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ECJ: Advocate General finds Dutch withholding tax on outbound dividends incompatible with EC free movement of capital – details

Advocate General (AG) Mengozzi of the European Court of Justice (ECJ) gave his opinion on 7 June 2007 in case of Amurta v. Inspecteur van de belastingdienst (C-379/05) on the compatibility of the Dutch dividend withholding tax on outbound dividends with the free movement of capital as set out in Art. 56 of the EC Treaty. Details of the opinion are summarized below.

Advocate General's Opinion.

Question 1

Discrimination

With respect to the first question as to whether the Dutch withholding tax on outbound dividends was compatible with Art. 56 and Art. 58 of the EC Treaty, the AG applied the discrimination test. Namely, he first examined whether or not (i) there is a difference of treatment entailed by the Dutch legislation and (ii) it relates to objectively comparable situations.

(i) Difference of treatment. The AG first noted that the Dutch provision exempts from the 25% withholding tax dividends paid by Dutch companies to companies subject to Dutch corporate income tax and holding at least 5% in the Dutch subsidiary, whereas it taxes such dividends paid to companies that are not established in the Netherlands. The latter companies were only exempt from the Dutch withholding tax, when their participation exceeded, at the time of the case at issue, 25% in the capital of the Dutch company pursuant to the provisions of the EC Parent-Subsidiary Directive. The AG concluded that such provision created an adverse difference of treatment for companies not established in the Netherlands.

The AG then examined whether such difference in treatment was compatible with the freedom of capital set out in Arts. 56 and 58 of the EC Treaty. The derogation from the prohibition of the restriction of the free movement of capital set out in Art. 58(1) may not constitute a means of arbitrary discrimination or a disguised restriction on the freedom (Art. 58(3)). It follows that permissible differences in treatment must relate to situations that are not objectively comparable or which are justified by reasons of general interest and proportionate to the aim they intend to achieve.

(ii) The comparability of situations. The AG referred to the Denkavit case and the ACT Group Litigation case and held that insofar an EU Member State exercises its tax jurisdiction over non-residents, either unilaterally or by way of a tax treaty, resident and non-residents are in a comparable situation. If the source state chooses to relieve economic double taxation domestically for its own residents by way of an exemption, this measure must be extended to non-residents where (internal) economic double taxation is the result of the exercise of its own tax jurisdiction. The AG concluded that the Dutch legislation in question, by denying the withholding tax exemption on dividends paid to non-resident companies, whereas providing for such exemption for resident parent companies, constituted an arbitrary discrimination incompatible with Art. 56 and Art. 58 of the EC Treaty.

Justifications

The AG rejected the justifications put forward by several governments, as follows:

-   Allocation of fiscal competence between the Netherlands and Portugal. In the absence of harmonization in respect of allocation of taxing power between the EU Member States, the EU Member States may freely determine such allocation under bilateral tax treaties, provided that such allocation conforms to EC law. The AG opined that the discrimination pertaining to the Dutch legislation is not the result of disparity of tax systems nor of the allocation of fiscal competence between the Netherlands and Portugal, but merely results from a discriminatory treatment by the Netherlands.
-   Coherence of the Dutch tax system. The AG rejected the justification of the coherence of the Dutch tax system. The Dutch government argued that the exemption of dividend withholding tax constitutes an administrative simplification insofar it would avoid the necessity of a refund of withholding tax to Dutch taxpayers that benefit from the participation exemption, however, it did not substantiate why the granting of exemption to non-resident companies would compromise the coherence of the Dutch tax system.
   

Question 2

The second question dealt with the issue of whether it is of importance whether the state of residence of the foreign shareholder/company, to which the exemption from the Dutch dividend withholding tax does not apply, grants a full credit to Netherlands dividend withholding tax. The AG analysed (i) the importance of a full credit granted under Portugal domestic law and (ii) the effect of a tax credit granted under a bilateral tax treaty.

(i) Full credit in the country of residence. The AG first observed that that it is not entirely clear from the referral whether Amurta could benefit under Portuguese law from a "full credit" or from a participation exemption, as was alleged by Amurta on the hearing, on the dividends received. The AG considered that if Amurta were correct, the question referred by the Dutch Court would only be hypothetical, so that the ECJ would not be competent to answer that question.

(ii) Effects of bilateral tax treaties. In contrast to (i), the neutralization of discriminatory effects of a domestic legislation can be ensured by the application of a tax treaty, which would allow taking account of the economic reality of the taxpayer's cross-border activities and taking account of the way Member States ensure the respect of the fundamental freedoms by means of an allocation of their taxing power, by reciprocal engagements based on a binding agreement. However, the AG noted two limitations to this principle. First, the global treatment under which the taxpayer is subjected must be in practice in conformity to EC law. Second, it is the duty of a Member State, the domestic law of which is discriminatory, to ensure the neutralization of the discrimination.

The AG noted that no reference were made by the Dutch Court that the full credit would result from the application of the Netherlands-Portugal tax treaty. To neutralize the discrimination, the tax treaty should provide for an allocation of the taxing power between the Member States that cancels out in practice the disadvantage borne by non-residents in the Netherlands. This would be achieved only by a total imputation of the Dutch withholding tax paid on Portuguese corporate income tax. Art. 24 of the Netherlands-Portugal tax treaty however only provides for an ordinary credit up to the amount of Portuguese corporate income tax due on the dividend income. In such a case, Amurta would bear the cost of excess credit related to the Dutch withholding tax. Consequently, the advantages granted to non-resident companies in the Netherlands would not be equal to those received by Dutch resident companies that are in a similar situation with respect to their participations in a Dutch subsidiary. Consequently, the discrimination would remain incompatible with Art. 56 and 58 of the EC Treaty.

The AG noted in conclusion that it is up to the national judge to interpret the domestic law applicable and to verify if the global treatment of a non-resident company, as allocated between the source state and the residence state under a tax treaty, is not less favourable than that granted to resident companies.

Comments. Although the AG answered the questions referred by the national court, the Amurta case at the end may not answer the question left open by the ECJ's Denkavit decision, as to whether or not a restriction is imposed on the freedom establishment in the case where a non-resident shareholder may fully credit the withholding tax levied by the source state against the tax due on the dividends in his residence state. This is due to the fact that the description of the Portuguese domestic law by the referring Court was "vague" and that according to the AG, Amurta provided details that the Portuguese domestic law relieves double taxation by means of a participation exemption regime and not by means of a full credit. If this is the case, the ECJ may not answer the above-mentioned question as it relates to a merely hypothetical dispute.

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