before the French Courts to get a refund of the withholding tax paid on the dividend distributions on the grounds that such withholding tax was irreconcilable with the freedom of establishment as construed by the ECJ. In order to understand the facts, you must take into account that under Arts. 119 bis and 187(1) of the French Tax Code, a withholding tax at a rate of 25% is levied on dividends distributed by French companies to foreign shareholders. Such withholding tax is generally reduced by application of a tax treaty. In contrast, qualifying parent companies that are subject to French corporate income tax at the standard rate (i.e. French parent companies or foreign parent companies with a permanent establishment in France to which the shares of the subsidiary are to be attributed) with a holding participation of at least 5% in their subsidiaries benefit from a participation exemption in respect of dividends received from their resident and non-resident subsidiaries, so that qualifying dividends are quasi-exempt from corporate tax. Under Netherlands law, a participation exemption is applicable, under certain conditions amongst others that the parent company owns at least 5% of the nominal paid-up capital of the subsidiary. As a corollary effect, Netherlands parent companies cannot credit the foreign withholding tax against Netherlands corporate tax.

The Court of Appeals of Nantes rejected this claim on 13 March 2001, arguing that Art. 119 bis (2) of the French Tax Code is not incompatible with Art. 43 of the EC treaty as the Netherlands parent company was not in a comparable objective situation in respect to French corporate income tax as a parent company benefiting from the French participation exemption. The Court held that the participation exemption regime is available only to parent companies that are subject to French corporate income tax at normal rate, either because they have their tax residence in France or because they have a permanent establishment in France. The Court also denied the necessity to refer to the ECJ for interpreting the compatibility of Art 119 bis (2) with Art. 43 of the EC treaty. The two companies referred their case to the Administrative Supreme Court, which rendered a preliminary decision on 15 December 2004. The Supreme Administrative Court opined that the dividend withholding tax, which is borne by the recipient of the dividends and not by the distributing company, in itself triggers a difference of treatment between a French parent company benefiting from the French participation regime and a foreign parent company. Accordingly, the Court questioned whether a French company and a foreign parent company are in a comparable situation in respect of a withholding tax mechanism. In the second stage, the Supreme Administrative Court questioned whether the provisions in respect of the dividend withholding tax (Art. 10) and on double taxation relief set out in Art. 24 of the France-Netherlands treaty may be analyzed as a simple tax sharing mechanism on dividends between France and the Netherlands without burdening the global tax liability of the Netherlands parent company, and thus not impeding the freedom of establishment.Lastly, the Supreme Administrative Court stated that considering that the Netherlands parent company may only benefit from the foreign tax credit where the latter exceeds the tax due in the Netherlands, it questioned whether or not it is necessary to take into account this situation to evaluate whether the withholding tax is compatible with the freedom of establishment. The Conseil d'Etat (France) submitted to the ECJ the following questions:

1. Is a system which imposes the burden of taxation on a parent company in receipt of dividends which is not domiciled in France, while relieving parent companies which are domiciled in France of a similar burden, open to challenge in the light of the principle of freedom of establishment?

2. Is such a system of deduction at source itself open to challenge in the light of the principle of freedom of establishment, or, where a taxation agreement between France and another Member State authorising that deduction at source provides for the tax due in that other Member State to be set off against the tax charged in accordance with the disputed system, must that agreement be taken into account in assessing the compatibility of the system with the principle of freedom of establishment?

3. In the event that the second alternative set out at 2 above is held to apply, is the existence of the aforementioned agreement sufficient to ensure that the disputed system may be regarded merely as a means of apportioning the taxable item between the two States concerned without any effect on the undertakings, or must the fact that a parent company which is not domiciled in France may be unable to set off tax as provided for by the agreement mean that this system must be regarded as incompatible with the principle of freedom of establishment?


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