The concept of “beneficial owner” as seen by the ECJ

Exemption from taxation of interest

In four different cases three Danish companies and one Luxemburgish company created within their holding company structures such arrangements that upon payments of interest from loans provided within these structures the companies applied the exemption from withholding tax on paid interest, even though in reality these companies were never really beneficial owners of the interest (according to Danish tax authorities) and this income essentially only ran through them to investors.

The ECJ stated that the term “beneficial owner” refers to the entity which benefits economically from the interest received, and also that a company of a Member State is considered to be the beneficial owner of interest or royalty payments only if it accepts them for the company and not for some other entity as a mediator (e.g. deputy, trustee, proxy holder), and if it can make decisions about their utilization freely. For the purposes of exemption as per Directive 2003/49 only an entity located in the European Union can be the beneficial owner. For the interpretation of this directive, the concept of “beneficial owner” as it is stated in conventions for the avoidance of double taxation is relevant.

The ECJ also looked into whether it is necessary for intranational law to include statutory rules combating abuse of tax regimes (Denmark had no such laws until 2015). European Union law includes a legal principle according to which legal entities cannot appeal to the EU law rule fraudulently or for abusive ends. According to the ECJ, this principle must be interpreted in the following way: national authorities and courts are under the obligation to refuse to grant entitlement to exemption from interest tax provided for in Directive 2003/49, even in cases where national law or the relevant convention do not include such provision.

The court also sought to define the constituent elements of abuse of rights. It states that a group of companies may be regarded as being an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principal objective (or one of its principal objectives) is to obtain a tax advantage running counter to the aim or purpose of the applicable tax law. The ECJ characterizes a number of indications of an artificial arrangement, these may be for example: the existence of a conduit company which is without economic justification, purely formal nature of the structure of the group of companies, financial arrangements etc.

The ECJ also stated that national authorities may refuse to recognize a company as the beneficial owner, or prove the existence of abuse of rights, without having to identify the entity or entities which they consider to be the beneficial owner of the interest.

In the case of a partnership limited by shares (SCA) which was accorded the status of an investment company in risk capital (SICAR) as per the law of Luxembourg, the Danish court must examine whether the interest paid to this company was exempt from corporate income tax in Luxembourg. If yes, then this interest cannot be exempt from withholding tax upon payment.

Exemption from taxation of dividends

The ECJ dealt with two cases regarding this. The first case regarded five private equity funds, none of which is a company resident in the European Union or in a country with which Denmark has signed a double taxation convention. These funds established a group consisting of a number of companies with the aim of purchasing a large Danish service producer while the parent company of the Danish service producer was resident in Luxembourg. The group of companies in question was the same one as in case C-115/16 regarding taxation of interest, see above. What makes this case interesting is the fact that Danish tax authorities were not in agreement regarding its solution. Luxembourgish tax authorities issued a certificate of residence for tax purposes for the parent company, and at the same time confirmed that the parent company was subject to corporate tax and was the beneficial owner of dividends. The Danish company paying the dividends asked for a binding assessment and inquired whether the dividends paid to the parent company in Luxembourg are exempt from tax. Danish Tax Commission provided a binding answer saying that these dividends cannot be exempt. The Danish subsidiary appealed and the National Tax Appeals Commission was of a different opinion, it claimed that the dividends can be exempt. Danish Ministry of Taxation disagreed with this decision and the case was relegated to the ECJ. The second case regarded a group established in the USA owning subsidiaries around the world including Bermuda. Both these cases had a common denominator. These groups of companies did not meet the conditions for exemption from taxation of dividends provided for in Directive 90/435 and created one or more artificial companies between the one that paid the dividends and the entity which had them at its disposal. These artificial companies met the formal requisites for exemption as per this Directive. Thus, this entire affair was essentially about abuse of rights and the definition of the concept of “beneficial owner”.

In this case, the ECJ did not comment on the concept of “beneficial owner”. So we can only assume whether the concept of beneficial ownership as provided for in Directive 90/435 (dividends) should be interpreted in a similar way as in the case of Directive 2003/49 (royalties and interest) in the light of the judgement discussed above.

As regards the issue of abuse, the ECJ reached essentially the same decisions as it did in the case of taxation of interest (see above). The court also stated that the aim of Directive 90/435 is to make easier the grouping of companies at the Union level by laying down tax rules which are neutral from the point of view of competition, so that the companies can increase their productivity and improve their competitiveness. This aim is not in accordance with the practice of creating financial constructions with the aim of benefiting from the advantages following from this Directive.

Now the question is how the above discussed judgements will manifest in rulings on similar disputes by Czech courts. But we can say that we are at least another step closer to clarifying the problematic concept of “beneficial owner” for tax purposes. Should you be further interested in this issue, do not hesitate to contact us.