Benefits for Collective Investment Vehicles in the EU

Transcription

1 Volume 68, Number 6 November 5, 2012 Benefits for Collective Investment Vehicles in the EU by Petrina Smyth and Eimear Burbridge Reprinted from Tax Notes Int l, November 5, 2012, p. 581

2 Benefits for Collective Investment Vehicles in the EU by Petrina Smyth and Eimear Burbridge Petrina Smyth and Eimear Burbridge are with Walkers in Dublin. The issue of treaty benefits and other domestic exemptions from withholding tax applicable to collective investment vehicles (CIVs) is a thorny topic. Over time, the trend has been increasingly toward denying relief for CIVs. However, some recent developments show that that trend has reversed. We have analyzed some of the recent developments, regarding both treaty benefits and domestic exemptions available within the European Union. I. Tax Treaty Benefits for CIVs The OECD published a report in May setting out detailed proposals for the granting of tax treaty benefits to CIVs. These proposals were incorporated into the 2010 commentary on the OECD model tax treaty. CIVs are defined in the OECD report as funds that are widely held, hold a diversified portfolio of securities and are subject to investor-protection regulation. The OECD model treaty in its current form contains no specific reference regarding how a CIV should be treated. In general, a CIV will be entitled to tax treaty benefits in its own right if it is treated as a person that is a resident of the state in question. However, it may also have to be the beneficial owner of the income in question in order to claim benefits. Historically, this has led to confusion and the nonapplication of tax treaty benefits to a large number of CIVs. The OECD report considered whether a CIV should be considered a person, a resident of a Contracting 1 The Granting of Treaty Benefits with respect to the Income of Collective Investment Vehicles. State, and the beneficial owner of the income it receives under income tax treaties that do not include a specific provision dealing with CIVs. A. Person The commentary to the model treaty states that the definition of the term person in the model treaty is not exhaustive and should be given a wide meaning. CIVs structured as companies constitute a person. The issue is less clear regarding trusts; however, in most cases, treaty benefits are not denied to trusts on the basis that a trust is not a person. B. Resident CIVs may be treated as residents of a contracting state depending on the tax treatment in the country of establishment. The OECD report states that for the purposes of the test of residence, the legal form the CIV takes will be relevant only to the extent this affects the taxation of the CIV in its state of establishment. Tax treaties stipulate that in order to be resident for the purposes of the treaty, a person must either be resident for the purposes of tax or, in some treaties, liable to tax in that jurisdiction (that is, the person is within the charge to tax in that particular jurisdiction). The liable to tax test is vague, and there is little OECD guidance on what this term actually means in practice. Case law suggests that entities may be considered liable to tax when they are exempt from tax. However, some jurisdictions take the view that entities exempt from tax are not liable to tax and therefore not entitled to treaty benefits. C. Beneficial Ownership The OECD report states that beneficial ownership is generally interpreted in accordance with the relevant TAX NOTES INTERNATIONAL NOVEMBER 5,

3 PRACTITIONERS CORNER jurisdiction s domestic law, since it is not defined in the model treaty. The report argues that a widely held CIV should be treated as the beneficial owner of the income it receives as long as the investment manager has discretionary powers to manage the CIV assets and the CIV itself is classified as a person and a resident of its state of establishment. Such a CIV should be able to claim treaty benefits in its own right. The OECD report also recommends that states discuss CIVs during treaty negotiations and that tax authorities clarify the treatment of specific types of CIVs in their respective countries, such as confirming whether the CIV is entitled to tax treaty benefits in its own right and providing for administratively feasible refund methods for the CIV. Further recommendations include having countries expressly providing for treaty entitlement by including a provision to this extent in tax treaties or exchanging notes to this effect. D. Implementation of the OECD Report Newer tax treaties negotiated among EU member states have included references to and definitions of collective investment schemes, which is a welcome development. For example, the Germany-Ireland income tax treaty 2 states that an Undertaking for Collective Investment in Transferable Securities (UCITS) established in either Ireland or Germany that receives income from the other contracting state will be treated as a resident of its state of establishment and the beneficial owner of that income but provided only that certain conditions are complied with. 3 The Germany- Ireland treaty also deals with Irish common contractual funds (CCFs) and states that Irish CCFs will be treated as fiscally transparent entities for the purposes of granting tax treaty benefits. This provision is also contained in the Hong Kong-Ireland, 4 Ireland-South Africa, 5 and Ireland-Qatar 6 tax treaties. The Ireland-Qatar tax treaty also states that a pension fund or CIV that is 2 Signed March 30, 2011, not yet in effect. 3 This will apply only to the extent that the beneficial interests in the UCITS are at least 95 percent owned by equivalent beneficiaries. Equivalent beneficiaries are defined under the treaty as: a resident of the state of establishment of the UCITS; and a resident of any other state who has an income tax treaty in place with either Ireland or Germany (depending on whether the income has arisen in Ireland or Germany) containing an information exchange provision and under which that resident would be taxed on that income at a rate at least as low as the rate under the Germany-Ireland tax treaty or the rate applicable under domestic German or Irish law (again depending on whether the income has arisen in Ireland or Germany). 4 Signed June 22, 2010, effective from January 1, Signed March 17, 2010, effective from April 1, Signed June 21, 2012, not yet in effect. controlled according to the laws of a contracting state will be regarded as a resident of that state for the purposes of the tax treaty. Under the Ireland-U.S. tax treaty, CIVs and any similar investment entities agreed on by the competent authorities of both Ireland and the U.S. will be considered to be residents for the purposes of the treaty. A limitation on benefits provision limits treaty benefits to those CIVs that can satisfy one of the safe harbors in the LOB provision. Similar to the Germany-Ireland treaty referred to above, a CCF neither will be treated as a resident of Ireland nor will be entitled to benefits in its own right because it is not treated as a resident of Ireland under the Ireland-U.S. competent authority agreement. While these tax treaty provisions may be helpful or unhelpful in terms of allowing the CIV to avail itself of treaty benefits, they at least provide some clarity in the area. II. Withholding Tax Refunds for CIVs Treaty benefits or domestic tax exemptions can be granted at source or by having the CIV make a refund application for the difference between the non-treaty rate and the treaty rate. Many jurisdictions have imposed burdensome administrative requirements on CIVs, thus making it virtually impossible to obtain refunds of withholding tax. The European Court of Justice has stated that such behavior by domestic tax authorities will no longer be tolerated. A number of recent ECJ judgments, particularly in Aberdeen, 7 have brought increased opportunity for withholding tax refund claims to be made on behalf of CIVs within the EU. Historically, the European Commission and the ECJ have focused on corporate investors that had incurred discriminatory withholding tax; however, their target has recently shifted toward withholding tax imposed on CIVs. When a higher rate of withholding tax is imposed in a jurisdiction on payments made to nonresident CIVs as opposed to equivalent resident CIVs, this may breach the nondiscrimination, freedom of establishment, and free movement of capital rules enshrined in the EC Treaty. The Aberdeen case was one of the first ECJ cases to consider the legality of an EU member state imposing withholding tax on dividends paid to nonresident CIVs while exempting domestic CIVs from such dividend withholding tax. The relevant provisions were Finnish domestic law provisions as opposed to an income tax treaty. Aberdeen was a Finnish resident real estate company that was owned by a Luxembourg SICAV (Société d Investissement à Capital Variable) real estate fund. Under Finnish withholding tax rules, dividends 7 Aberdeen Property Fininvest Alpha Oy (C-303/07), June 18, NOVEMBER 5, 2012 TAX NOTES INTERNATIONAL

4 paid by Aberdeen to its Luxembourg SICAV parent were subjected to withholding tax, whereas a Finnish CIV parent would not have been subject to the same withholding tax. Under EU law, persons that are objectively comparable are entitled to the same tax treatment. The ECJ stated that such discriminatory treatment was contrary to the freedom of establishment and free movement of capital. The ECJ held the following: Investment funds of differing legal form can be compared and this is not an argument for justifying a difference in treatment. A Luxembourg SICAV was considered comparable to a local CIV or company. Whether the recipient CIV is subject to domestic corporate tax in its jurisdiction of establishment is irrelevant when the jurisdiction of the dividendpaying company has chosen not to tax that dividend when it is received by a domestic entity. The taxation of the CIV at an investor level should not be taken into account. The risk of tax avoidance is not a sufficient reason to impose withholding tax. As a result of Aberdeen, it has become possible for CIVs to recover withholding tax incurred in other EU jurisdictions. Several countries are currently granting refunds of withholding tax on the basis of Aberdeen claims, including Poland, Finland, Hungary, Norway, and Austria. On March 9, 2012, the Dutch Court of Appeal ruled in a case 8 concerning a Finnish CIV that had requested a refund of Dutch withholding tax that it had incurred on distributions received from Dutch companies. The Finnish CIV was a tax-exempt entity and, as such, had no ability to recover the withholding tax incurred. In comparison, Dutch tax-exempt entities were entitled to withholding tax refunds. The Finnish CIV therefore argued that the withholding tax was contrary to the right to free movement of capital under EU law. The Dutch court found in favor of the CIV because it was in a comparable situation to a Dutch tax-exempt entity that would also be entitled to a full refund (even though Dutch CIVs are not entitled to withholding tax refunds under Dutch law) and stated that the CIV should be granted a refund of the withholding tax along with statutory interest. The decision has been appealed by the Dutch tax authorities to the Dutch Supreme Court and is unlikely to be heard before On May 10, 2012, the ECJ handed down its judgment in Santander. 9 The Santander case was made up of a number of joined cases in which Spanish, German, and Belgian UCITS and U.S. regulated investment 8 Den Bosch Court of Appeal, Mar. 9, Joined cases C-338/11 and C-347/11. PRACTITIONERS CORNER funds argued that the levy of French withholding tax (at the rate of 25 percent) on French-source dividends received by them was in breach of EU law, because such French-source portfolio dividends paid to French resident CIVs were fully exempt from French withholding tax. The ECJ referral resulted from the French tax authorities having rejected multiple Aberdeen-type claims filed by nonresident CIVs since the decision. The following questions were referred to the ECJ: whether the unit holders situation in the CIVs should be taken into account in order to assess the compatibility with the free movement of capital regarding withholding tax on dividends; and if so, when might the withholding tax levied on dividends be considered as contrary to the free movement of capital. The ECJ ruled that certain non-french resident CIVs were entitled to a full refund of the 25 percent French withholding tax on French-source portfolio dividends they received. The judgment of the ECJ supports the position of CIVs claiming refunds of withholding taxes incurred across Europe. The ECJ held that the difference in treatment constitutes a restriction on the free movement of capital. Such a difference in treatment cannot be allowed if the foreign and domestic CIVs are in a comparable situation and the restriction is not capable of being justified by reasons in the public interest. The ECJ stated that the French legislation made a distinction based on the place of residence of the CIV. In the ECJ s view, the position of the investors in the investment fund claiming the refund was irrelevant and the comparison should only be made at the level of the investment fund without taking into consideration the position of its investors. As a result, the ECJ ruled that the nonresident CIVs were comparable to French domestic CIVs, which are eligible for exemption from French withholding tax. The ECJ stated that the restriction could not be justified by an overriding reason in the public interest. As a result of the ECJ ruling, France has introduced legislation (effective from August 18, 2012) that exempts EU CIVs and CIVs located in jurisdictions with which France has signed a tax treaty containing an administrative assistance clause from withholding tax on dividends received from companies that are tax resident in France. The withholding tax exemption will apply when the CIV: has similar characteristics to a French UCITS, French real estate fund, or French fixed-capital fund; and raises funds from a number of investors and the CIV invests such funds in a manner that is in the interest of its investors. The legislation also introduced a 3 percent dividend levy on dividend payments made by French resident TAX NOTES INTERNATIONAL NOVEMBER 5,

5 PRACTITIONERS CORNER companies (other than small and medium-size enterprises) to resident and foreign shareholders. The 3 percent dividend levy will not apply to dividends distributed by a number of French CIVs, including French UCITS, French real estate funds, French fixed-capital funds, and French securitization vehicles. A. Commission Referrals to ECJ The European Commission has made requests to a number of member states to amend what it perceives as discriminatory domestic legislation regarding CIVs. Some member states have amended their national legislation as a result of such requests, while others have been referred to the ECJ by the European Commission for failure to respond to such requests as follows: The European Commission formally requested Estonia to amend its tax legislation on June 16, 2011, as under Estonian tax law, domestic CIVs are treated more favorably than comparable CIVs established in other EU member states or in countries of the European Economic Area. The European Commission formally requested Poland to amend its tax legislation on June 16, 2011, since it believes Poland currently discriminates against investment funds and pension funds from other EU countries and countries of the EEA. Under Polish tax legislation, domestic CIVs and pension funds are exempted from corporate income tax. However, CIVs established outside Poland can only benefit from this exemption under specific conditions that are not applied to Polish CIVs and will therefore incur withholding tax. The ECJ s decision in Santander is welcomed because it has provided greater clarity for CIVs regarding reclaims of withholding tax under domestic law provisions. From a tax treaty perspective, it is hoped that treaty negotiators of newer and updated income tax treaties will include specific references to CIVs in order to provide comfort to both the CIV itself and its investors. 584 NOVEMBER 5, 2012 TAX NOTES INTERNATIONAL