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CJEU rules nonresident UCITS entitled to exemption from Danish dividend withholding tax

Executive summary

On 21 June 2018, the Court of Justice of the European Union (CJEU) decided case C-480/16, Fidelity Funds, and held that Danish tax law was incompatible with the free movement of capital in Article 63 of the Treaty on the Functioning of the EU (TFEU), because nonresident undertakings for collective investment in transferrable securities (UCITS) were not granted exemption from dividend withholding tax (WHT) on portfolio shares in Danish companies.

Detailed discussion

Facts

A UCITS that is tax resident in Denmark and has made an election to be treated as a distributing UCITS under section 16 C of the Danish Tax Assessment Act (TAA) is exempt from WHT on portfolio dividends received from Danish companies. However, a resident UCITS must apply a 27% WHT on distributions to its members in order to ensure taxation of the dividends. Taxation is thus shifted from the UCITS level to the member level. On the other hand, a nonresident UCITS is subject to WHT tax of 27% (current rate) on portfolio dividends received from Danish companies. Nonresident UCITS are usually entitled to claim a refund of 12% causing the effective taxation to be 15%.

The case concerned three UCITS organized by Fidelity in the United Kingdom and Luxembourg that derived portfolio dividends from Danish companies and that had paid Danish WHT. The certificates issued by the funds were available for Danish investors but were not actively marketed towards such investors. The UCITS filed refund claims for the years 2000-2009 arguing that Danish tax law was incompatible with the free movement of capital and the free movement of services. The Danish tax authorities rejected the claims, arguing that the Danish rules were not discriminatory as they may be justified by the need to ensure a balanced allocation of the taxation powers and to safeguard the coherence of the Danish tax system.

CJEU decision

The CJEU held that the case should only be considered under Article 63 TFEU on the free movement of capital, since the impediment on the free movement of services was an unavoidable consequence of the Danish tax treatment of the dividends paid to nonresident UCITS.

According to the CJEU, resident and nonresident UCITS were subject to a different tax treatment regarding dividends received from Danish companies. Since nonresident UCITS were not entitled to an exemption from WHT, they were subject to more burdensome taxation vis-á-vis resident UCITS. The difference in tax treatment could discourage nonresident UCITS from buying Danish shares and could discourage Danish investors from buying units in nonresident UCITS. The Danish legislation thus involved a restriction on the free movement of capital.

The CJEU noted that a national law that causes a restriction on the free movement of capital is only allowed if it concerns situations that are not objectively comparable or is justified by an overriding reason in the public interest.

The question whether the situations were objectively comparable should be evaluated on the basis of the aim pursued by the national law as well as their purpose and content. The aim of the national law at stake was, on the one side, to ensure that indirect investments in Danish companies through a Danish UCITS receive the same tax treatment as a direct investment in Danish companies. On the other side, the aim of the national law was to ensure that dividends did not escape Danish taxation irrespective of the WHT exemption at the UCITS level.

With regard to the first aim, the CJEU concluded that when a Member State expands its taxing powers to dividends received by nonresident UCITS, resident and nonresident UCITS will be in comparable situations with regard to the risk of economic double taxation.

With regard to the second aim, the CJEU noted that Denmark imposed an obligation on resident UCITS to apply WHT, whereas such an obligation could not be imposed on nonresident UCITS. However, according to the CJEU, the crucial issue was the substantive taxation rights to the income of the members rather than the taxation technique. A nonresident UCITS could have members that were tax resident in Denmark. On this basis, resident and nonresident UCITS were in objectively comparable situations. The fact that Denmark could not impose taxation on nonresident investors on dividends from nonresident UCITS was found to be a logical consequence of the shifting of the taxation from the UCITS level to the investor level.

On this basis, the CJEU concluded that resident and nonresident UCITS were in objectively comparable situations.

The CJEU then went on to examine whether the national law was justified by an overriding reason in the public interest, in this case, the balanced allocation of powers to taxation and the need to safeguard the coherence of the tax system.

According to the CJEU, the national law could not be justified by a need to ensure a balanced allocation of powers of taxation, because Denmark did not levy tax on dividends paid to resident UCITS. On the other hand, the national law could, in principle, be justified in the need to safeguard the coherence of the tax system. Hence, the exemption from WHT granted to resident UCITS was conditional upon resident UCITS applying WHT on distributions to its members.

With regard to the proportionality of the national law, the CJEU noted that the coherence of the tax system could be safeguarded if nonresident UCITS that qualified as distributing UCITS under section 16 C TAA were granted the option of a WHT exemption provided that they agreed to apply Danish WHT on distributions to its members. The fact that nonresident UCITS did not have this option gave rise to economic double taxation. On this basis, it was concluded that the national Danish law could not be justified in the need to safeguard the coherence of the tax system.

In summary, the CJEU held that the Danish taxation of nonresident UCITS was incompatible with the free movement of capital.

Implications

The decision means that Denmark will be required to amend its rules on dividend taxation of resident and nonresident UCITS. For the time being it is uncertain how the law will be changed. The Danish law also allows for certain resident non-UCITS investment funds to receive portfolio dividends from Danish companies exempt from WHT, and the conclusion reached by the CJEU should equally be applicable to nonresident non-UCITS investment funds.

Nonresident UCITS that are resident in other Member States and that meet the requirements for a distributing UCITS laid down in section 16 C TAA, should be entitled to a refund of Danish WHT paid as from June 2008 and onwards (statute of limitations is 10 years). In order to prevent that a refund claim is time barred it would be prudent to file an application no later than 21 December 2018 (reaction deadline of six months). Since the case was decided on the basis of the free movement of capital, refunds should arguably also be available to UCITS in third countries (see case C-190/12, Emerging Markets).

EYG no. 010014-18Gbl

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