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EU Law Based Withholding Tax Claims

Recovery of the "unrecoverable"

Action recommended for EU and Non-EU based investment funds

As you may be aware, over recent years there has been a significant amount of activity in the EU regarding the compatibility of EU Member State dividend withholding tax legislation with European law, particularly where the Member State in question chooses to tax a non-resident investor at a higher rate than a comparable resident investor. This has led to a vast number of claims being filed against EU Member States by portfolio investors, both within and outside the EU (commonly referred to as Fokus Bank/Aberdeen claims after the line of tax cases at the ECJ which established certain principles regarding withholding taxes).

To date there have been some successful reclaims in some of the smaller markets within the EU (e.g. repayments have been made to certain European investment funds on claims filed in Norway, Finland, Poland, etc.). However, generally claims filed are still under consideration and are being resisted by the tax authorities in each jurisdiction. In this regard there is a significant case pending with the European Court of Justice (ECJ) that is likely to have significant implications for both claims made to date and for any funds that have yet to make claims. It is advisable for investment funds (generally UCITS or UCITS equivalents outside the EU — e.g. Unit Trusts or RICs, but with other possibilities as well e.g. LLCs and partnerships in some instances) to review their position with regard to such claims as soon as possible. The same approach is advisable for all portfolio investors e.g. pension funds, insurers, banks, etc.

Background to claims

Generally, investment funds that invest in global equities are subject to withholding taxes on the dividend income they receive. Certain withholding taxes may be recoverable after application of domestic exemptions in certain territories or after application of DTC's that are in existence. However, it is generally the case that where withholding tax is imposed on foreign dividends received, an element of that withholding is not recoverable by the fund and is therefore a final cost (in some circumstances, e.g. Canadian Unit Trusts or U.S. RIC's the withholding may be flowed through to investors in a fund who may or may not claim credit against domestic tax liabilities, but the position at the fund level will be a withholding tax cost). In Europe the rate of nonrecoverable withholding in many markets is around 15 percent.

The opportunity now is for funds to recover that previously nonrecoverable withholding tax based on EU law arguments. The free movement of capital provision of the Treaty on the Functioning of the European Union (TFEU) states that there should be no restriction on the movement of capital between Member States and between Member States and Third Countries. This article has been referred to in a number of tax cases over the last 10 years and this line of cases from the ECJ has established the principle that there may be discrimination where a Member State chooses to exempt a domestic investor from a withholding tax (e.g. a domestic UCITs fund or pension fund) whereas they apply a nonrecoverable withholding tax on a comparable non-resident investor (e.g. foreign UCITs or other investment or pension fund).

These arguments have been used to date in claims made by both EU and non EU portfolio investors across at least 18 EU territories where withholding taxes have been imposed. Some territories have paid out to some investor types, but many claims made to date are still pending and are being resisted by the tax authorities in each jurisdiction. However a number of cases are progressing through both domestic courts in various EU territories and through the European courts.

Pending case

Although there have been prior decisions from the ECJ relating to certain portfolio investors (e.g. pension funds), which are very helpful, the position of UCITs and similar vehicles has not been considered specifically until now. In this regard we expect a very significant judgment to be released by ECJ before mid-May (joined cases C-338 to C-347). The cases relate specifically to the French withholding tax regime as applied to dividend payments to non-resident investment funds of various types, including those outside of the EU (specifically the U.S. but with relevance for other jurisdictions). While the case relates to the French regime, it has far wider implications for claims against many EU Member States and we highly recommend that certain actions are carried out by all investment fund clients wherever they are based in advance of the release of the case decision is released.

The case has been fast tracked by both the French courts and the ECJ, with the referral only taking place in late 2011. Before the referral, the French Supreme Court (Conseil d'Etat) ruled that the French rules were indeed contrary to EU law and, furthermore; there was no valid justification for the discrimination taking place. However the Court had some uncertainty as to at what level the discrimination should be assessed. The French Court also concluded that the situation of investment fund claimants from outside the EU (i.e. U.S. or Canada) should be treated in the same way as those from within the EU. It appears that the case questions subsequently referred to the ECJ in the cases relate more to claim quantum and at what level the discrimination is assessed, rather than whether there is any discrimination at all. The claims outstanding to date against France amount to some €4.2bn and as such the decision is likely to be one of the more significant tax cases in monetary terms, to be made by the ECJ.

Temporal limitation risk

One note of caution, and the reason funds should consider their position now, is that during pleadings the French tax authorities asked the ECJ, should they decide in favor of the taxpayers, to apply a temporal limitation on claims. In other words, if the case is successful and leads to repayments to the claimants, the tax authorities asked the Court to restrict the application of the decision only to those funds that have filed claims before the decision of the ECJ is delivered. Temporal limitations have been considered before by the ECJ in similar cases, but have to date not been applied. However given the existing value of claims made to date and with the potential value of claims that could still be made by other claimants, combined with the uncertain economic situation in Europe, there is a risk that the ECJ will choose to apply the principle in this instance. This would be unwelcome news for any funds awaiting developments in the law before taking any actions themselves.

Recommended actions
  • If there are any investment funds with French Dividend income for the period January 1, 2010, to December 31, 2011 (whether within the EU or outside e.g. UCITS, partnerships, U.S. RICs, Unit Trusts, etc.) that have not filed claims or considered filing claims in France, they should consider their position and if necessary protect their claim position by early to mid- May of 2012.
  • Fund complexes should assess the viability of EU claims across all EU markets and protect claims where sound arguments and value exists as soon as possible. While the case referred to above, relates to the French regime and is therefore not binding on the other EU Member States, the general principles of EU law arising from the decision will be relevant for claims in those other territories as well (e.g. funds that have received dividends from France, Belgium, Denmark, Finland, Germany, Italy, Poland, Spain, Sweden, etc.).
  • If your fund engages in securities lending activities, consider the implications of EU law based withholding arguments for value derived through manufactured dividend payments.

For additional information or questions, please contact Kit Dickson +44 (0) 7789 273879 and or for RIC specific questions, please contact Eric Byrnes +1 973 602 6710.

Ted Dougherty
National Managing Partner, Asset Management Tax
Deloitte Tax LLP
+1 212 436 2165

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