ECJ – Recent Developments in Direct Taxation 2014

I. S. 20Introduction

On 20 November 2013, the Commission decided to bring an action before the ECJ concerning the manner in which Belgium taxes, on the one hand, dividends and interest distributed to a Belgian investor by non-resident foreign cooperative societies and companies pursuing a social objective (Case 2008/4802) and, on the other hand, interest paid to non-resident collective investment companies (CICs) and certain interest paid to non-residents on securities deposited with a non-Belgian financial institution (Case 2008/4157). According to the website Taxud-unit-d3@ec.europa.eu, the case is still pending before the ECJ but seems not to have received a case number yet^. No Advocate General’s opinion has been delivered yet.

II. Facts

The rules that are relevant for Case 2008/4802 are as follows. Pursuant to Article 21, 6° of the Belgian Income Tax Code (“BITC”), the first tranche of dividends (i.e. 190 €) distributed by cooperative societies is tax exempt if the distributing company is recognized by the Nationale Raad voor Cooperatie/Conseil National de la Coopération. The Commission claims that only cooperative societies established under Belgian law are recognized. Pursuant to Article 21, 10° BITC, the first tranche of dividends and interest (i.e. 190 €) paid by companies pursuing a social objective are tax exempt provided that the company is recognized by the relevant Ministries, carries on social objectives as defined by statute (e.g. aid to persons, environmental protection, development aid etc.) and the bylaws of the company provide that in case of liquidation the net assets of the company are re-invested in another company pursuing a social objective. The Commission again claims that only companies formed under Belgian law are recognized. According to the Commission, this discriminatory treatment of the shareholders and creditors of such companies discourages investment in foreign cooperative societies and in foreign companies pursuing a social objective and therefore constitutes an unjustified restriction of the free movement of capital under Article 63 TFEU and Article 40 EEA.

Case 2008/4157 has two aspects. The first one concerns the taxation of CICs with respect to the receipt of interest. The second concerns the payment of certain interest to non-residents on securities deposited with a non-Belgian financial institution. In relation to the first part of Case 2008/4157, the following rules are relevant. Belgian collective investment companies (CICs) are liable to Belgian corporate tax. However, the tax base of a Belgian resident CIC (and non-resident CICs with a permanent establishment in Belgium), is not determined according S. 21to the general rules. Rather, its tax base is composed of a very limited number of items and does not include investment income (Article 185 (a) (1) BITC). By virtue of Articles 249 and 261 BITC, corporate tax due by resident CICs (and non-residents that have a permanent establishment in Belgium) is levied by way of withholding tax on income from investments in shares and interest-bearing securities. The current rate of withholding tax is 25 % (Article 269 BITC). According to Article 279 BITC, the withholding tax is credited against the corporation tax and Article 304 (2) BITC provides that any excess is refundable. Consequently, Belgian resident CICs (and non-residents with a permanent establishment in Belgium) are able to credit the withholding tax levied on interest earned against the corporate tax due, if any, and are able to recover any excess withholding tax credit. Non-resident CICs (with no Belgian permanent establishment) are subject to withholding tax on interest earned from a Belgian source. However, they are not entitled to credit that tax against Belgian corporate tax (as they are not liable to it) and are not entitled to any refund (Article 248 BITC). The Belgian withholding tax thus represents the final Belgian tax liability of non-resident CICs (with no Belgian permanent establishment). According to the Commission, this different tax treatment of CICs discourages cross-border investment in debt claims by CICs and constitutes an unjustified restriction of the free movement of capital (Articles 63 TFEU and 40 EEA).

As to the second part of Case 2008/4157, the Commission claims that Belgian legislation charges withholding tax on interest paid on securities deposited or registered in an account with financial institutions established outside Belgium. According to the Commission this rule discourages cross-border investment as Belgium exempts interest related to securities deposited or registered in an account with a Belgian financial institution and it therefore constitutes an unjustified restriction on the freedom to provide services and the free movement of capital (Articles 56 and 63 TFEU and 36 and 40 EEA). The Commission does not mention which provision of the BITC is at issue here. We assume that the Commission is referring to Article 230, 2° jo. Article 264bis BITC which it then seems to interpret a contrario. According to those provisions, interest that is paid out by a Belgian financial institution to a non-resident, is exempt from Belgian withholding tax if the debtor of the interest is a Belgian resident or a non-resident that includes the interest cost amongst the deductible charges of a permanent establishment outside Belgium. In other words, this case envisages the situation of (1) a non-resident of Belgium that has granted a loan to (2) a Belgian resident or a non-resident of Belgium, (3) that loan is part of the liabilities of a permanent establishment which the debtor has outside Belgium as a result of which (4) the interest is part of the expenses of that non-Belgian permanent establishment and (5) the interest is paid to the non-Belgian creditor out of an account of the debtor with a financial institution in Belgium. This provision envisages the very specific situation that interest which is of non-Belgian source (because of its allocation to the reS. 22sults of a non-Belgian permanent establishment) is paid to a non-resident creditor out of a Belgian bank account. As a general rule, in case of payment of interest by a Belgian bank, the latter is, as a paying agent, liable to withhold tax upon settling interest payments (Article 261 BITC). However, as Article 230, 2° jo. 264bis BITC concerns foreign source interest paid to a non-resident recipient, the BITC provides for an exemption from withholding tax as Belgium has no tax jurisdiction over such income. This is a correct application of the principle of territoriality as recognized by the ECJ in Futura. We fail to see where the Belgian statute imposes a withholding tax charge where interest is paid on securities kept in a financial institution outside Belgium. If the Commission draws this conclusion, from an a contrario interpretation of Article 230, 2° jo. 264bis BITC, such interpretation is not correct. Moreover, there is no need to provide an exemption from Belgian withholding tax where non-Belgian source interest is paid to a non-resident creditor out of a non-Belgian bank account as Belgium has no tax jurisdiction over such income, nor does Belgium impose a withholding tax liability on a non-resident bank that is the paying agent of non-Belgian source interest. Therefore, this case does not require further analysis.

III. Discussion

A. Relevant Freedom

As the disputed national rules in Case 2008/4802 concern the investment by (often small) shareholders or creditors in certain types of companies and apply regardless of whether the shareholder/creditor owns a certain number of shares and/or of whether he can exercise a definite influence over the company, the Commission rightly asserts that the relevant freedom is the free movement of capital.

In Case 2008/4157 the disputed national rules in the case of interest paid to CICs concern the payment of interest on interest-bearing securities, irrespective of whether the creditor has a shareholding in the paying company. These rules must therefore be tested against the TFEU and EEA provisions on the free movement of capital, as the Commission asserts.

B. Discrimination or Restriction on the Freedom

In Case 2008/4802 the national rules provide a tax exemption on dividends and interest payments by recognized cooperative societies and companies pursuing a social objective. In an infringement case it is for the Commission to prove that a S. 23Member State has failed to fulfil its obligations under EU law. The Commission must submit all factual evidence to the ECJ that is necessary for the examination of whether there is such an infringement and cannot base its case on mere assumptions that non-residents are treated less favourably than residents. It does not follow from the Belgian legislation that only companies formed under Belgian law and established in Belgium qualify for recognition under the relevant provisions of the BITC. The Law of 20 July 1955 on the setting up of the Nationale Raad voor de Cooperatie/Conseil National de la Coopération (the agency competent to recognize cooperative societies qualifying for the tax benefit) expressly provides that it can recognize societies established in other EU Member States. It could be that in practice only Belgian cooperative societies and companies pursuing a social objective are actually recognized. However, the burden is on the Commission to make that clear. If the Commission meets this burden proof, discriminatory treatment of the shareholders and creditors of such types of companies, based on the residence of these companies, will be found to exist. As the rule dissuades Belgian resident shareholders and creditors from making investments in foreign cooperative societies and in foreign companies pursuing a social objective (and will hamper such companies in seeking funding on the Belgian capital market), it restricts the free movement of capital. Other cases in point where the ECJ ruled accordingly are e.g. Verkooijen, Commission v. France (fixed levy) and Weidert-Paulus. The question of whether such a restriction may be justified is discussed infra sub c. It is observed that the provision regarding the cooperative societies (Article 21,6° BITC) was enacted long before 1994 and has not been amended since then. Accordingly, the question arises whether it is grandfathered under Article 64 TFEU (standstill-clause) when it concerns capital movements with third countries. The answer is that in most instances, Article 21,6° BITC will not come within the scope of Article 64 TFEU. Article 64 TFEU only allows the application of national restrictive provisions on the free movement of capital with third countries that concern, inter alia, a “direct investment”. According to the ECJ’s case law, this expression includes investments of any kind by individuals or legal persons which serve to establish or maintain lasting and direct links between the investor and the investee. As regards shareholdings, this condition supposes S. 24that the investment enables the shareholder to effectively participate in the management of the company or in its control. Most often, participations in cooperative societies that come within the scope of Article 21,6° BITC will not meet these tests as the investors only own a very small amount of shares. The provision on companies pursuing a social objective was enacted in 1999 and can thus never come within the scope of the standstill clause of Article 64 TFEU.

The national measure at stake in Case 2008/4157 concerning the interest paid to CICs is similar to the one for which Belgium was condemned by the ECJ in its judgment of 25 October 2012 in case C-387/11. That judgment was the result of an infringement procedure against Belgium. The Commission found that under Belgian law, a Belgian CIC was, upon receipt of Belgian source dividends, entitled to credit the tax withheld at source against its corporate tax liability (if any) and to receive reimbursement of any excess tax credit so that ultimately the company did not pay any tax on the dividends received, while CICs established in other Member States were liable to pay Belgian withholding tax on Belgian source dividends, without being entitled to any refund. The Court held that the Belgian rules breached the TFEU and EEA provisions on the free movement of capital and freedom of establishment and dismissed the justifications put forward by Belgium. This judgment is one of many in the area of cross-border dividends (some of which also concern CICs) according to which a Member State infringes the TFEU freedoms if it provides relief for economic double taxation on dividends distributed by a company resident in that Member State to a shareholder who is also a resident of that State, whereas it does not provide such relief and charges a withholding tax on dividends distributed by a company resident in that Member State to a shareholder who is a resident of another Member State.

In response to this judgment, Belgium changed its domestic law regarding the payment of dividends to CICs but left its legislation on interest payments unaffected. This keeps the door open for a new infringement procedure.

S. 25In view of the similarities between the current case and the ECJ’s judgment in case C-387/11, the question arises as to whether this new infringement procedure will again lead to a condemnation by the ECJ of the Belgian tax rules on CICs.

However, in light of the ECJ’s judgment in Truck Center, prima facie this question should be answered negatively. In Truck Center, it was argued that the Belgian rules on withholding tax on interest payments infringed the freedom of establishment of a Luxembourg lender (who was also a main shareholder of the Belgian borrowing company) as the former was liable to a 15 % withholding tax on interest paid by the Belgian borrower, while payments of interest by Belgian borrowers to Belgian corporate lenders were exempt from withholding tax. In her opinion, AG Kokott observed that a case like Truck Center concerning interest payments is to be distinguished from the cases involving outbound dividends (quoted in footnote 13) where the ECJ had to examine national measures that aim at avoiding economic double taxation that would otherwise arise when a company distributes profits to a shareholder that is himself also liable to tax on the dividend received. In contrast to dividends, the exemption from withholding tax on interest paid to Belgian corporate lenders does not aim at exempting the interest from tax in the hands of the recipient in order to avoid economic double taxation. Unlike dividends, interest is not paid out of income of the paying company on which tax has already been paid. Rather interest is a deductible charge for the payor/borrowing company and is liable to corporate tax only in the hands of the recipient/lender. The position of the ECJ that in the case of a distribution of dividends, resident and non-resident shareholders are in comparable situations as soon as a Member State imposes a charge to tax on the dividends that they receive from domestic companies (that have already paid tax on the distributed profit), can not therefore be maintained with respect to interest payments. The ECJ in Truck Center followed suit and held that a domestic lender and a lender based in another Member State are not in objectively comparable situations. According to the ECJ, the payment of interest by a company resident in a Member State (Belgium) to another company resident in that State and the payment of interest by a company resident in a Member State (Belgium) to a company not resident there (Luxembourg) gives rise to two distinct charges that rest on separate legal bases. In the first (domestic) case, no withholding tax is charged, but in accordance with the Belgian corporate tax rules, the interest is included in the tax base of the recipient and taxed on the same footing as that company’s other income. In the second (cross-border) case, a withholding tax is assessed at source pursuant to the discretionary powers which Belgium and Luxembourg have reserved for themselves in the alloS. 26cation of taxing powers in their bilateral tax treaty. According to the ECJ “those different procedures for charging tax thus constitute acorollary to the fact that resident and non-resident recipient companies are subject to different charges”. Finally, the Court also held that resident and non-resident companies receiving interest are in a different situation with regard to the recovery of the Belgian tax. While resident recipients are directly subject to the supervision of the Belgian tax authorities which can ensure compulsory recovery of the tax, that is not the case for non-resident recipient companies inasmuch as in their case, recovery of the tax requires the assistance of the tax authorities of the other state.

Accordingly, following this case law one may be tempted to conclude that a CIC receiving Belgian source interest but which is based in another Member State is not comparable to a Belgian CIC receiving Belgian source interest. Following this conclusion, the different tax treatment of both types of payment under Belgian law does not infringe the TFEU and EEA freedoms as the Commission claims.

The question, however, arises as to whether this prima facie conclusion is based on a correct reading of the Truck Center judgment. In that case, the Belgian corporate lender (with whom the Luxembourg corporate lender was compared) was liable to Belgian corporate income tax and the interest received was included in its tax base. That is, however, not the case for the Belgian CIC receiving Belgian source interest. Although that entity is liable to Belgian corporate tax, its interest income is not included in its tax base and thus remains exempt from taxation. In deciding whether a national rule is discriminatory, the purpose of that rule must be considered. The purpose of the Belgian tax rules on CICs established in Belgium is to make them liable to corporate income tax, but to exempt their investment income from taxation as these companies are, for that type of income, mere pass-through entities for their unitholders. As non-resident CICs are also pass-through entities for investment income of their unitholders, non-resident and resident CICs are arguably in a comparable situation. Accordingly, non-resident CICs should enjoy the same exemption of withholding tax on Belgian source interest as Belgian CICs.

This conclusion is supported by the ECJ’s judgments in Santander and in the various pension fund-cases. First, in Santander (which involved different treatment of resident and non-resident CICs with respect to the payment of dividends), the French Government tried to justify its different treatment by relying on the ECJ’s judgment in Truck Center. The ECJ rejected that argument with the S. 27following words: “(…) in Truck Center, the national legislation at issue provided that both resident recipient companies and non-resident recipient companies were to be taxed in respect of certain nationally sourced income. That legislation simply laid down different procedures for charging tax depending on the place where the recipient company had its registered office, which were justified on account of an objective difference in the situations in which resident and non-resident companies found themselves. However, in the cases in the main proceedings, the legislation at issue does not simply provide for different procedures for charging tax depending on the place of residence of the recipient of nationally sourced dividends, On the contrary, it provides that only non-resident UCITs are to be taxed on such dividends”. This reasoning applies mutatis mutandis to the Belgian source interest payments in the case at hand. Secondly, in another case, under the national laws of Portugal and Finland domestic pension funds were exempt from tax on investment income (dividends in casu) while non-resident pension funds were subject to withholding tax. The argument that resident and non-resident funds were not objectively comparable was dismissed by the ECJ and the national rules were found to be restrictions on the free movement of capital. Finally, our conclusion is also indirectly confirmed by the ECJ’s judgment in Truck Center. After having decided that there was no discrimination, the ECJ also found that the Belgian withholding tax assessed only against the non-resident corporate lender did not constitute a (non-discriminatory) restriction on the freedom on the following ground: “the difference in tax treatment resulting from the tax legislation at issue in the main proceedings does not necessarily procure an advantage for resident companies because, firstly, as was pointed out by the Belgian Government at the hearing, those companies are obliged to make advance payments of corporation tax and, secondly, the amount of withholding tax deducted from the interest paid to a non-resident company is significantly lower than the corporation tax charged on the income from resident companies which receive the interest”. This argument does not hold in the case of Belgian CICs. As they are exempt on their investment income, they should, contrary to the facts and measures at stake in Truck Center, not have made any prepayments of corporate tax. This is another reason why the Truck Center case is not relevant to the case at hand.

In summary, there seem to be reasonably good grounds for distinguishing the pending case on CICs receiving Belgian source interest income, from the ECJ’s case law in Truck Center and to decide that the Belgian rules are (once again) restrictive. Whether such restriction may be justified is discussed infra sub c.

C. S. 28Justification of the Restriction on the Freedom

It is hard to see what arguments the Belgian Government might rely on to justify the restriction in Case 2008/4802. Presumably, they will argue that the exclusion of non-resident companies from the tax benefit is justified by the fact that the recognizing authorities are unable to verify whether non-resident entities meet the criteria for recognition, which is a justification based on the need to ensure effective fiscal supervision. An automatic exclusion of all non-resident entities is, however, a disproportionate restriction. For entities based in other Member States, the Belgian State can rely on the Mutual Assistance Directives and for entities based in Iceland and Norway on the EOI provisions of the tax treaties with these countries. For entities based in Liechtenstein it can rely on the TIEA between both countries. As Belgium has a very wide network of more than 100 tax treaties, it can, with respect to third countries, make use of the EOI provisions included in these treaties and, in the absence thereof, of a network of some 20 TIEAs or of the Multilateral Convention on Assistance in tax matters. In all those instances, the restriction cannot be justified on grounds of ensuring effective fiscal supervision.

In the Belgian CIC case involving dividends, the Belgian Government attempted to justify the restriction as being necessary to ensure the effectiveness of fiscal supervision and to preserve the balanced allocation of taxing powers. Both of these grounds were dismissed by the ECJ. We believe that in the current pending Case 2008/4157, the ECJ should also dismiss these justifications. In Skorpio, the ECJ decided with respect to the first ground and more particularly the need to ensure the effective collection of the tax liability of a non-resident, that: “the procedure of retention at source and the liability rules supporting it constitute alegitimate and appropriate means of ensuring the tax treatment of the income of aperson established outside the State of taxation and ensuring that the income concerned does not escape taxation in the State of residence and the State where the services are provided (…). Moreover, the use of retention at source represented aproportionate means of ensuring the recovery of the tax debts of the State of taxation”. Such a justification can obviously be accepted only if the state of source of the income has a legitimate tax claim on the non-resident taxpayer. As Belgium does not tax resident CICs on domestic interest, it should have no tax claim on non-resident CICs which it can legitimately enforce by way of levying a withholding tax. SimiS. 29larly, a Member State should not be allowed to rely on the need to preserve the balanced allocation of taxing rights to justify taxation imposed on non-residents if it has unilaterally waived its right to tax resident taxpayers. Furthermore, the need to preserve the coherence of the Belgian tax system should not be successful as the corporate tax exemption of a Belgian CIC is not conditional on the redistribution by the CIC of the interest received by it, nor on its unitholders being taxed on the distribution received as a means of compensation for the corporate tax exemption. Maybe the Belgian Government will argue that the tax treaty between Belgium and the state of residence of the CIC will reduce the rate of withholding tax under Belgian domestic law or provide for a credit of the withholding tax against the CIC’s tax liability in its state of residence. Such an argument should not be admitted for several reasons. First, it is uncertain whether a CIC is protected by the tax treaty. The assertion that it is, supposes that it is a resident of the other Member State which means that it is “liable to tax” in that State (Article 4 OECD MC). In certain states, CICs are not considered to be taxpayers and hence are not protected by tax treaties. Secondly, even if the CIC is treaty protected, the ECJ has on several occasions made it clear that the tax treaty must fully neutralize the effect of the withholding tax imposed by the source state (i.e. Belgium). This means that the state of residence of the CIC provides a full tax credit for the Belgian withholding tax against the CIC’s corporate tax liability in that state. Such a credit is not guaranteed by the Belgian legislation, nor by the Belgian tax treaties. This also supposes that the interest will be taxed in the CIC’s state of residence, which is beyond the control of Belgium. In many instances, CICs will, as in Belgium, not effectively pay tax on the Belgian source interest and thus the effect of the Belgian withholding tax will not be neutralized at all.

IV. Conclusion

Case 2008/4802 is a marginal case. The onus of proving that only Belgian entities are recognized and thus that only profit distributions and interest payments by Belgian entities enjoy the tax relief, rests on the Commission. The Law providing the conditions for the recognition of cooperative societies seems to indicate that the Commission’s claim is not founded. If the Commission meets its burden of S. 30proof though, a restriction on the free movement of capital which does not seem to be justified will have been identified.

Case 2008/4157 – as far as it concerns interest payments to non-resident CICs – should not be decided along the lines of the ECJ’s judgment in Truck Center. Rather, the line of reasoning adopted in the dividend cases concerning tax exempt CICs and pension funds should be applied. Following that reasoning, there is a restriction on the free movement of capital which does not seem to be justified.

Case 2008/4157 – as far as it concerns interest payments to non-residents relating to securities deposited with non-Belgian financial institutions – seems to be based on a misinterpretation of the Belgian legislation and the Commission’s claim does not seem to be founded.