background image
CJEU Holds Portugal Must Allow Non-Resident Financial Institutions to Deduct Expenses on Interest Income Received in Portugal — Orbitax Tax News & Alerts

On 13 July 2016, the Court of Justice of the European Union (CJEU) issued its judgment concerning Portugal's differing tax treatment of interest income received in Portugal by resident and non-resident financial institutions.

The case involved Portugal-based Brisal - Auto Estradas do Litoral SA (Brisal) and KBC Finance Ireland (KBC). In 2004, Brisal entered into an external financing agreement with a syndicate of banks, which was later expanded to include KBC. As a non-resident bank, KBC was subject to tax withholding on the gross interest income received in Portugal, while the resident banks that were part of the agreement were subject to tax on the net interest income. At the time, the applicable withholding tax rate for non-resident financial institutions was 20%, unless reduced by a tax treaty, and the tax rate for resident financial institutions was 25%.

Brisal and KBC filed an administrative appeal for a review of the withholding tax, arguing that the differing treatment resulted in an increased tax burden for non-resident financial institutions that violates the freedom to provide services and the free movement of capital under the Treaty on the Functioning of the EU (TFEU). The appeal made its way to Portugal's Supreme Administrative Court, which decided to stay the proceedings and to refer to the CJEU for a preliminary ruling on possible restrictions on the freedom to provide services. The free movement of capital aspect was not referred as it was considered to be a consequence of possible restrictions on the freedom to provide services and not a primary issue.

In its decision, the CJEU found that Portugal may levy a withholding tax on interest payment to non-resident financial institutions, but must also allow non-residents to deduct related business expenses in the same manner as resident financial institutions. In particular, the CJEU found that:

  • Article 49 EC does not preclude national legislation under which a procedure for withholding tax at source is applied to the income of financial institutions that are not resident in the Member State in which the services are provided, whereas the income received by financial institutions that are resident in that Member State is not subject to such withholding tax, provided that the application of the withholding tax to the non-resident financial institutions is justified by an overriding reason in the general interest and does not go beyond what is necessary to attain the objective pursued;
  • Article 49 EC precludes national legislation, such as that at issue in the main proceedings, which, as a general rule, taxes non-resident financial institutions on the interest income received within the Member State concerned without giving them the opportunity to deduct business expenses directly related to the activity in question, whereas such an opportunity is given to resident financial institutions;
  • It is for the national court to assess, on the basis of its national law, which business expenses may be regarded as being directly related to the activity in question.

Note - the decision is made in reference to Article 49 of the European Community (EC) Treaty because the currently relevant Article 56 of the TFEU was not in force at the time of the case.

Click the following link for the full text of the CJEU judgment.