Decision of the European Court of justice on the prevention of abuse of international tax treaties

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Pepeliaev Group advises that a decision[1] in favour of a taxpayer was handed down by the European Court of Justice[2]. This may be of significance for the development in Russia of the concept of a beneficial owner.

Facts in the case

In 2013 a Dutch holding company received dividends from its German subsidiary. In addition to performing the functions of an international holding company, the Dutch company also sold raw materials and provided intra-group financing. For these purposes the Dutch company rented an office and hired employees. At the same time the Dutch company paid dividends to its sole shareholder, a German company.

In accordance with the double taxation treaty between the Federal Republic of Germany and the Netherlands, the tax at source withheld in Germany when dividends were paid to the holding company was to be refunded from the state budget. However, German tax authorities refused to refund the tax to the Dutch holding company by applying national GAAR as a justification instead of applying the EU Parent-Subsidiary Directive.

The EU Parent-Subsidiary Directive contains no restrictions on the nature of the activity and no requirements as to the amount of income received in order for reduced tax rates to be applied to dividends. However German national GAAR significantly toughens similar provisions of the Directive.

The German tax authorities were guided specifically by the German domestic legislation when refusing to refund the tax. In their opinion, the Dutch holding company performed only functions connected with asset management, and, accordingly, it did not perform independent economic activity and could not receive income from such activity. Moreover, representatives of the German tax authority considered that the inclusion of the Dutch holding company in the ownership structure was not justified by economic reasons.

In its decision on this case, the ECJ specified that it is unlawful to apply the provisions of the national GAAR with the aim of combating abuses in the area of applying international tax treaties, which toughens the requirements of the EU Parent-Subsidiary Directive and breaches, in particular, the fundamental principle of freedom of establishment.

In the Court’s opinion, the nature of the requirements and restrictions provided for in the German national rules is based on the presumption of a tax abuse, and for this reason allows the tax authorities not to analyse each specific case of the application of tax benefits.

At the same time the ECJ underlined that the performance of only managerial functions by the Dutch company cannot in itself serve as an element of an tax abuse and it is necessary to conduct comprehensive and complete analysis of all organisational and economic aspects of the activity of the group of companies in general.

Please note that it is not the first time that the ECJ has recognised German national GAAR as not complying with European legislation. Therefore, at the end of 2017 one more decision was handed down in favour of the taxpayer on a similar issue[3].

What to think about and what to do

It is likely that in the near future German tax legislation will be amended to repeal the contentious provisions which the ECJ recognised as contradicting EU law. In this regard the decision being analysed will be of interest for international groups that have an economic presence in Germany.

It is easy to notice that the contentious provisions of German legislation with regard to anti-tax abuse have much in common with similar provisions of the Russian Tax Code, Russian case law and the position of the Russian tax authorities. The approach of the German tax authorities is also similar to Russian realities in issues of assessing whether the application of tax benefits under international tax treaties is lawful.

In particular, in its Letter No. SА-4-9/8285 dated 28 April 2018, the Federal Tax Service laid down its legal position that “the use of controlled holding companies and the fact that assets may be lawfully transferred to a management company registered in a jurisdiction granting tax benefits does not mean that economic grounds will automatically arise for applying the benefits stipulated by international double tax treaties. Companies that service the interests of only their own group and entities affiliated with it do not qualify to use the advantages of double tax treaties in situations where the receipt of income is not justified from an economic perspective”.

The ECJ adopted its decision, mainly, based on the specifics of the regulation of the common market inside the EU: the principle of the freedom of establishment, in fact, does not allow a legal entity from another EU country to be ‘disqualified’ only based on the possibility and the presumption of tax abuse without a thorough investigation of the specific circumstances. The ECJ’s decisions cannot be applied in Russia, as distinct from the decisions of the European Court of Human Rights.

At the same time, some conclusions of the ECJ are also important for the Russian practice: a tax claim against those participating in international operations should not be based on formal signs and wide presumptions, such as the presumption that there is no business purpose for which a foreign party is included in the structure when such foreign party performs only holding functions. The formal approach would mean an excessive diminution in freedom of economic activity.

The ECJ’s position offers further confirmation that the approach of Russian tax authority to issues of assessing the lawfulness of the application of preferential provisions within the framework of international tax treaties should not be exclusively formal. For the purpose of an unbiased and comprehensive analysis of the activity of the company applying for tax benefits, the tax authorities must assess the economic activity of the group in general. The Russian Federal Tax Service oriented tax authorities to this position in Letter No. SА-4-7/9270@ dated 17 May 2017.

Help from your adviser

Pepeliaev Group offers a wide range of services involving comprehensive support for business on international taxation issues associated with the application of provisions of double taxation treaties.

In particular, our experts possess extensive experience of proving the beneficial ownership of income both at the pre-trial stage and in court, and provide advisory services on contentious matters of application of double taxation treaties and the assessment of whether beneficial ownership of income is present.

[1] Resolution of the European Court of Justice dated 14 June 2018 in case No. С-440/17, GS.

[2] The Court of the European Union (the “ECJ”) is located in Luxembourg, and it should not be confused with the European Court of Human Rights, which is located in Strasbourg.

[3] Single Decision of the ECJ dated 20 December 2017 (C-504/16), Deister Holding, and C-613/16 (Juhler Holding).

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