The Danish Supreme Court has now given its final judgments in the so-called "Danish Cases". To some degree, the determination of who is "beneficial owner" remains fact specific, but the Supreme Court has set a strict general standard for an intermediate company to qualify for exemption from Danish withholding taxes.
The focal point in the "Danish Cases" is the "beneficial owner" quality of EU resident companies receiving dividend or interest payments or accruals from their Danish resident group companies, and whether the Danish companies should have withheld tax on such payments - and whether they acted negligently in not doing so. On 9 January 2023, the Supreme Court gave judgment on dividend withholding taxes and on 4 May 2023 the Supreme Court gave judgment on interest withholding taxes on paid and accrued interest.
In February 2019, the Court of Justice of the European Union (CJEU) ruled in several joined cases regarding the Danish withholding tax regime for dividends and interest paid to companies in other EU Member States. The CJEU ruled that a general prohibition on abuse exists in EU law and must be applied by all EU Member States, and that beneficial ownership is not only an international tax law but also an EU law notion.
The CJEU judgment in the dividend withholding cases is available here: Joined Cases C-116/16 and C-117/16
The CJEU judgment in the interest withholding cases is available here: Joined Cases C-115/16, C-118/16, C-119/16, C-299/16
Following the CJEU's judgments and Danish High Court judgments in 2021, the Supreme Court gave final judgments on 9 January 2023 and 4 May 2023 in the dividend and interest cases, respectively.
The Supreme Court heard two cases together and, accordingly, ruled on two sets of facts.
Before going into the specific cases, the Supreme Court stated that the notion of “beneficial ownership” was not defined in the double tax treaties in question. Since the notion delimits the tax competence between the contracting states, the Supreme Court found that it followed from the context that the meaning cannot rely on the legislation of the respective contracting states. The Supreme Court further stated that the notion of “beneficial ownership” must be understood in light of the OECD Model Convention, including the 1977 commentaries regarding the countering of abuse. According to these commentaries, the notion is intended to ensure that double tax treaties do not aid in tax evasion or avoidance through “artifice” or “artificial legal constructions”, which makes it possible to “benefit from both the advantages following from certain national legislation and the tax exemptions, which follow from the double tax treaties”. In the revised commentaries from 2003, this is clarified and specified, and it is, among other things, mentioned that it would not be in accordance with the object of the treaty to grant a tax exemption if a person, other than as an agent or intermediary, merely functions as a “conduit” for another person who actually receives the income in question.
One of the cases (C-116/16 T Danmark before the CJEU) concerned dividends from a Danish subsidiary to a Luxembourg parent company. The Supreme Court held that the dividend paid to the Luxembourg parent company had been transferred to the private equity funds controlling the structure and potentially to the ultimate investors, and that the Luxembourg company had no separate functions. Hence, neither the EU Parent Subsidiary Directive nor Danish tax treaties applied, and the dividend was subject to Danish withholding tax.
The other case (C-117/16 Y Denmark before the CJEU) concerned two dividend distributions from a Danish subsidiary to its Cyprus parent company, a major distribution in 2005 and a minor in 2006. The Cyprus parent company subsequently used the dividends to pay principal and interest on loans from its Bermuda parent company. The Bermuda parent company, in turn, used the proceeds to pay dividends to its US parent company. The Supreme Court held that the Danish subsidiary was obliged to withhold tax on the major dividend distribution in 2005. For the minor distribution in 2006, the Supreme Court held that there was no obligation to withhold tax.
The High Court had reached the opposite conclusion, ruling that no tax applied to the major distribution since the ultimate parent company in the structure was resident in the US, and the dividends could have been distributed directly to the US parent without taxation at source. The Supreme Court, however, held that it was key that the dividend remained with the Bermuda company for a period of approximately five months, during which the amount was invested in bonds and that, during this time, the group was free to decide to utilise the dividend for other purposes than to repatriate it to the US parent company. On this basis, the distribution of dividend triggered Danish withholding tax.
In reaching this conclusion the Supreme Court considered the fact that the Danish subsidiary could have distributed the dividend directly to the US parent company without taxation at source under the double tax treaty between Denmark and the US.
In considering this issue, the Supreme Court referred to the CJEU's judgment of 26 February 2019, paragraph 108 and paragraph 110, stating that when examining the structure of the group it is immaterial that some of the beneficial owners of the dividends paid by the conduit company are resident for tax purposes in a third state which has concluded a double tax treaty with the source state. The existence of such a treaty cannot in itself rule out an abuse of rights. Thus, a treaty of that kind cannot call into question that there is an abuse of rights where its existence is duly established on the basis of a set of facts showing that economic operators have carried out purely formal or artificial transactions devoid of any economic and commercial justification, with the essential aim of benefiting improperly from the exemption from withholding tax. However, it remains possible, in a situation where the dividends would have been exempt had they been paid directly to the company having its seat in a third state, that the aim of the group’s structure is unconnected with any abuse of rights. In such a case, the group cannot be reproached for having chosen such a structure rather than direct payment of the dividends to that company.
The Supreme Court further noted that no specific information was provided about the background for the decision in 2005 to establish a group structure according to which the Cyprus company would be incorporated as the new parent company for the Danish subsidiary - and subsequently participate in an overall distribution of dividends from Denmark to Bermuda and the US - rather than making the US company the parent company of the Danish subsidiary so that the dividend could be distributed directly to the US parent company.
In these circumstances, the Supreme Court considered that clear evidence is required to assume that there was no abuse of rights under the Parent-Subsidiary Directive in distributing to the Cyprus company - which is where the tax liability arose according to the Danish Corporation Tax Act. The Supreme Court concluded that such clear evidence did not exist and emphasized that the final decision to repatriate the dividends to the US parent company was not made until 22 March 2006, that, before this, the dividends were deposited in Bermuda for approximately 5 months, during which the amount was invested in bonds, and that during this time the group was free to decide to utilise the dividends for other purposes than to repatriate it to the US parent company. In view of the above, the Supreme Court further found that that the US parent company was not the beneficial owner of the dividend according to the double tax treaty between Denmark and the US.
Also, based on the fact that the Danish subsidiary was familiar with the basis for the distribution to the Cyprus parent company, the Supreme Court found that the Danish subsidiary acted negligently in not withholding tax on the dividend distribution and hence was liable for the taxes not withheld.
Again, the Supreme Court heard two cases together and, accordingly, ruled on two sets of facts.
Before going into each specific case, the Supreme Court referred to the European Court of Justice judgment of 26 February 2019, stating that a group of companies which is not organised for reasons which reflect economic reality, which has a structure which is purely formal and which has as its main purpose or as one of its main purposes to obtain a tax advantage which is contrary to the object and purpose of the applicable tax legislation may be regarded as an artificial arrangement. According to the Court, this is the case in particular where the payment of tax on interest is avoided by introducing into the group structure a flow-through entity between the company transferring the interest and the company which is the beneficial owner of the interest (paragraph 127).
Further, the Court held that it is irrelevant, for purposes of analysing the group structure that some of the beneficial owners of the interest transferred by flow-through companies are resident for tax purposes in a third State with which the source State has concluded a double taxation convention, and that the existence of such a convention cannot in itself exclude the existence of an abuse of rights (paragraph 135). However, according to the Court, in a situation where the interest would have been exempt if it had been transferred directly to a company established in a third State, it cannot be excluded that the objective of the group structure does not amount to an abuse of rights. In such a case, the group's choice of such a structure instead of paying the interest directly to that company cannot be called into question (paragraph 137).
As regards the burden of proof of abuse, the European Court of Justice stated, inter alia, that, to refuse to recognise a company as the beneficial owner of interest or to establish abuse, a national authority is not required to identify the entity or entities which it considers to be the beneficial owner of that interest (paragraph 145).
Further, the Supreme Court reiterated its judgment of 9 January 2023 on dividends. The Supreme Court stated that the notion of “beneficial ownership” must be understood in light of the OECD Model Convention, including the 1977 commentaries regarding the countering of abuse. According to these commentaries, the notion is intended to ensure that double tax treaties do not aid tax evasion or avoidance through “artifice” or “artificial legal constructions”, which make it possible to “benefit from both the advantages following from certain national legislation and the tax exemptions that follow from the double tax treaties”. In the revised commentaries from 2003, this is clarified and specified, and it is mentioned, among other things, that it would not be in accordance with the object of the treaty to grant tax exemption if a person, other than an agent or intermediary, merely functions as a “conduit” for another person who actually receives the income in question.
One of the cases (C-115/16 N Luxembourg before the CJEU) concerned payments and accruals of interest from a Danish subsidiary to its Luxembourg parent company. The other case (C-118/16 X Denmark before the CJEU) concerned payments and accruals of interest from a Danish subsidiary to its Swedish parent company. The Supreme Court held in both cases that the Danish subsidiary was obliged to withhold tax at source in connection with the interest payments and accruals, and, further, that the Danish subsidiary acted negligently in not withholding tax and hence was liable for payment of the tax.
The Supreme Court stated that a restructuring had been carried out in both cases, involving the establishment of companies in Sweden or Luxembourg that had to be seen as a comprehensive and "prearranged tax arrangement".
The Supreme Court held that the foreign companies should be considered flow-through entities, since they could "not freely dispose" over the interest from their Danish subsidiary. Hence, neither the EU Interest and Royalties Directive nor Danish tax treaties applied.
Further, the Supreme Court held that in the assessment of whether a company should be considered the beneficial owner of the interest or should be considered a flow-through entity, it is irrelevant whether effective payment of the interest has taken place or whether the interest has been accrued to the loan principal, just as it is irrelevant whether the interest has subsequently been converted into shares of the debtor company.
Moreover, the Supreme Court concluded that it could not be determined who, when not the immediate recipient, was the ultimate beneficial owner of the interest because of lack of information on what had ultimately happened to the interest, etc.
Finally, the Supreme Court held that, in both cases, the Danish subsidiary was familiar with the basis for the interest payments being subject to Danish tax and, accordingly, had acted negligently in not withholding tax and hence was liable for payment of the tax.
The Danish Supreme Court has now given its final judgments in the "Danish Cases", and the beneficial owner notion and the abuse doctrine prescribed by the European Court of Justice have been applied by the Danish court.
The determination of the existence of abuse and beneficial ownership remains fact specific for each case, of course, but the Supreme Court seems to have set a strict general standard for an intermediate company to qualify for exemption from Danish withholding taxes - and, as illustrated by the Cyprus case, for entities up chain from such intermediate to qualify as ultimate beneficial owners, irrespective of the formal structure and payment flow.
There is little guidance on what is required to qualify as beneficial owner, and one should be cautious to rely on an argument based only on the time between receipt and retransfer of e.g., dividends. Reverse engineering in relation to e.g., the emphasis placed by the Supreme Court on the Cyprus dividends remaining with and being invested by the Bermuda company for approximately five months is hardly the sole parameter for an entity to pass the beneficial owner test.
Except for what is ascertainable from the facts of the cases now decided and from reading backwards from the Supreme Court's reasoning, the judgments provide little general guidance on what is required to qualify as beneficial owner and as ultimate beneficial owner, i.e. when an entity up chain from the intermediate company may qualify as beneficial owner. The evidence produced by the parties in the matters now decided was not enough to persuade the Supreme Court, which found that the Danish subsidiaries had not established that the up chain companies or their shareholders were the ultimate beneficial owners. Several other matters are pending or forthcoming before the Danish courts and are likely to provide better guidance on the issue.