A. EC Parent-Subsidiary Tax Directive — The Latest News.
In 1990, Directive 90/435 was promulgated, introducing a streamlined system of taxation for intra-EC dividends, with the objective of exempting from withholding dividends and other profit distributions paid by subsidiaries to their qualified parent companies. It was also designed to eliminate any double taxation of such income at the level of the parents (the "Parent-Subsidiary Directive"). On December 22, 2003, the Council of the European Union adopted a further Directive1 which extends the scope of the Parent- Subsidiary Directive. The key amendments are as follows:
1. List of Qualifying Companies.
The list of qualifying companies annexed to the Parent-Subsidiary Directive has been extended, as has been long expected, to include (i) the European Company;2 (ii) the European Cooperative;3 and (iii) a number of companies considered as corporate taxpayers in their Member States of residence (such as cooperatives), but deemed to be transparent for tax purposes by other Member States. In the case of the hybrid companies referred to under item (iii) above, the Member State of the parent is still authorized to tax the parent company on its share of the profits of what it may deem to be a transparent subsidiary, as and when such profits arise. But in order to avoid double taxation, the Member State of the parent company must either exempt those profits or allow the parent to credit (on a proportional basis) any tax paid by the subsidiary (or by any qualifying lower-tier subsidiary) against its own tax liability. Thereafter, the Member State of the parent may no longer tax the profits of the supposed transparent subsidiary if and when they are actually (subsequently) distributed to the parent company.
2. Minimum Qualified Shareholdings.
The threshold for qualified parent-subsidiary shareholdings will gradually be reduced from the present 25 percent (although some Member States already allow for lower — usually 10 percent — levels) as follows:
(i) From January 1, 2005, the minimum holding percentage need only be 20 percent;
(ii) From January 1, 2007, the minimum percentage need only be 15 percent; and
(iii) From January 1, 2009, the minimum holding percentage will stand at 10 percent.
This is obviously a key change which will be very helpful for various multi-national groups.
3. Branches as Parent Companies.
The scope of the Directive has been extended to include the payment of profit distributions to a permanent establishment (i.e., a branch) located in a Member State other than the Member State(s) of both the parent and subsidiary (whether or not the parent and subsidiary are both located in the same Member State). In fact, it is more common to have a branch in the EU holding shares of stock in a company on its books.
4. Use of the Tax Credit Method.
Pursuant to the Parent-Subsidiary Directive, the Member State of the parent company must either refrain from taxing the distributed profit (the "exemption" method) or authorize the parent company to deduct (on a proportional basis) the tax paid by the subsidiary on the distributed profits from its own corporation tax (the "credit" method). The scope of the credit method has now been extended by means of this amending directive in order to allow a parent to credit taxes paid by both direct and any lower-tier subsidiaries on any profits distributed up through the chain, provided that all such subsidiaries otherwise meet the (shareholding/corporate type/EU residence) requirements of the Parent-Subsidiary Directive.
5. Implementation.
Member States are required to bring these amendments into force by January 1, 2005, at the latest.
B. EC Interest And Royalty Withholding Tax Directive.
1. Legislative History.
An initial proposal to abolish withholding taxes levied on payments made between parent companies and subsidiaries was made by the European Commission at the end of 1990. As the European Council was unable to reach a consensus at that time, the European Commission decided to withdraw its proposal at the end of 1994.
In 1998, the European Commission presented a new proposal, designed to establish a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States in order to abolish withholding taxes levied at source on such payments. Five years later, the Member States finally reached an agreement and, on June 3, 2003, adopted Council Directive 2003/49 (the "Interest/Royalty Directive").4
2. Entry into Force and Implementation.
The Interest/Royalty Directive was published in the Official Journal of the European Union on June 26, 2003, and entered into force the same day.
Member States were required to implement the Directive no later than January 1, 2004.5 In the event of a failure of any one Member State to do so, a taxpayer may be able to argue that the Directive has "direct effect" and, hence, may be applied directly by national courts and jurisdictions. According to the jurisprudence of the European Court of Justice, for a Directive to be deemed to have direct effect, its provisions must be unconditional and sufficiently precise, and should confer rights, the contents of which can be determined based on the provisions of the measure standing on its own.
Greece, Portugal and Spain (the latter for royalty payments only) have been authorized to delay the entry into force of the Interest/Royalty Directive until Directive 2003/48 on the Taxation of Savings Income also comes into effect.6 Thereafter, they will benefit from a transitional period of eight (for Greece and Portugal) and six (for Spain) years (see infra).
3. The Principle.
Pursuant to the Interest/Royalty Directive, interest7 or royalty8 payments are exempt from any taxes imposed on such payments in the source country, whether by deduction at source or by assessment, provided that (i) the beneficial owner9 of the interest or royalties is a company10 of another Member State or a permanent establishment situated in another Member State belonging to an EU-based company; and (ii) the company which is the payer, or the company whose permanent establishment is the payer, is an associated company of the beneficial recipient/owner of the payment.11 To that end, two companies will be deemed to be "associated" if one company has a direct minimum holding of at least 25 percent in the capital of the other company, or if a third company has a direct minimum holding of at least 25 percent in the capital of both companies.12 With respect to this 25-percent ownership requirement, however, the Interest/Royalty Directive leaves the following windows open:
(a) Any Member State has the option of not applying this Directive when the 25- percent ownership requirement has not been maintained for an uninterrupted period of at least two years.13
(b) Member States have the choice of replacing the criterion of a minimum holding in the capital with that of a minimum holding of voting rights.
The above-described general rule will not be immediately applicable to interest and royalty payments made from Greece or Portugal,14 as these two countries remain authorized, for a period of eight years as from the entry into force of the Directive 2003/48 on the Taxation on Savings Income, to withhold tax on payments of interest or royalties, which may not exceed 10 percent during the first four years and five percent during the next four years. In addition, Spain will also remain entitled to withhold tax of up to 10 percent on royalty payments only (but for no more than six years as from the entry into force of Directive 2003/48 on the Taxation on Savings Income).15 Any tax paid in Spain, Greece or Portugal is to be allowed as a deduction from the tax due on the income of the recipient of such interest or royalty payments.
4. Exclusions from the Interest/ Royalty Directive.
The source Member State may exclude the following four situations from the general exemption:16
(a) Payments which are treated as a distribution of profits or as a repayment of capital under the laws of the source Member State;
(b) Payments on debt claims which carry a right to participate in the debtor’s profits (i.e., profit-sharing loans);
(c) Payments on debt claims which entitle the creditor to exchange its rights for a right to participate in the debtor’s profits (i.e., convertible debt); or
(d) Payments on debt claims which contain no provision for the repayment of principal (perpetual debt) or where the repayment is due more than 50 years after the date of issue.
5. Anti-Abuse Provisions.
Member States enjoy broad discretion to apply a withholding tax on interest or royalties in the event of abuse:
(a) First off, the Interest/Royalty Directive does not preclude the application of domestic or agreement-based provisions required for the prevention of fraud or abuse.17
(b) In addition, in the case of transactions for which one of the principal motives is tax evasion, tax avoidance or abuse, then Member States may refuse to apply the Directive.18
(c) Finally, any transaction which is not at arm’s length is excluded from the scope of the Directive to the extent of any amounts which would not have been agreed between unrelated persons. Thus, for example, transactions involving a thinly-capitalized company may be excluded from the scope of the Directive.19
6. Procedure.
The Interest/Royalty Directive allows Member States to require that the exemption from withholding tax be substantiated — at the time of payment of the interest or royalties — by an attestation, which must contain certain information such as a proof of the recipient’s tax residence, its beneficial ownership, and information with respect to the shareholding (or voting rights).20 Member States may also request proof of the legal justification for the payments under the governing contract (e.g., loan agreement or licensing contract). Finally, Member States may make it a condition for exemption that it has issued a decision granting the exemption following the above-described attestation.21
7. Relationship with Domestic or Treaty Provisions.
The Interest/Royalty Directive expressly confirms that it does not in any way affect the application of domestic or agreement-based provisions, which go beyond the provisions of this Directive and are designed to mitigate or eliminate the double taxation of interest and royalties.22 The impact of this provision is not to be overlooked. Indeed, the scope of the Directive is somewhat limited (e.g., a 25-percent holding requirement, the adoption of one of the corporate forms listed in the Annex to the Directive, the express exclusions from the benefit of the Directive). By contrast, at least some double taxation conversions (and at times, even sometimes domestic law) reduce the withholding taxes on interest or royalty payments to zero, without requiring compliance with the (strict) conditions of the Directive.
8. Latest Developments.
On December 30, 2003, the European Commission presented a proposal for a Council Directive amending the Interest/Royalty Directive.23 The proposal is two-fold:
(a) One of the concerns expressed by the European Council was that the benefits of the Interest/Royalty Directive should not accrue to companies that are otherwise exempt from tax on interest and royalty payments due to special tax regimes. To that end, the proposal requires that the interest or royalty payment be effectively subject to tax in the Member State of the beneficial owner in order to qualify.
(b) The proposal extends the scope of the Directive to other legal entities (the European Company, the European Cooperative Society, and certain other legal forms such as a cooperative), mirroring what has been done to the Parent- Subsidiary Directive, discussed in Section A.1 above.
On April 1, 2004, the European Commission presented another proposal to amend the Directive so as to incorporate transitional periods for the Czech Republic, Latvia, Lithuania, Poland, and Slovakia.24
Footnotes
1 Council Directive 2003/123/EC of Dec. 22, 2003 amending Directive 90/435 on the Common System of Taxation Applicable in the case of Parent Companies and Subsidiaries of Different Member States, O.J. No. L/007 of Jan. 13, 2004, at p. 41.
2 EC Council Reg. No. 2157/2001 of Oct. 8, 2001 on the Statute for a European Company (SE), O.J. No. L/294 of Nov. 10, 2001, at p. 1.
3 EC Council Directive No. 2003/72/EC of July 22, 2003 supplementing the Statute for a European Cooperative Society with regard to the Involvement of Employees, O.J. No. L/207 of Aug. 18, 2003, at p. 25.
4 EC Council Directive No. 2003/49 of June 3, 2003 on a Common System of Taxation Applicable to Interest and Royalty Payments made between Associated Companies of Different Member States, O.J. No. L/157 of June 26, 2003, at p. 49.
5 Id. at art. 7.
6 Id. at art. 6. Directive 2003/48 on the Taxation of Savings Income will enter into force on January 1, 2005, provided that agreements for equivalent measures are reached with certain third countries (namely Switzerland, Andorra, Liechtenstein, Monaco, and San Marino) and agreements for the same measures are entered into with dependent or associated territories of Member States.
7 The term, "interest", means income from debt claims, whether or not secured by a mortgage and whether or not carrying a right to participate in the debtor’s profits. It includes income from securities, bonds or debentures, including any premiums attaching thereto. Penalty charges for late payment are not treated as interest for these purposes, however.
8 The term, "royalties", means payments of any kind received as consideration for the use of, or the right to use, any copyrights (including for) software, patents, trademarks, designs, secret formulae or processes, or for information concerning industrial, commercial or scientific experience. Payments for the use of, or the right to use, industrial, commercial or scientific equipment (i.e., lease payments) are also regarded as royalties.
9 Pursuant to Article 1.4 of the Interest/Royalty Directive, a company will be treated as the beneficial owner of the interest or royalties only if it receives those payments for its own benefit and not as an intermediary (such as an agent, trustee or authorized signatory) for some other person.
10 The company must take one of the forms listed in the Annex to the Interest/Royalty Directive and be subject to one of the taxes listed therein.
11 Id. at arts. 1.1. & 1.7. 12 Id. at art. 3 (b). The Interest/Royalty Directive requires that the holdings only involve companies resident in the EC. Consequently, related parties without a common EU parent company would not be entitled to the benefits of the Directive in relation to interest and royalty payments made between them.
13 Arguably, the ECJ decision in the Denkavit case (Case C- 283/94 of October 17, 1996) — according to which the minimum holding period does not have to be reached at the moment dividends are distributed (for purposes of the Parent-Subsidiary Directive) — should apply as well (if only by analogy) to the situations covered by the Interest/Royalty Directive.
14 Interest/Royalty Directive, at art. 6.1.
15 Id. at art. 6.1.
16 Id. at art. 4.1.
17 Id. at art. 5.1.
18 Id. at art. 5.2.
19 Id. at art. 4.2.
20 Id. at art. 1.11.
21 Id. at art. 1.12.
22 Id. at art. 9.
23 Proposal for a Council Directive amending Directive 2003/49/EC on a Common System of Taxation Applicable to Interest and Royalty Payments made between Associated Companies of Different Member States, COM (2003) 841 final.
24 Proposal for a Council Directive amending Directive 2003/49/EC as regards the Possibility for Certain Member States to apply Transitional Periods for the Application of a Common System of Taxation Applicable to Interest and Royalty Payments made between Associated Companies of Different Member States, COM (2004) 0243.
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