Beneficial Ownership: Final Judgments in the "Danish Cases" - Dividends
On 9 January 2023, the Danish Supreme Court gave final judgements in the first two of the so-called "Danish Cases" to reach the Court. Ruling on dividends distributed to holding companies in Luxembourg and Cyprus, the Supreme Court held in favour of the Danish Ministry of Taxation.
Introduction
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 acted negligently in not withholding.
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 of abuse exists in EU law and must be applied by the Member States, and that beneficial ownership is not only an international tax law but also an EU law notion.
The CJEU judgement in the dividend withholding cases is available here: Joined Cases C-116/16 and C-117/16
The CJEU judgement 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 judgements and judgements on 3 May 2021 from the Danish High Court, the Supreme Court gave final judgements in the dividend cases on 9 January 2023.
The Supreme Court judgements
The Supreme Court heard two cases and, accordingly, ruled on two sets of facts.
Beneficial ownership
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 Mod-el 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 “artifi-cial legal constructions”, which makes it possible to “benefit from both the advantages following from certain national legislation and the tax exemptions, which follows 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, in another way than as an agent or intermediary, merely functions as a “conduit” for another person who actually receives the income in question.
Luxembourg case
One of the cases (C-116/16 T Danmark before the CJEU) concerned dividends from a Danish subsidiary to a Luxem-bourg 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 Lux-embourg 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.
Cyprus case
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 com-pany in turn used the proceeds to pay a dividend to its US parent company. The Supreme Court held that the Danish sub-sidiary was obliged to withhold tax on the major dividend distribution in 2005. For the minor distribution in 2006, the Su-preme Court held that there was no obligation to withhold tax.
Ultimate beneficial owners
The High Court had come to 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 judgement 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 eco-nomic 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 hereafter 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 was not present and emphasized that the final decision to repatriate the dividends to the US parent company was not made until 22 March 2006, that the dividends before this 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.
Interest issues
Finally, the Supreme Court held that the Ministry of Taxation was entitled to claim late payment interest - including com-pounding interest provided for in Danish law - on dividend taxes not duly paid. This conclusion should be seen in light of the Danish rules, which do not allow a taxpayer who has been successful in first instance proceedings to deposit disputed amounts to prevent interest from accruing pending appeals instance litigation. Due to this lack of an option to pay in the disputed amount to the Revenue, the amount of late payment interest was about twice the amount of dividend tax in dis-pute.
The Supreme Court stated in this regard:
"The Supreme Court is aware that an understanding of the Danish Tax Collection Act in accordance with its wording entails that the tax authorities' overall interest claim against the Danish subsidiary is very high compared to the amount subject to withholding […]. This must be regarded in connection with the fact that the Danish subsidiary – as a consequence of the Danish Tax Tribunal and partly the High Court having upheld the company’s claim – did not have the possibility to deposit the disputed amounts, for example by depositing them on the tax account and hereby avoiding the addition of interest until the time when the courts might upheld the Ministry of Taxation’s claim in the cases." (Unauthorised translation)
Quite exceptionally, the Supreme Court included an obiter dictum in its reasoning, urging the Danish legislator to consider the quality of the present interest rules:
"At the same time, the Supreme Court finds that there is reason for the legislators to consider whether con-sequences of the Danish Tax Collection Act such as those at issue, which must be seen in the context of the question about the right to deposit disputed amounts, are desirable." (Unauthorised translation)
Into the future
Final Supreme Court judgements in the Danish Cases on interest withholding taxes are expected in May 2023 and may shed additional light on the beneficial owner notion and the abuse doctrine prescribed by the European Court of Justice and now applied by the Danish court. The determination remains fact specific for each case, of course, but the Supreme Court would seem 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 ulti-mate beneficial owners irrespective of the formal structure. There is little guidance on what is required to qualify as bene-ficial owner and one should be cautious reverse engineering from 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; this is hardly a sole parameter for an entity to pass the beneficial owner test.