Denmark Tax Alert - 18 January 2012
Tax authorities lose another beneficial ownership case
By Jens Wittendorff, Birgitte Tabbert and Kim Wind Andersen
The Danish National Tax Tribunal published its decision on 13 January 2012 in the fourth of a series of cases dealing with the beneficial ownership of dividends and interest paid by a Danish company to a nonresident holding company (SKM2012.26.LSR). The tribunal ruled in favor of the taxpayer, with the result that the dividends could be paid from Denmark free from Danish withholding tax.
This is the first case in which the National Tax Tribunal has found that an EU parent company was the beneficial owner of dividends covered by the EU Parent-Subsidiary Directive (PSD).
Under Danish tax law, dividends and interest paid to a nonresident company are subject to withholding tax unless certain conditions are satisfied. The withholding tax is currently 27% (28% before 1 January 2012) on dividends paid to a parent company, and 25% on interest. The rate may be reduced or eliminated if a taxpayer is entitled to invoke the benefits of a tax treaty or the PSD or the Interest and Royalties Directive. To benefit from treaty protection, the taxpayer normally must be the beneficial owner of the relevant income.
The acquisition of many Danish companies by corporate investors and private equity funds in recent years has prompted the Danish tax authorities to examine the structuring and fund flows of such acquisitions. These tax audits have given rise to a number of cases where the tax authorities have asserted that nonresident holding companies located within the EU or in treaty countries are not the beneficial owners of dividends and interest paid by Danish companies. The tax authorities have taken the position that the payments were subject to withholding tax and charged the Danish companies for failing to meet their withholding tax obligations.
Facts of the case
The most recent beneficial ownership case involved a U.S. listed company that owned a Danish company (Denmark ApS) through its subsidiary in Bermuda (Bermuda Ltd.). A dividend distribution from Denmark ApS to Bermuda Ltd. would trigger Danish withholding tax of 28%. To avoid the withholding tax, Bermuda Ltd. established a subsidiary in Cyprus (Cyprus Ltd.) that acquired all the shares in Denmark ApS for EUR 90 million. Shortly thereafter, Denmark ApS distributed dividends in the amount of approximately EUR 76 million to its new parent company, Cyprus Ltd. Cyprus Ltd. used the funds to repay the EUR 76 million to its parent company, Bermuda Ltd., which Bermuda Ltd. had loaned to Cyprus Ltd. to enable it to acquire the shares in Denmark ApS. One year later, Denmark ApS distributed another dividend of approximately EUR 12 million to Cyprus Ltd., which again was passed on to Bermuda Ltd.
The main function of Cyprus Ltd. in the years at issue was to own shares in Denmark ApS. Cyprus Ltd. did not have an office or any personnel in Cyprus.
The legal structure after the reorganization was as follows:
Arguments of the parties
The Danish tax authorities took the position Cyprus Ltd. was not the beneficial owner of the dividends under article 10 of the Denmark-Cyprus tax treaty and, therefore, the dividends should be subject to the 28% withholding tax. According to the authorities, the Cyprus holding company was a mere conduit company and the sole purpose of the arrangement was to circumvent Danish withholding tax on dividends. The tax authorities also argued that neither EU law nor article 5 of the PSD prevented Denmark from levying withholding tax on the dividends.
The taxpayer claimed that article 1(2) of the PSD, which authorizes Member States to apply anti-avoidance measures, requires that such measures be set forth in domestic tax law. Denmark does not have any specific anti-avoidance rules on beneficial ownership, so Denmark would have to rely on domestic substance-over-form or assignment of income doctrines. The taxpayer argued that the requirements for invoking these doctrines were not met in the case.
The taxpayer also argued that Cyprus Ltd. was the beneficial owner of the dividends because it could not be considered a conduit company. Alternatively, if Cyprus Ltd. could not be considered the beneficial owner, US Inc. would have to be considered the beneficial owner of the dividends because Bermuda Ltd. had redistributed the dividends to its ultimate parent company, US Inc. in 2005. As a result, the Denmark-U.S. treaty should apply, which would also result in no Danish withholding tax.
Decision of the tribunal
The National Tax Tribunal concluded that Cyprus Ltd. could not be considered the beneficial owner of the dividends under article 10 of the Denmark-Cyprus treaty because the dividend distributions made by Denmark ApS to Cyprus Ltd. were subsequently passed on to Bermuda Ltd.
The tribunal held that, regardless of the possible onward distribution of the dividends to the U.S. company, the Denmark-Cyprus treaty is the applicable treaty for purposes of determining the withholding tax consequences. Neither the Denmark-Cyprus treaty (or commentary thereto) nor the commentary to the OECD model treaty seems to allow the application of another tax treaty.
The tribunal stated that article 5 of the PSD exempts dividends distributed by an EU subsidiary to its EU parent company from withholding tax. No anti-abuse concept can be inferred from the general rule in the PSD. Article 1(2) gives Member States the discretion to deviate from the directive in cases of abuse, etc.; the PSD does not preclude the application of domestic law or treaty provisions necessary to prevent fraud and abuse. Although Denmark has not adopted any legislation to this effect, it relies on its general principles, including case law, to disregard abusive arrangements.
However, in the present case, the Cypriot company was a legally established and properly functioning company, and by virtue of its ownership of the shares in the Danish company, was the proper recipient of the dividends distributed by the Danish company. The fact that the main activity of Cyprus Ltd. was to hold shares in the Danish company did not necessarily imply that it was not a commercial operation and, thus, the case differed from other cases in which the Danish Supreme Court has ruled that an arrangement was abusive and, therefore, should be disregarded. As a result, under article 5 of the PSD, the distributions by the Danish company are exempt from withholding tax.
Although the facts of this case are somewhat different from the facts of the other cases involving dividend distributions, the decision seems to indicate the tribunal’s position on the application of tax treaties and the PSD to withholding tax on dividends. The Ministry of Taxation is considering whether to appeal the case to the High Court.