The Court of Justice of the European Union rules against Danish tax legislation
On 21 June 2018, the Court of Justice of the European Union (CJEU) concluded in a case that the Danish rules exempting Danish investment funds from withholding tax constitute a restriction on the principle of free movement of capital.
On 13 October 2016, the Danish Eastern High Court referred a case to the CJEU enquiring whether the principle of free movement of capital precluded a tax regime like the Danish. In Denmark, a non-resident investment fund pays a 15 per cent withholding tax on dividend payments from Danish companies, whereas an equivalent Danish investment fund can obtain an exemption from withholding tax, either because it makes a minimum distribution to its members, which is subject to withholding tax, or technically calculates a minimum distribution, which is also subject to withholding tax.
Advocate General issues opinion on Danish withholding tax treatment of dividends distributed to foreign investment funds
CJEU's decision of 21 June 2018
Restriction on the free movement
The CJEU concluded that the Danish rules constituted a restriction on the free movement of capital due to the difference in the tax treatment of non-resident investment funds. Hence, the Danish rules can only be upheld if they are justified by an overriding reason in the public interest and proportionate.
Re the justification
The Danish Ministry of Taxation stated that the differences in the tax treatment could be justified by:
- the need of a balanced allocation of the taxation powers between the member states; and
- the need to safeguard the coherence of the tax system.
1. Re securing the balanced taxation right between the member states
First, the CJEU stated that the preservation of the allocation of the power to impose taxes between Member States may justify a restriction on the exercise of freedom of movement, in particular where the system is designed to prevent the Member State's right to exercise its powers of taxation in relation to activities carried out in its territory. However, the CJEU held that, where a Member State has chosen not to tax resident investment funds in receipt of nationally-sourced dividends, it cannot rely on the argument that there is a need to ensure a balanced allocation between the member states in order to justify the taxation of non-resident investment funds.
2. Re the need to safeguard the coherence of the tax system
Secondly, the CJEU concluded nevertheless that the need to safeguard the coherence of a tax system may serve as a justification of a restriction such as the one in these proceedings. For such an argument to succeed, a direct link must be established between the tax advantage concerned and the corresponding tax levied.
CJEU concluded that a direct link is established between the tax advantage and the corresponding tax levied. CJEU concluded that a direct link is established between the tax advantage and the corresponding tax levied, as the advantage that a Danish investment fund can obtain in the form of an exemption from withholding tax on Danish dividend is offset by the withholding tax levied on distributions from the fund to its investors
Less restrictive - proportionality
However, the justification needs to be proportionate, i.e. the question then becomes whether the tax legislation goes beyond what is necessary in order to safeguard the coherence of the tax system.
The CJEU stated that the internal coherence of the tax system could have been maintained if the non-resident investment funds, which meet the conditions of the Danish tax legislation, were eligible for exemption from withholding tax, provided that the Danish tax authorities ensured that the latter paid a tax that was equivalent to the tax that Danish investment funds are required to retain on the minimum distribution.
Allowing non-resident investment funds to enjoy exemption from Danish withholding tax, under those conditions, would have been less restrictive than the current system.
As such, since a less restrictive measure is available, the justification cannot be said to be proportionate.
The CJEU concluded that the free movement of capital must be interpreted as precluding the Danish tax legislation, under which dividends distributed by a Danish residential company in Denmark to a non-resident investment fund are subject to withholding tax, while dividends distributed to an investment fund resident in Denmark are exempt from such tax, provided that the undertaking makes a minimum distribution to its members, or technically calculates a minimum distribution, and withholds on that actual or notional distribution the tax payable by its members.
Kromann Reumert comments
In the finishing note of the Advocate General's opinion, the Advocate General observed that as Fidelity Fund did not attempt to meet the Danish tax requirements – even as a precautionary measure – and therefore, in all likelihood Fidelity Fund may not succeed in its action.
As the CJEU in their ruling does not address the issue whether or not Fidelity Fund should have tried to meet the requirement set out for Danish investment funds, it will be interesting to see how the Danish Eastern High Court decides to construe the CJEU ruling in this regard.