Volume 55, Number 4 July 27, 2009 ECJ Finds Finnish Withholding Tax Rules Unacceptable in Luxembourg SICAV Case by Tom O Shea Reprinted from Tax Notes Int l, July 27, 2009, p. 305
ECJ Finds Finnish Withholding Tax Rules Unacceptable In Luxembourg SICAV Case by Tom O Shea Tom O Shea, Ph.D., is a lecturer in tax law at the Centre for Commercial Law Studies, Queen Mary, University of London. E-mail: t.oshea@qmul.ac.uk In Aberdeen Property Fininvest Alpha Oy (Case C-303/ 07), the European Court of Justice determined that Finnish withholding taxes on dividends paid by a Finnish company to its Luxembourg SICAV (société d investissement à capital variable) parent company were incompatible with articles 43 EC and 48 EC, in circumstances in which similar dividends paid to a Finnish parent company were exempt from taxation. (For the full text of the judgment, see Doc 2009-13866 or 2009 WTD 116-14.) Background This matter came before Finland s Central Tax Commission (CTC) when Aberdeen Property Fininvest Alpha Oy ( Alpha ) sought a preliminary ruling on the taxation of dividends to be paid by that company to Aberdeen Property Nordic Fund I SICAV ( Nordic ), its parent company. Alpha queried whether it had to charge withholding tax on dividends paid to Nordic, given that dividends paid to Finnish resident parent companies were not subject to withholding tax. Alpha argued that this difference in tax treatment was contrary to the freedom of establishment and the free movement of capital provisions of the EC Treaty. The CTC decided that Alpha was required to charge withholding tax on dividends paid to Nordic. It based its decision on two grounds: First, a SICAV was not a company listed in the Annex of the EU parent-subsidiary directive (90/435/EEC), so that a dividend paid to it was not exempt from withholding tax; and second, a SICAV was different from a Finnish share company in that a SICAV was not liable to tax in its state of residence, whereas a Finnish share company was, and the Finnish company was a company within the meaning of the directive. Alpha appealed this decision to the Supreme Administrative Court, which referred the Community law issue to the ECJ for a preliminary ruling. Which Freedom Applied? The ECJ noted that in the order for reference Nordic was to hold 100 percent of the shares in Alpha. Accordingly, the Court decided that the freedom of establishment was the primary freedom applicable because the 100 percent shareholding was sufficient to give Nordic a definite influence over the decisions of Alpha and enabled it to determine its activities. Restriction on the Freedom of Establishment Under the Finnish rules, a Finnish share company or investment fund governed by Finnish law that received dividends from another Finnish company was exempt from tax, whereas dividends paid by a Finnish company to a nonresident company that was not regarded as a company under the EU parent-subsidiary directive (such as Nordic) were subject to withholding tax at the rate specified in the appropriate income tax treaty or, in the absence of same, at the rate of 28 percent. The Court recognized that this difference in tax treatment constituted a restriction on the freedom of establishment because the Finnish tax rules subjected dividends paid to a nonresident company to a series of charges to tax, whereas there was no such series of charges to tax for dividends paid to a Finnish share company or investment fund. The Court echoed its settled case law that: TAX NOTES INTERNATIONAL JULY 27, 2009 305
once a Member State, unilaterally or by way of convention, imposes a charge to income tax not only on resident shareholders but also on nonresident shareholders in respect of dividends which they receive from a resident company, the position of those non-resident shareholders becomes comparable to that of resident shareholders. 1 Therefore, Finland was obliged to extend the economic double taxation relief granted to resident parent companies to nonresident parent companies that were in a comparable situation. Objective Difference in Situation The Finnish and Italian governments argued that there was an objective difference in the situation between a Finnish resident company and a nonresident SICAV, pointing out that the SICAV had a different legal form that did not exist in Finland; that resident companies were subject to income tax in Finland, whereas a SICAV resident in Luxembourg was not; and the problem of a series of charges to tax did not arise in relation to a SICAV resident in Luxembourg because it was a transparent entity: In other words, the problem of the series of charges to tax impacted at the level of the shareholders in the SICAV only. The Court held that the nontaxation of the Finnish dividend income in Luxembourg did not justify the different tax treatment in Finland. These arguments were rejected by the ECJ, which recognized that the company law of the member states had not been harmonized and that it would deprive the freedom of establishment of its effectiveness if the legal form of a SICAV could justify a difference in tax treatment of dividends. Similarly, the Court held that the nontaxation of the Finnish dividend income in Luxembourg did not justify the different tax treatment in Finland. Lastly, the Court noted that it was Finland that imposed the series of charges to tax on the dividends distributed to the SICAV. Accordingly, the Court found that the differences between a SICAV and a Finnish company were 1 Aberdeen Property, para. 43. not sufficient to create an objective distinction with respect to exemption from withholding tax on dividends received. 2 Justification The Finnish and Italian governments argued that the Finnish rules could be justified on three general interest grounds: the need to prevent tax avoidance, the need to preserve the balance in the allocation of taxing rights between Finland and Luxembourg, and the need to ensure the coherence of the Luxembourg tax system. The Court rejected these arguments. Need to Prevent Tax Avoidance Finland argued that the exemption of the dividends paid to Nordic (which did not pay tax on those dividends) generated the risk that artificial arrangements would be put in place with the intention of avoiding all forms of tax on income. 3 The ECJ commented that a national measure restricting freedom of establishment may be justified where it specifically targets wholly artificial arrangements designed to circumvent the legislation of the Member State concerned. 4 However, the Court noted that the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping tax normally due on the profits generated by activities carried out on the national territory. 5 In this case, the Finnish tax rules were not targeted specifically at purely artificial arrangements and, accordingly, could not be justified on grounds of preventing tax avoidance. Need to Ensure Balance in Allocation of Taxing Rights The ECJ stated that such a justification may be accepted when the tax system in question was designed to prevent conduct capable of jeopardising the right of a Member State to exercise its tax jurisdiction in relation to activities carried out on its territory. 6 However, in this case Finland had chosen not to tax resident companies on such dividend income. Accordingly, Finland could not argue that its rules were necessary to maintain its taxing rights. The Court then pointed out that Finland had already taxed the business profits of the dividend-paying company, so exemption of those dividends from withholding tax did not deprive Finland of the right to tax the income relating to activities carried out on its territory. 2 Id., para. 55. 3 Id., para. 58. 4 Id., para. 63. 5 Id., para. 64. 6 Id., para. 66. 306 JULY 27, 2009 TAX NOTES INTERNATIONAL
Need to Ensure Coherence of Finnish Tax System The Court accepted that the need to preserve the coherence of the Finnish tax system may justify a restriction on the freedom of establishment. However, in this case, the Court found that there was no direct link between the exemption from withholding tax in relation to Finnish resident recipient companies and the taxation of those dividends as income of the shareholders. 7 In other words, the exemption of the dividends from withholding tax was not made subject to a condition requiring that the dividends received be distributed onward by the receiving company so that their taxation in the hands of the shareholders in the company allows the exemption from withholding tax to be offset. 8 Conclusion of the ECJ The ECJ concluded that the Finnish withholding tax rules at issue were incompatible with articles 43 EC and 48 EC. Analysis Aberdeen Property is a significant judgment of the ECJ for many reasons. First, the Court reminds the member states that even though the list of companies that qualify for benefits under the EU parent-subsidiary directive is limited to those companies specified in the Annex to that directive, other EU companies still possess Community law rights if they comply with the conditions set out in article 48 EC. The second reason is the Court s finding that there was no objective difference in situation between a Luxembourg (SICAV) company and a Finnish company to justify the different treatment of outbound dividends paid by Alpha to Nordic, which incurred withholding taxes, whereas dividends paid by a Finnish company to another Finnish resident company did not. The third reason is the Court s rejection of the Finnish argument that there was an objective difference in situation between a Finnish company and a Luxembourg SICAV because there was no company in Finland with a similar legal form to a Luxembourg SICAV. Article 48 EC Under article 48 EC, two conditions are required to be met: the company must be formed in accordance with the law of an EU member state; and the company must have its registered office, central administration, or principal place of business within the Community. 7 Id., para. 74. 8 Id., para. 73. In Überseering (Case C-208/00), the Court highlighted that: those companies or firms are entitled to carry on their business in another Member State. The location of their registered office, central administration or principal place of business constitutes the connecting factor with the legal system of a particular Member State in the same way as does nationality in the case of a natural person. 9 In Aberdeen Property, Nordic was a Luxembourg company in the form of a SICAV and, even though such a company did not appear on the list of Luxembourg companies in the Annex of the parent-subsidiary directive, it was still a Luxembourg company and entitled to exercise the fundamental freedoms, particularly the freedom of establishment. Objective Difference Finland placed significant emphasis on the fact that the SICAV was a transparent and tax-free entity in Luxembourg, its state of residence. Consequently, Finland argued that the situations of resident and nonresident companies receiving dividends from a Finnish resident company were not comparable. However, the Court rejected this argument because this type of reasoning failed to take into account the Court s earlier judgment in the Test Claimants in Class IV of the ACT Group Litigation ( ACT IV GLO ) (Case C-374/04), 10 also concerning outbound dividends. In ACT IV GLO, the Court noted that: once a Member State, unilaterally or by a convention, imposes a charge to income tax not only on resident shareholders but also on non-resident shareholders in respect of dividends which they receive from a resident company, the position of those non-resident shareholders becomes comparable to that of resident shareholders. 11 In other words, once a source state (Finland) taxed the dividend stream of the nonresident Luxembourg company, this made the nonresident company comparable to a Finnish resident company from the taxation perspective. Therefore, the nonresident company was entitled to no less favorable treatment in Finland than a Finnish resident company receiving similar dividend income from a Finnish (subsidiary) company. The ECJ stated, [It] is solely because of the exercise by that State of its taxing powers that, irrespective of any taxation in another Member State, a risk of a series of 9 Überseering, para. 57. 10 For a detailed discussion of the ACT IV GLO, see Tom O Shea, Dividend Taxation Post-Manninen: Shifting Sands or Solid Foundations? Tax Notes Int l, Mar. 5, 2007, p. 887, Doc 2007-3338, or 2007 WTD 44-4. 11 ACT IV GLO, para. 68. TAX NOTES INTERNATIONAL JULY 27, 2009 307
charges to tax may arise. 12 The Court repeated this reasoning in Aberdeen Property, commenting that the nontaxation of the dividend income in Luxembourg does not create a difference between a SICAV and a [Finnish] resident company which justifies different treatment as regards withholding tax on dividends received by those two classes of company. 13 Legal Form of the Company The Court stressed that the fact that there was no type of company under Finnish law with a legal form similar to a Luxembourg SICAV cannot in itself justify a difference in treatment, since, as the company law of the Member States has not been fully harmonised at Community level, that would deprive the freedom of establishment of all effectiveness. 14 Nordic was a validly formed Luxembourg company and accordingly was entitled to exercise the freedom of establishment in Finland granted by articles 43 EC and 48 EC. Final Thoughts The decision of the Court in Aberdeen Property highlights the importance of understanding the concept of objective difference in situation. Generally, residents and nonresidents are in objectively different situations, 12 Id., para. 70. 13 Aberdeen Property, para. 51. 14 Id., para. 50. but sometimes in an EU context a nonresident that has exercised a fundamental freedom guaranteed by the EC Treaty may be in a comparable situation to a resident. In such circumstances the nonresident is entitled to national treatment, meaning that the nonresident may have to be treated no less favorably than a resident from the taxation point of view. In this instance, Finland taxed the dividend income of the nonresident. This made the nonresident comparable to a resident company receiving similar dividends. Since Finland chose to relieve economic double taxation of its residents, Finland was obliged to extend that relief to the nonresident that was in a comparable situation. That Finland was allowed under its income tax treaty with Luxembourg to impose a 5 percent withholding tax was, according to the Court, of no relevance. 15 It was Finland that imposed the series of charges to tax (imposing a corporate income tax on the dividend-paying company s profits and a withholding tax on the subsequent dividend). This series of charges to tax amounted to a restriction on the freedom of establishment; as Finland relieved the series of charges to tax in relation to its own companies, it was required to extend similar relief to nonresidents in situations when Finland taxed the dividend income of the nonresident received from the Finnish company. By taxing the nonresident on its dividend income, Finland made the nonresident recipient comparable to a Finnish resident company receiving similar dividends. 15 Id., para. 68. 308 JULY 27, 2009 TAX NOTES INTERNATIONAL