International Tax Panorama

On 30 January 2020, the Court of Justice of the European Union (CJEU) issued its decision in the Köln-Aktienfonds Deka case (C-156/17) regarding the compatibility of free movement of capital under EU law with the Dutch withholding tax on dividends distributed to non-resident investment funds. The Court held that some of the requirements for a refund imposed under Dutch law are incompatible with the free movement of capital.

1. Facts of the case: 

KA Deka is a form of a contractual investment fund established in Germany, which complies with the EU Directive 2009/65/EC requirements on Undertakings for Collective Investment in Transferable Securities (UCITS). It made investments on behalf of individuals. Their share price was listed on a stock exchange in Germany. However, the shares were traded via a so-called ‘global stream system’ whereby the participant data has not been disclosed to the fund.

KA Deka also had portfolio investments in the Netherlands that did not exceed 10% of the share capital of the participations held.  However, a 15% Dutch dividend withholding tax was withheld on the distributions made by the Dutch portfolio companies to KA Deka. According to the German tax law requirement, individuals who have invested in an investment fund are deemed to receive a minimum amount of dividends on which they were in principle, taxed. Thus, KA Deka filed claims for the repayment of the withholding tax levied on dividends received from Dutch companies (in between 2002 and 2008), based on equal treatment under EU law. 

2. Dutch legislation on Fiscal Investment Institution:

In principle, dividend distributions to both resident and non-resident investment funds are subject to a 15% Dutch dividend withholding tax under Dutch law. However, Dutch resident funds that qualify as a  fiscal investment institution (“FBI”) are subject to 0% corporate income tax under a specific tax regime. FBI’s are entitled to a Dutch withholding tax refund (before 2008), or a tax credit(as from 2008) withheld on their income.

Two major requirements must be met in order to qualify for FBI. These are the redistribution requirement and the shareholder requirement. In the redistribution requirement,  the profits must be distributed within eight months at the end of the financial year. In the shareholder requirement, a single individual must own a maximum interest of 25% in the FBI, and sole corporate shareholder must hold a maximum interest of 45% in the FBI. This shareholder requirement applies to regulated funds only, whereas regulated Investment funds are those funds that meet the requirements under the Dutch Financial Supervision Act.

On the other hand, there is a Dutch dividend withholding tax on dividend distributions to foreign investment funds, as these funds are not entitled to any refund or any credit on the tax withheld upon distribution of profits to their participants.

Previous Ruling on the same issue: 

In 2015, the Dutch Supreme Court concluded that foreign investment funds are not comparable to Dutch fiscal investment institutions because these foreign funds are not withholding agents for the Dutch dividend withholding tax. The Supreme Court, therefore, ruled that the European Union (EU) treaty freedoms did not require the Netherlands to refund Dutch dividend withholding tax incurred by foreign investment funds on their Dutch portfolio dividend income. However, as a result of subsequent developments in the CJEU’s case law, the correctness of the Supreme Court was challenged, among other things, by the German investment fund in the case at hand.

Past developments in the case :

Initially, before the Dutch tax authorities, KA Deka argued that the differential treatment is contrary to the free movement of capital under EU law and hence requested a refund of the Dutch dividend withholding tax levied. The Dutch tax authorities denied the refund request by arguing the following points: 

• Since a foreign investment fund was not subject to Dutch dividend withholding tax, it is not objectively comparable to an FBI,
• Also, KA Deka failed to meet the shareholder requirement (on account of insufficient evidence) as well as the redistribution requirement (only deemed distributions were made to the shareholders). Thus it not objectively comparable to FBI. 

This case further went to the Dutch lower Court.

In 2016 the Dutch lower Court raised a set of preliminary questions with the Dutch Supreme Court. The Dutch Supreme Court further referred these questions to the CJEU. However, the Dutch Supreme Court withdrew the preliminary question on the withholding tax obligation, after the CJEU verdict in the Fidelity Funds case (C-480/16). Therefore the questions only concerned the shareholders and the redistribution requirement. 

The request for a preliminary ruling concerned the compatibility with the free movement of the capital of the following two conditions of the fiscal investment institution regime, namely:

• The requirements relating to the shareholders/participants of the investment fund (shareholder requirement); and
• The obligation to distribute the profits which accrue to its shareholders/participants on an annual basis within 8 months of the end of its financial year (redistribution requirement)

Analysis of the CJEU decision

The CJEU gave its final judgement in the case by answering the two preliminary questions in the following ways: 

1. Shareholder requirement

As far as the first test is concerned the CJEU accepted that the Dutch shareholder requirement does not discriminate between Dutch resident and non-resident investment funds, as both are subject to the same conditions. However, the Court stated that the non-resident taxpayers requesting the tax advantage benefit should not be subject to an excessive administrative burden, which will make them impossible to qualify for the benefit. In the present case, it was impossible to identify the fund participants because of the system to trade shares in the fund that it had opted to apply. The CJEU acknowledged that the inability to prove the shareholder requirement was on account of (i) the intrinsic complexity of the information required, (ii) the evidence requested, or (iii) applicable EU privacy laws. Therefore, the CJEU found that failure to meet administrative proof requirement to fulfill the shareholding requirements did not, in and of itself, constitute a violation of the principle of free movement of capital.

On the contrary, the CJEU concluded that it was for the Dutch Supreme Court (i.e., the referring court) to determine whether discrimination exists in practically implementing the shareholder requirements of Dutch law for resident and non-resident investment funds. In this respect, If the information requested is only from non-resident funds rather than Dutch FIIs for meeting shareholder requirements, this practice could be contrary to EU law. 

2. Redistribution requirement

The redistribution requirement states that the qualifying investment funds must distribute their profits within eight months of the end of the corresponding financial year. Here the CJEU found that the denial of the benefits of the Dutch FBI to a non-resident fund whose profits are subject to tax in its state of residence, even if such profits have been distributed or not, can amount to a restriction on the free movement of capital. This is specifically in situations where it is impossible or excessively difficult for this non-resident fund to comply with the Dutch distribution requirement. 

The CJEU held that the condition essentially was too stringent, and should be interpreted in light of the objective of the rule (i.e., probably taxation at the level of the participant within a reasonable time). In the present case, the taxpayer was deemed to have distributed the dividends under German domestic law, and it was taxed at the level of its participants.

The CJEU also notes that the Dutch Supreme Court must investigate the purpose of the redistribution requirement. If the principle purpose is the taxation of profits made by a shareholder in an investment fund, then a non-resident investment fund whose profits are not distributed but are deemed to have been distributed and hence are taxed as such in respect of the shareholder in that fund, must be regarded as being in an objectively comparable situation (i.e. in both cases, the level of taxation is transferred from the investment fund to the shareholders). In such case, the redistribution requirement is contrary to EU law assuming the fund distributed or is deemed to have distributed income for tax purposes.

Future Implications of the decision: 

The ruling is a significant development and could shed light on the refund claims made by numerous investment funds in EU jurisdictions, especially in relation to Dutch dividend withholding tax. The CJEU has provided much-needed clarity for determining whether the resident and non-resident funds are in comparable situations. Especially when assessing whether a non-resident fund is in an objectively comparable position to a resident fund, the core objective of the underlying legislative measure must be considered. Also, there is no such requirement for distributions to be actually made which could also impact non-distributing accumulation funds, where the investors are taxable even on the basis of a deemed yield rather than distributions received. 

Since the CJEU decided to let several considerations up to the Dutch Supreme Court for verification, the CJEU’s ruling does not provide final clearance. Yet, the CJEU’s ruling suggests that the Dutch tax authorities may no longer require foreign investment funds to meet the Dutch requirements in full. On the other hand, the CJEU’s ruling may increase the relevancy of the burden of proof.

The CJEU’s judgment solely focuses on the system that applied before 2008. The question of whether the Dutch dividend withholding tax system for Dutch investment funds, as it stands from 2008 onwards, is incompatible with the free movement of capital, is currently pending before the Dutch Supreme Court in another leading case.

Following this CJEU judgement, the domestic procedure will start where the Dutch Supreme Court can be expected to answer the preliminary questions of the Lower Court. It is then up to the Lower Court to determine how to precisely apply the framework laid down by the CJEU (and the Supreme Court) in the case of KA Deka.