EU constraints on recent and expected tax changes in Belgium

EU constraints on recent and expected tax changes in Belgium D. Garabedian Madrid, 31 May 2014 Brussels London - www.liedekerke.com

Overview Notional interest deduction (NID) Fairness tax Hybrid loans Exit taxes upon transfer of seat Withholding tax Fiscal autonomy & EU law 2

NID Principle Belgian companies and PEs can deduct a notional interest charge based on their total equity (share capital + retained earnings) Risk capital is multiplied by a rate based on ten-year Belgian government bonds For 2014: 2.63% standard rate, 3.13% for SMEs 3

NID ECJ, 4 July 2013, C-350/11 Argenta Spaarbank (I) Equity invested in PEs in countries with which Belgium has an income tax treaty was excluded from the NID calculation basis Same rule for equity invested in immovable property in a treaty country 4

NID C-350/11 Argenta Spaarbank(II) Argenta BelCo No Belgian NID for Dutch net asset No Dutch NID for Dutch net asset DutchPE 5

NID C-350/11 Argenta Spaarbank (III) ECJ Decision: Exclusion of foreign net assets from calculation basis is a restriction on freedom of establishment Not justified by balanced allocation of taxing power or coherence of the national tax system 6

NID C-350/11 Argenta Spaarbank (IV) Remarks: In Belgium, net operating loss of foreign PE is deductible from domestic profit net assets or net asset Computation of exempt income under double tax treaty 7

NID Impact Argenta Reaction by Belgian legislature: Abolition of exclusion from NID calculation basis of the equity invested in foreign exempt PEs But correction occurs at a later stage: the NID calculated on the higher calculation basis has to be reduced by NID relating to PEs or real estate outside EEA; and NID relating to PEs or real estate inside EEA, except if and to the extent that that part of the NID exceeds the profits attributable to the permanent establishments or immovable property 8

Fairness tax (I) Fairness tax imposed on non-sme companies that, for a taxable period, distribute dividends in excess of their taxable result to the extent that the difference stems from notional interest deduction or carried-forward losses applied during that year 9

Fairness tax (II) Hence, fairness tax will never apply if no dividends are declared in a taxable period Separate tax: in addition to other taxes Minimum tax: no offset against tax attributes Net cost: fairness tax is not deductible Tax rate: 5.15% Consistent with Parent-Sub Directive? Compare ECJ 4 October 2001, Athinaiki Zythopoiia with ECJ 26 June 2008, Burda 10

Hybrid financial instruments Principle (1) Treated as debt in Belgium the interest paid on the loan is tax-deductible in Belgium Treated as equity in Luxembourg the interest is not taxed in Luxembourg, under the participation exemption As a result: deduction in Belgium and no taxation in Luxembourg 11

Hybrid financial instruments Principle (II) Characteristics of a hybrid financial instrument to qualify as debt in Belgium and equity in Luxembourg: a profit participating loan ( PPL ) which is convertible into shares, has a maturity of at least 10 years, renewable, is subordinated, bears profit-linked interest and is stapled to shares of the issuing company. 12

Hybrid financial instruments Example (1) Used by Belgian intra-group finance companies Belgian intra-group bank is funded partly by equity and partly by the PPL and lends money to the operational companies Typically 1/5 ratio because of Belgian thin-cap rule 13

Hybrid financial instruments Example (1I) The intra-group bank: benefits from the NID on that part of the loans that is funded by equity, and is only taxable on a limited spread on the portion of the loans funded by the PPL 14

Hybrid financial instruments Example (III) OpCo OpCo loan interest BelCo Intra-group bank PPL interest LuxCo OpCo Limited spread taxable in Belgium Interest treated as dividend participation exemption 15

Proposed changes to Parent-Subsidiary Directive Proposed amendment Tax exemption of parent company (LuxCo) if the subsidiary (BelCo) was able to deduct the distributions/interest payments Will the PPL structure still work? Will Luxembourg be obliged to deny participation exemption under the new rules? 16

Exit Tax Introduction Taxation on capital gains is typically deferred until the time they are realized A cross-border relocation of corporate seat triggers a shift of tax residence Consequence: Home State loses taxing power over capital gains Exception: Home State retains power to tax capital gains on assets linked to a PE that remains on its territory 17

Exit Tax C-371/10 National Grid Indus (NGI) NGI BV Dutch tax res. Transfer of seat NGI BV UK tax res. 18

Exit Tax NGI case Conditions Immediate exit tax contrary to freedom of establishment (not proportionate) Proportionate exit tax Deferral of payment until actual realization Crystallization of tax base at the time of transfer Arguably, Home State may demand interest payment Home State may demand bank guarantee Home State may impose administrative formalities Deferral has to be optional 19

Facts: Exit Tax C-164/12 DMC Beteiligungsgesellschaft (I) Two Austrian corporate partners in a German limited partnership exchanged their partnership interests in return for shares in a German company Germany taxed capital gains, but provided option of deferral of taxation over 5 years subject to provision of guarantee 20

Exit Tax C-164/12 DMC Beteiligungsgesellschaft (II) Main points to note: Recovery spread over 5 years is proportionate because the risk of nonrecovery increases over time An assessment of the risk of non-recovery is necessary in order to require a guarantee 21

Exit Tax Belgian law Limited neutrality in case of transfer of seat No exit tax if Belgian-resident company relocates to EU Member State if and to the extent assets are used in a PE that remains in Belgium and contribute to the taxable profits of the Belgian PE PE condition also applies in case of crossborder mergers (in accordance with Tax Merger Directive) Consistent with EU law? 22

Withholding tax (I) CJEU, C-384/11, Tate & Lyle Background Withholding tax exemption threshold: 10% Dividends-received deduction threshold 10% or EUR 2.5 million 23

Withholding tax (II) CJEU If holding under 10%, but at least EUR 2.5 million: Belgian parent: + withholding tax creditable and very little taxation because 95% dividend received deduction Non-Belgian parent: withholding tax = final tax Indirect discrimination, contrary to freedom of movement of capital Double taxation treaty only sufficient if full tax credit Source state has obligation to remedy discrimination 24

Withholding tax (III) CJEU, C-384/11, Tate & Lyle Expected reaction by Belgian legislature: Withholding tax on dividends to non-belgian parent company with holding of at least EUR 2.5 million but less than 10% limited to 1.7% Cf. Belgian dividends-received deduction: 33.99% * 5% Retroactive effect of decision 25

Withholding tax (IV) CJEU, C-387/11, Commission v. Belgium Background: semi-transparency of investment companies Subject to Belgian corporate income tax, but income tax base limited to non-deductible business expenses & received abnormal or gratuitous benefits Withholding tax on Belgian income creditable and refundable Result: no taxation of Belgian income if investment company 26

Withholding tax (V) CJEU Discrimination of non-resident investment companies (without Belgian PE), for which Belgian withholding tax is not offset by limited tax base. Contrary to freedom of establishment & freedom of movement of capital Double taxation treaty only sufficient if full tax credit Source state has obligation to remedy discrimination 27

Withholding tax (VI) CJEU, C-387/11, Commission v. Belgium Reaction by Belgian legislature Dividend withholding tax no longer creditable for Belgian investment companies as from assessment year 2014 Significant derogation from semi-transparent treatment Limited to dividend withholding tax Limited to investment companies Retroactive effect of judgment 28

Withholding tax (VII) Restrictions on free movement of capital Effect on investment funds established outside the EEA Confirmed in CJEU, C-190/12 Emerging Markets Series of DFA Investment Trust Company (10 April 2014) 29

Fiscal autonomy & EU law (I) Fiscal autonomy Fiscal autonomy for the Regions in the area of personal income taxation Regions have the power to decide on certain tax incentives (e.g., tax break for financing own home) Non-resident taxation remains a federal competence EU law Requires the grant of equal tax incentives to non-residents in a situation comparable to that of a resident 30

Fiscal autonomy & EU law (II) Federal tax regime with regional nuances Need to assign non-residents to a region 75% threshold But tax residence by definition outside Belgium Criteria Origin of earned income If earned income derived from multiple regions: Level of earned income Actual working days 31

Fiscal autonomy & EU law (III) Compare to Flemish jobkorting Introduced in 2009: flat-rate tax reduction for residents of the Flemish Region who work in the Flemish Region. Critique by European Commission: Inconsistent with free movement of workers and freedom of establishment Discrimination against non-residents as the tax benefit was not available to persons living outside the Flemish Region, even if they earned all or virtually all of their income there Abolished in 2011 32