By Anno Rainer, Pascal Van Hove and Brecht Sohier
On 8 May 2008, Advocate General (AG) Sharpston issued her opinion in the Cobelfret v. Belgium case (Case C-138/07), involving the compatibility of the Belgian dividends received deduction regime (DRD) with the EC Parent-Subsidiary Directive. According to AG Sharpston, the DRD is not compatible with article 4(1) of the Directive since the double taxation of dividends may result in instances where a Belgian parent company has no taxable profits. AG Sharpston further recommends that the European Court of Justice (ECJ) reject the Belgian government’s request to limit the temporal effects of the decision should the ECJ rule in favor of the taxpayer.
EC Parent-Subsidiary Directive
The Parent-Subsidiary Directive establishes a common system of taxation applicable for parent companies and subsidiaries of different EU Member States to prevent double taxation of dividends. Under article 4(1), when a subsidiary in one Member State distributes a dividend to its parent company in another Member State, the country of the parent company must either: (1) refrain from taxing the dividend; or alternatively (2) it must grant a tax credit for the corporate income tax paid by the subsidiary on the underlying profits. Member States are permitted to disallow a fixed amount of the management costs related to the share participation, up to a maximum of 5% of the dividends.
Moreover, profits distributed by a subsidiary to its parent company are conditionally exempt from withholding tax.
Belgian DRD Regime
In its implementation of the Parent-Subsidiary Directive, Belgium elected to refrain from taxing previously taxed profits/dividends distributed by the subsidiary (i.e. the first option). Belgium currently grants a 95% deduction for dividends on participations representing at least 10% of the subsidiary's nominal share capital or, alternatively, participations with an acquisition value of at least EUR 1.2 million, if these participations are held for at least one year and qualify as financial fixed assets. However, because of Belgium’s tax rules relating to the determination of a Belgian company’s taxable basis, Belgian parent companies may not be effectively entitled to the DRD on dividends received.
For Belgian corporate income tax purposes, dividends received from subsidiaries are first included in the taxable basis of the parent company. Such dividend income is amalgamated with the net income (or loss) from other activities/operations and disallowed expenses, and then qualifying foreign permanent establishment (PE) income is exempted. It is only at this stage that a Belgian parent company can apply the DRD, i.e. deduct 95% of the qualifying dividends received from its taxable income. The deduction, however, may be used only to the extent there is taxable income remaining after the exemption of foreign PE income, i.e. it cannot lead to a negative result. Hence, the DRD can only reduce the taxable basis to zero – if there is no taxable income or insufficient taxable income after the exemption of foreign PE income in a given year, any “excess” DRD is definitively lost (i.e. there is no carryforward or carryback).
Facts of the Case
In 1994, 1995 and 1997, Cobelfret, a Belgian company, incurred tax losses and was unable to use the DRD. In 1996, there were insufficient profits and, therefore, Cobelfret was unable to claim the full 95% deduction on the dividends received from Belgian and U.K. subsidiaries. The company successfully challenged the Belgian DRD before the Court of First Instance of Antwerp as an incorrect implementation of the Parent-Subsidiary Directive on the grounds that the DRD did not result in Belgium refraining from taxation. Upon appeal by the Belgian tax authorities, the Court of Appeal of Antwerp referred the case to the ECJ; the European Commission supported the position of the company.
Opinion of AG Sharpston
AG Sharpston agreed with the taxpayer and the European Commission on all accounts. According to AG Sharpston, a taxpayer can directly rely on article 4(1) of the Directive and Belgium failed to implement the Directive correctly because it does not effectively refrain from taxing dividend income in all situations.
In fact, the Belgian rules subject the 95% deduction to an additional condition that is not provided for in the Directive. According to AG Sharpston, the effect of the Belgian DRD regime is that, while dividends received from a subsidiary are always included in the parent company’s basis of assessment, they cannot always be deducted since a deduction is disallowed if the parent has no taxable profits for the relevant period. This ultimately gives rise to a higher tax because it will reduce the amount of the loss that may be carried forward. Moreover, according to AG Sharpston, the fact that application of the credit method (i.e. the alternative method allowed under the Directive) can lead to the same result as the DRD regime is irrelevant since Belgium elected not to use the credit method to prevent the double taxation of dividends.
AG Sharpston also opines that, even if domestic and cross-border situations are treated equally, Belgium’s current DRD mechanism cannot in itself render the transposition of the Directive correct.
Finally, AG Sharpston advises the ECJ not to limit the temporal effects of a taxpayer favorable decision because Belgium failed to demonstrate that there is a risk of serious economic repercussions.
Preliminary Comments
Notably, the conditions to qualify for the DRD (i.e. satisfying a minimum holding period and participation and financial fixed asset qualification) are not applicable to benefit from the Belgian capital gains exemption.
Although the ECJ still needs to rule on the case, AG’s Sharpston’s opinion is excellent news for Belgian taxpayers with excess DRD, since the ECJ generally follows the opinion of the AG.
It should be noted that two other Belgian cases are pending before the ECJ challenging the same set of rules (KBC Bank NV (C-438/07) and S.A. Beleggen, Risicokapitaal, Beheer (C-499/07)). The first case raises additional questions, including: (1) whether the freedom of establishment principle of the EC Treaty requires that qualifying dividends be completely exempt from Belgian taxation in the same way as profits of foreign PEs; and (2) whether the free movement of capital principle prohibits dividends received from subsidiaries resident in third countries from being treated less favorably than domestic Belgian or EU dividends.
It likely will be up to the national Belgian courts to decide whether the ECJ’s interpretation of the Parent-Subsidiary Directive is relevant to purely national Belgian situations, given the fact that the Belgian legislator decided to treat both cross-border and domestic situations in the same way.
AG Sharpston’s opinion that EU Member States must not apply additional conditions not provided for in the Directive jeopardizes Belgium’s requirement regarding the relevant participation qualifying as a financial fixed asset. (Belgium introduced this condition effective, in principle, from tax year 2004 (i.e. financial years ending on 31 December 2003 or later)).
For Belgian corporate taxpayers that have already filed (protective) claims or initiated (protective) legal proceedings, AG Sharpston’s opinion substantially increases the likelihood of a positive outcome. Potentially affected taxpayers that have not yet taken appropriate action are advised to consider doing so.
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