Publication date: 27/01/2021
On 1 December 2020, the Ghent Court of Appeal ruled on the question whether the exemption of withholding tax (WHT) laid down in the Parent-Subsidiary Directive (PSD) could be refused on the basis of abuse. This case is particularly relevant because it is the first time that a Court of Appeal has applied the Danish cases. The implications cannot be underestimated, especially in an M&A environment.
A US private equity group acquired a Belgian group in 2003 via a Dutch CV. In 2012, a restructuring took place whereby a.o. external financing was obtained in order to transfer a group entity, and the generated cash was distributed to the ultimate shareholders via a newly incorporated Luxembourg holding company through a capital reimbursement and dividend distribution. The withholding tax exemption laid down in the PSD was relied upon in respect of dividends distributed by the Belgian company to the Luxembourg holding company. A similar restructuring had already taken place in 2006.
The case essentially deals with two legal issues: (i) the application of (general) anti-abuse rules denying the benefit of a withholding tax exemption and (ii) the (non-)application of the tax-neutral merger regime. In this newsletter we shall focus on the first element.
Decision of the Court
The Belgian domestic legal framework on abuse – as relevant to the present case – consists of (i) the general anti-abuse rule (GAAR) and (ii) the specific anti-abuse rule (SAAR) as implemented by the (amended) PSD. The current GAAR under Belgian tax law was implemented as of tax year 2013. The previous version of the GAAR was in practice ineffective.
Considering the dates of entry into force of the new GAAR and the PSD SAAR, neither applied to the case, and hence only the “old” and ineffective GAAR could be applied. The BTA therefore sought to apply the general principle of EU law that EU law cannot be relied on for abusive or fraudulent ends (principle of prohibition of abuse of rights). The Court agreed and, in line with the Danish Cases, ruled that the prohibition of abuse should be considered a general principle of EU law and, consequently, that it had a duty to prevent abuse under this principle even if there is no adequate legal basis in national law (i.e. the “old” GAAR). The Court therefore held that, although the new GAAR cannot as a matter of principle be applied, abuse of the PSD can still be sanctioned under the general EU law principles.
Indications of abuse
The Court first recalls the indications of abuse presented by the CJEU in the Danish cases (See EU Tax Alert – April 2019 for more information on this case). These include the fact that all or almost all of the income is – very soon after its receipt – passed on to entities not benefitting from the PSD, the interposed company only makes an insignificant taxable profit because it is required to pass on the income, the absence of economic activity and substance, the way in which transactions are financed, the various contracts existing between the companies, the valuation of the equity of the interposed company and the inability to have economic use of the income received. With that last element, the CJEU suggests that the lack of beneficial ownership has become an indication of abuse.
According to the Court a.o. the following are indications of abuse:
- income is up-streamed shortly after receipt, to ultimate beneficial owners that cannot benefit from the PSD;
- a Luxembourg holding company is interposed as a sub-holding which appears to have limited substance while the group has no economic activity in Luxembourg;
- a similar reorganisation was already implemented in 2006, when a burdensome ‘double holding’ structure was created in order to upstream cash and capital gains to the shareholders without tax leakage;
- the CV was only converted from a closed to an open CV in order to facilitate a tax-free distribution to the shareholders.
- a ruling was obtained in the Netherlands to ensure that, upon conversion to an open CV, the CV’s capital would equal the market value of its Belgian participation. This ruling was obtained under the condition that the Belgian subsidiary would not distribute a dividend. This condition was circumvented by interposing the Luxembourg holding company, whose beneficiary would be unknown to the Belgian tax authorities.
Weighing the tax and non-tax motives
The Court goes on to analyse whether there were sufficient non-tax motives to support the transactions.
The Court first observes that the entry of the third party investor may provide an economic explanation for the existence of a vehicle which serves as a joint venture, but it does not provide a justification for setting it up in Luxembourg nor for all the other restructuring operations. According to the Court, no concrete economic reasons are given for the various transactions. The taxpayer only offered general justifications (e.g. simplification, cost saving, structure is part of daily consultancy practice, normal market practice for international groups to be financed externally for a healthy « debt to equity ratio”).
Concept of beneficial ownership
In line with the interpretation of the term “beneficial ownership” by the CJEU in the Danish cases, the Court states that the term beneficial owner should be given a broad economic interpretation (substance over form approach). This implies that the recipient of the income is only the beneficial owner if it economically benefits from the income and has the power freely to determine how to use this.
This interpretation goes against the rather legalistic/formalistic/form-based interpretation that has always been given by the Belgian Minister of Finance in the past, and which taxpayers in the past relied upon. Although applying this new interpretation retroactively may be in line with EU law, it clearly raises fairness issues.
Conclusion of the Court
The Court concludes that, taking into account all facts and circumstances, there is no doubt that the Luxembourg holding company was used as a flow-through company with the intention to allow the group’s profits (including capital gains) to accrue tax-free to the ultimate shareholders. The Court thus holds that the entire context provides sufficient proof of the subjective and objective elements of abuse of the PSD.
Although a critical analysis of this Court case goes beyond the scope of this newsletter, we notice in practice that the BTA increasingly raises questions in relation to substance as well as beneficial ownership in cases where a withholding tax exemption is claimed or a refund is requested, even for the past. As in the case discussed here, we also see in practice that the BTA addresses these questions not only to the Belgian company that distributes the dividend or pays the interest, but also to the foreign parent company. In such cases, a consistent approach by all group companies is highly recommended, especially since the Belgian subsidiary may not always have sufficient knowledge about its parent company and the underlying reasons for certain transactions to provide an accurate answer. Furthermore, the cross-border exchange of information between tax administrations is becoming more and more effective.
An increased focus on abuse and beneficial ownership can also be observed in other countries.
In order to ensure that holding and finance structures are acceptable from a tax perspective, taxpayers will need to pay much attention to the proper documentation of the business reasons for the use and location of the holding/finance company and for the restructuring steps and financial transactions that are taken, and their actions should be consistent with those reasons. Since the interpretation of the beneficial ownership concept has evolved into an economic concept, it will equally be imperative to monitor the cash flows going forward if third countries are involved.
Forewarned is forearmed: this age-old adage takes on even greater significance when it comes to taxes.