The European Commission asked the Netherlands on 19 November to amend the limitation on benefits (LOB) provision in the existing Dutch-Japanese tax treaty. The LOB provision may be detrimental to Dutch companies held by residents of certain EU/EEA countries when they receive interest, royalties and dividends from Japan. They may face higher Japanese withholding tax on these types of income than Dutch companies held by Dutch shareholders. This is inconsistent with EU law. If no satisfactory response is given within two months, the Commission may refer the Netherlands to the European Court of Justice. The Netherlands can only amend the tax treaty with Japan's cooperation. The Netherlands may have to compensate shareholders if the ECJ decides that the LOB provision contravenes EU law. In anticipation of the ECJ ruling, entities that are excluded from the benefits of the tax treaty may request the Dutch Revenue Service for a refund of excess Japanese tax paid. It can be argued that the Dutch Revenue Service should use its discretionary power to compensate the disadvantaged entities ahead of the ECJ's decision. However, it is doubtful whether the Dutch Tax Authorities will grant a refund request.
The tax treaty entered into force on 1 January 2012. It reduces and, under certain circumstances, exempts taxes on dividends, interest, royalties and other income in the source state. The treaty includes a tax exemption on dividends paid by qualifying shareholdings. The tax exemption on dividends in the source state applies if a resident of one of the states has held shares representing at least 50% or more of the voting power in a company that is resident in the other state for at least six months. For shareholdings between 10% and 50%, a reduced 5% tax rate applies in the source state. In other cases, 10% may be levied by the source state. The treaty reduces the tax on royalty payments to 10% and on interest, to 0% in the source state. However, the Netherlands does not levy withholding tax on interest and royalty payments.
The LOB provision is drafted to avoid treaty shopping. It targets transactions where a third-party resident or corporation sets up a Dutch or Japanese intermediary company which income is passed through by the shareholders in an attempt to achieve a minimal tax rate. The LOB provision aims to discourage intermediary companies that have no legitimate business purpose beyond minimising tax exposure. In the treaty, certain treaty benefits regarding dividend, interest, royalty, capital gains and other income payments are limited to qualified residents.
Under the current terms of the LOB provision, some entities are excluded from the benefits of the tax treaty. This means that they suffer higher Japanese taxes on certain income received from Japan than similar companies with Dutch shareholders or whose shares are listed and traded on "recognised stock exchanges", which include certain EU and even third-country stock exchanges.
In the Open Skies cases and the Gottardo case, the ECJ ruled that if an EU/EEA state concludes a treaty with a non EU/EEA state, that treaty must comply with the non-discrimination principles included in the TFEU. The ECJ held that the freedom of establishment (article 49 TFEU) precludes EU/EEA states from concluding treaties with non EU/EEA states if no account is taken of certain aspects of EU law. When an EU/EEA state concludes a bilateral international convention with a non EU/EEA state, the fundamental principle of equal treatment requires that the EU/EEA state grants nationals of other EU/EEA states the same advantages as those which its own nationals enjoy under that convention.
Based on the above case law, there are two incompatibilities with EU law. First, some EU/EEA stock exchanges are not mentioned in the LOB provision, such as the stock exchanges from Budapest, Prague, Warsaw and Athens. This exclusion is an obstacle to the free movement of services or capital because these stock exchanges are treated differently by the Netherlands.
Second, the LOB provision contains a derivative benefits test without a general EU dimension. A crucial element of this beneficial ownership test is that the shareholder must have been able to claim equivalent benefits under its "own tax treaty". This means that certain Dutch companies cannot claim certain treaty benefits for dividends received from Japan because their non-Dutch shareholder is not an equivalent beneficiary.
The Commission states that these two elements of the treaty are discriminatory and restrict the freedom of establishment.
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