On 21 June 2018, the Court of Justice of the European Union (CJEU) rendered its decision in the Fidelity Funds case (C-480/16), concerning the compatibility with EU law of the Danish withholding tax on dividends distributed to non-resident investment funds. The Court concluded that the Danish legislation is contrary to the free movement of capital.
The case concerns Fidelity Funds and NN (L) SICAV (the Funds), two investment funds whose registered offices are in the UK and Luxembourg, respectively.
Danish investment funds that have invested in Denmark are not subject to Danish withholding tax (WHT), provided that they fulfil the requirements of Article 16C of the Danish Tax Assessment Act (which requires, inter alia, that the funds redistribute their income to their shareholders – either by actual distribution or by determining a notional minimum distribution taxed at the level of the investors).
On the other hand, under Danish tax law, foreign UCITS funds are liable to WHT levied on dividends from Danish companies, even if they fulfil the requirements of Article 16C.
The Funds thus argued that this different treatment was contrary to the free movement of capital, and requested a refund of the Danish withholding tax levied.
The Danish Eastern High Court referred the question to the CJEU for a preliminary ruling.
On 20 December 2017, Advocate General Mengozzi issued his conclusions on the case (please refer to our Fund Taxation Alert 2018-01 for further information).
Subsequently, the decision from the CJEU was rendered on 21 June 2018.
The CJEU decision
The difference in tax treatment of dividends, according, in particular, to the UCITS’ place of residence, may discourage non-resident UCITS from investing in Danish companies and investors resident in Denmark from acquiring shares in foreign UCITS. Accordingly, the CJEU concluded that the Danish tax legislation constitutes a restriction to the free movement of capital.
The Court then noted that, as Denmark chose to levy tax on the income received by non-resident UCITS, the latter are in a situation comparable to that of UCITS resident in Denmark.
The Court then went on to assess whether the restriction can be justified by the need to ensure a balanced allocation of taxing rights and the need to safeguard the coherence of the Danish tax system.
The Court first rejected the balanced allocation of power to tax between Member States as a justification.
As for the need to safeguard the coherence of the tax system, since the Danish rules make the tax exemption conditional on an (actual or notional) minimum distribution to investors, which is subject to Danish withholding tax, the advantage granted to resident UCITS in the form of a withholding tax exemption is offset by the subsequent taxation of the dividends distributed onwards, in the hands of their investors.
Nevertheless, such a restriction is not proportionate, as a less restrictive measure would be to allow non-resident UCITS to benefit from the withholding tax exemption, provided they pay a tax equivalent to that which Danish funds benefiting from the Article 16C fund status are liable to levy on the minimum distribution required.
Consequently, the Court concluded that the Danish legislation is contrary to the free movement of capital.
KPMG Luxembourg comments
The case provides some interesting insight into whether the comparability analysis should be carried out at the level of the investment fund or whether the situation of the investors should also be considered, especially in cases where a withholding tax exemption on dividend distributions is subject to a minimum distribution requirement.
In the case at hand, the Court took the view that a minimum distribution requirement and the corresponding obligation for the investment fund to act as a withholding agent on behalf of its investors is not decisive to distinguish between resident and non-resident UCITS.
However, at this time, it is uncertain how the CJEU’s decision will be applied to non-resident funds.
Indeed, the Eastern High Court could construe the case as follows:
Depending on the ruling from the Eastern High Court, the Danish tax authorities may require evidence that the fund’s investors have effectively been subject to tax on the (actual or notional) distribution.
For Luxembourg funds, it would nevertheless be almost impossible to demonstrate for each individual investment that it has been taxed, since funds do not always know the identity of investors. For example, funds which are widely held are normally distributed via nominee accounts and therefore it isn’t clear who the investors are. Also, the nominees/distributors are bound by the EU General Data Privacy Regulations and are, therefore, not permitted to disclose the information. We, therefore, believe that such requirement would go too far and not be compatible with EU law.
In addition, investment funds in Luxembourg are often umbrella funds with several sub-funds/share classes, which can be a mix of capitalizing and distributing sub-funds/share classes.
In this case, if option 2 is applied by the Danish Court, it would be necessary to compute a ratio of capitalization and distribution parts within the umbrella fund taking into account the investment policy of the different sub-funds/share classes.
Given the above, we would recommend filing reclaims for distributing funds and mixed funds for which it is possible to make a split between the distributing and capitalizing parts.
For purely capitalizing funds (having no distributing sub-funds/share classes), we would recommend waiting until a decision from the Danish Eastern High Court is rendered (expected at the beginning of 2019) to see whether the said Court also grants capitalizing funds the opportunity to reclaim the taxes based on the CJEU decision.
Finally, it is expected that Denmark will amend its domestic law to allow foreign funds, which are subject to conditions in line with the conditions currently applicable to domestic funds under Article 16C, to benefit from WHT exemption in the future.
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