On 26 February 2019, the Court of Justice of the European Union (CJEU) issued its long awaited judgements in six joint Danish cases which deal with the interpretation of beneficial ownership and the existence of abuse of EU law such as the Parent-Subsidiary Directive (PSD) and the Interest & Royalties Directive (IRD). The cases involve intermediary holding and financing companies which are controlled by entities that do not themselves have access to these directives.
Mandatory anti-abuse rule
The CJEU starts its judgments by considering that national authorities and courts have to refuse the benefits of primary and secondary EU law in cases of abuse, even in absence of anti-abuse provisions in national law or in bilateral tax treaties. Although the CJEU has indeed applied such a mandatory anti-abuse rule to EU benefits before, this might be the first CJEU decision of this kind involving direct taxation.
The CJEU continues by clarifying that the term ‘beneficial owner’ in the IRD should be interpreted as the entity which benefits economically from the interest received and has the power to freely determine the use of the interest income. This definition is comparable with the definition of beneficial ownership in the OECD Model Convention. The CJEU confirms that beneficial ownership should be interpreted similarly under the IRD and the OECD Model Convention. There may for example not be a legal liability for the direct recipient of the interest income to transfer the interest income in full directly or indirectly to another entity. The CJEU also rules that the interpretation of the term ‘beneficial owner’ should be a dynamic one. Later changes to the OECD Commentary therefore need to be taken into account when defining the term ‘beneficial owner’ under the IRD.
Tax avoidance and abuse of law
In its further considerations, the CJEU provides further guidance on the determination of abuse of law. As in previous cases, an abusive practice according to the CJEU requires objective actions (e.g. the creation of an artificial arrangement) and subjective intentions (the objectives being to take advantage of EU law through that artificial arrangement).
According to the CJEU, the presence of a certain number of indicators may demonstrate an abusive structure. The CJEU emphasizes the need for economic activity in or economic justification for a given structure. This assessment must be made by making an analysis of all relevant factors of an individual case including:
• the question whether or not the intermediate company is economically entitled to its income (or is contractually or in fact obliged to forward its income);
• the conduct of other economic activities at the level of the intermediate company than intermediate holding and finance activities (as evidenced by the management of the intermediary company, its balance sheet, its cost structure and the expenditure actually incurred, to the staff that it employs and to the premises and equipment that it has available);
• the level of equity-funding of the intermediate company; and
• the timing of the set-up of the structure in relation to changes in relevant tax legislation.
The existence of a tax treaty between the source country and the country of residence of the alleged beneficial owner is not automatically indicative of absence of a tax-avoidance intention.
In conclusion, the CJEU decided that the definition of ‘beneficial owner’ under the IRD should be aligned with the definition in the OECD Model Convention and the OECD Commentary thereto. The CJEU provided further guidance on the determination of abuse of law, considering that a certain number of (objective) indications may already demonstrate that a certain structure is abusive.
For the Netherlands as a source country, this judgment may be very relevant as the Netherlands has recently updated safe harbour (substance) requirements in the anti-abuse rules in its domestic dividend withholding tax exemption and non-resident corporate income taxation. The question arises if, considering this judgement, these safe harbour requirements are in each case sufficient to distinguish genuine structures from abusive structures.
For intermediate holding and finance companies often managed and controlled in countries like the Netherlands and Luxembourg, this judgment provides more guidance on minimum local substance.