On May 17, 2017, the Court of Justice (‘CJ’) decided that the Belgian fairness tax is partially at odds with EU law (Case C-68/15 X v Ministerraad).
As a recap, the fairness tax is a separate tax of 5,15% which is levied in the hands of a company that (1) distributes profits while (2) it has benefitted in the year of distribution from the notional interest deduction (NID) and/or tax losses carried forward (TLCF). A complex formula determines the fairness tax base. The fairness tax applies to domestic companies, as well as Belgian branches of foreign companies, for which the formula is somewhat different (see infra, next steps).
The CJ was requested by the Belgian Constitutional Court to render a preliminary ruling with regard to the following questions (in slightly different order):
- Does the fairness tax constitute a withholding tax, prohibited by Article 5 of the Parent-Subsidiary Directive (‘PSD’)?
- Does the fairness tax violate Article 4(1)(a) of the PSD – which in the case of Belgium requires a 95% ‘exemption’ of the dividend received in the hands of the dividend receiving company – where such company decides to redistribute those profits, which are then subject to fairness tax?
- Does the fact that the different formula applied to Belgian companies vis-à-vis Belgian branches of foreign companies can result in a less advantageous treatment of the latter, constitute an infringement of the freedom of establishment?
In short, the CJ’s answer to these questions was: ‘no’, ‘yes’ and ‘it depends’:
- As to the first question, the CJ confirmed the Burda case-law (Case C‑284/06), according to which the concept of a withholding tax should be interpreted legalistically, in that the taxable persion of the tax concerned should be the holder of the shares. As the fairness tax is formally levied at the level of the distributing company, it does not violate Article 5 PSD. With this judgment, the CJ therefore seems to (once and for all) reject the approach adopted in Case C‑294/99 Athinaïki Zythopoiïa, in which the concept of a withholding tax was construed economically.
- As to the second question, the CJ decided that including dividends received by a Belgian company from its EU subsidiary in the fairness tax base when these are redistributed (in any later year), violates article 4(1)(a) PSD. This conclusion is logical: a Member State that exempts (albeit for 95%) dividends received in the year of receipt (and thus ab initio acts in line with article 4(1)(a) PSD) cannot detract from that obligation by – in substance – subjecting those dividends to tax in a subsequent year (e.g. upon redistribution). The CJ came to a similar conclusion in a judgment in a similar (French) case, also rendered on May 17, 2017 (Case C-365/16 AFEP and Others). On the basis of the latter decision, some authors have argued that the obligation to exempt extends not only to redistributions in years subsequent to the year of receipt, but also those in the year of receipt itself (P. Van Den Berghe, “Hof van Justitie doet fairness tax wankelen”, Fisc. Act. 2017, nr. 20, 1-4). Whilst I am cautious to make a contrario conclusions on the basis of CJEU judgments which are always case-specific, especially where the CJEU remains silent on a certain point, I do agree with the author’s conclusion. This is because in both Case C-68/15 and Case C-365/16, the CJ indicates that the obligation to avoid double taxation embedded in article 4(1)(a) PSD applies irrespective of “whether the chargeable event of the taxation of the parent company is the receipt of those profits or their redistribution” (which I read as ‘irrespective of the timing of the taxable event’). What Member States cannot do directly, they cannot also do indirectly.
- Finally, the CJ ruled that the different treatment of Belgian branches of foreign companies compared to domestic companies violates the freedom of establishment (without there being a justification), but only if and to the extent that Belgian branches are – due to the application of the different formula – worse off than domestic companies. This would be the case where “the method of calculating the taxable amount of a non-resident company led to [the foreign] company being taxed even on profits not falling within the tax jurisdiction of [Belgium]” (see infra for the formula, next steps). The CJ defers this assessment to the Belgian referring court, which is to decide whether this is actually the case. In that respect, the CJ rightly holds that it is irrelevant that the formula may, on occasion, result in (branches of) non-resident companies being taxed more favourably than resident companies.
Next steps: technical amendments / suggestions
The CJ having rendered its decision, it will now be up to the Belgian Constitutional Court to render a final judgment (reflecting the CJ decision but also responding to Belgian constitutional law queries).
After this judgment, the fairness tax will have to be amended to accommodate all conflicts with higher-ranking norms identified. All in all, by ruling that the fairness tax does not constitute a (prohibited) withholding tax in the sense of Article 5 PSD, the CJ’s judgment leaves the fairness tax largely unaffected (as otherwise, fairness tax could never be levied). Consequently, the CJ judgment would only appear to require minor adjustments, which may nonetheless be very technical. However, as any increased technicality of the fairness tax would frustrate any ‘tax simplification’ objective, it could be wondered whether the fairness tax shouldn’t simply be abolished altogether.
Assuming that the fairness tax would remain ‘alive and kicking’, Belgium must, firstly, ensure that distributed profits received by a parent company (falling within the scope of the PSD) are never – i.e. in any given tax year – included in the fairness tax base upon redistribution (see second question). This will require the introduction of a mechanism that allows for tracking of those profits throughout the fiscal life of a company.
Secondly, Belgium must also ensure that (Belgian PEs of) non-resident companies are not treated disadvantageously compared to purely Belgian resident companies, in that it would need to avoid that the fairness tax base of the former includes profits that do not fall within the Belgian tax jurisdiction. Grosso modo, the fairness tax base formula for both categories of companies is as (1) the amount of the gross dividend less (2) the final final (Belgian) corporate tax base (effectively subject to tax) in the year of distribution, with the net amount thereof (the ‘untaxed dividend’) being multiplied by (3) a factor representing the extent to which NID or TLCF were used to reduce the final (Belgian) corporate tax base. The difference largely lies in component (1):
- For Belgian companies, it is logically determined as the gross dividend.
- For Belgian PEs of non-resident companies, however, it is calculated as (a) the total dividend (distributed by the foreign company) multiplied by (b) the proportion of the accounting result (of the year of distribution) of the Belgian PE in the worldwide accounting result.
The application of the formula for Belgian PEs may lead to an amount of ‘untaxed dividend’ being taken into consideration that exceeds the (cumulative) profits of the Belgian PE. To ensure that the fairness tax base does not include profits not subject to the Belgian tax jurisdiction, it could at first sight be contemplated to adjust (1) of the formula for Belgian PEs. One way of doing that would prima facie appear to apply components (a) and (b) of the formula ‘as is’, but provide an upper limit, i.e. the cumulative amount of accounting profits (excl. losses) of the Belgian PE. Another option would be to amend component (b) of the formula, in that the total dividend of the foreign company would be multiplied by the cumulative proportion of the accounting profits (excl. losses) of the Belgian PE in the cumulative worldwide accounting result. These are obviously just first remarks, which need to be assessed in more detail so that unequal treatment would be avoided in each and every situation.