Background and information
For some years now European financial services (FS) institutions, mainly led by the funds industry, have been taking action against certain EU Member States on the grounds that in some cases the imposition of withholding taxes on dividends was illegal under the EU Treaty. This was on the basis that EU Member States under the Treaty are not permitted to treat foreign investors, and in particular EU and European Free Trade Association (EFTA) shareholders, more harshly than equivalent domestic investors.
These cases were being pursued under the "Free Movement of Capital" provisions. Unusually, these provisions in the EU Treaty also granted rights against discrimination to investors in countries outside the EU and EFTA. A recent case that concerns France and both EU and non-EU investors has been decided in favour of the investors and against France. This has potential implications for any foreign investor in EU equity investments and therefore will be of wide interest.
Investment funds win case against discriminatory French WHT
The case concerned the French tax rules applicable to dividends distributed by French companies to foreign investment funds. Under current French tax rules, dividends paid to investment funds that are not resident in France are taxed at source at the rate of 30% (25% before January 1, 2012), but are exempt from tax when paid to French-resident investment funds.
Ten investment funds resident in Belgium, Germany, Spain and the United States that invested in shares in French companies (among other things) and received dividends from those shares subject to French dividend withholding tax, contested the French tax rules through the French domestic court system on the grounds that they breached the free movement of capital guaranteed by EU law.
The Tribunal administratif de Montreuil (the Tribunal), before which these actions were brought, asked the European Court of Justice (the Court), in essence, whether:
- French legislation that taxes French dividends distributed to investment funds differently according to the place of residence of the recipient investment fund violates EU law; and
- for the purpose of determining if there may be a difference in treatment amounting to discrimination, only the situations of the investment funds must be compared or if the situations of the shareholders in the investment funds must also be taken into account.
The Court's deliberations
The Court decided that a difference in the tax treatment of dividends according to the investment funds' place of residence may discourage, on the one hand, non-resident investment funds from investing in companies established in France and, on the other, investors resident in France from acquiring shares in non-resident investment funds.
Accordingly, the Court concluded that the French legislation constitutes a restriction on the free movement of capital, which, in principle, is prohibited under EU law.
The Court examined whether this restriction (i.e., discrimination) could be potentially justified, on the grounds that:
- the French and non-French investment funds are not in objectively comparable situations; or
- there is an overriding reason in the public interest.
Are French and non-French investment funds in comparable situations?
For the purpose of determining whether the situations of the foreign and French investment funds investing into the same French companies are comparable, the Tribunal asked the Court whether the situation of their shareholders must be taken into account along with that of the investment funds. In reply, the Court ruled that the French rules establish a relevant distinguishing criterion based on the investment funds' place of residence, in that it subjects the non-resident investment funds to withholding tax only on dividends they receive.
In the light of this, the Court considered that for the purpose of determining whether the rules are discriminatory, the situations must be compared only by reference to the investment funds, without taking account of the situation of their shareholders. Accordingly, the different treatment of resident investment funds and non-resident investment funds cannot be justified by a relevant difference in their situations.
Can the French rules be justified by the overriding reasons in the public interest?
The Court also considered whether the different treatment could be justified by overriding reasons in the public interest, because this is acceptable under the terms of the Treaty on the Functioning of the European Union (TFEU). The Court examined a number of arguments put forward by the French government, summarily and conclusively dismissing each of them. Specifically, the Court said:
- France has chosen not to tax its resident investment funds on receipt of French dividends and therefore cannot rely on the argument that there is a need to ensure a balanced allocation between the Member States of the EU of the power to tax.
- Similarly, the French rules cannot be justified by the need to guarantee the effectiveness of fiscal supervision, because the withholding tax affects solely and specifically non-French residents.
- Lastly, the French rules cannot be justified by the need to preserve the coherence of the French tax system because there is no link between the exemption from withholding tax on French dividends received by a French investment fund and the taxation of those same dividends as income received by the shareholders in that same French fund.
Additional deliberations on the position of non-EU investment funds
The Court also considered whether the different treatment of non-EU investment funds could also be justified by overriding reasons in the public interest. The Court noted that the French government simply argued that the discrimination should be justified by the need to guarantee the effectiveness of fiscal supervision, but then failed to put forward any further evidence to substantiate its point in relation to the position of non-EU investment funds.
Article 64 of the TFEU contains a provision that permits EU Member States to discriminate against non-EU countries in cases of "direct investment" when the relevant law existed on December 31, 1993. The Court noted that the Tribunal did not ask the Court to consider whether French withholding tax rules could be justified under this provision and therefore it did not further comment. However, it is worth noting that the reason the Tribunal did not ask the Court to consider this justification is that on May 23, 2011, the French Supreme Administrative Court had already ruled that only in exceptional situations can the investment made by open-ended investment funds be qualified as "direct investments," thereby possibly justifying the discriminatory effect of the French tax rules.
Consequently, the Court concluded that it could not find a reasonable justification for the discrimination against foreign investment funds. Therefore, it decided that the French rules that tax French dividends at source when received by foreign investment funds, but exempt the same dividends from tax when received by French investment funds, violate EU law and are without justification.
In its ruling, the Court does not distinguish between foreign EU investment funds and foreign non-EU investment funds.
Given the decision of the Court and the 2011 opinion issued by France's Supreme Administrative Court, we expect the Tribunal to confirm the decision of the Court by the end of 2012 in relation to the ten test cases and the further 2,500 cases standing behind them. We understand that the French tax administration has received approximately 10,000 fund reclaims since PwC filed the first claims with them in 2004 and estimate that France may end up refunding up to €20 billion of previously withheld taxes to foreign investment funds.
We expect that the French tax administration will issue some guidance commenting on this case, specifying the conditions when French source dividends declared to non-French investment funds may benefit from a withholding tax exemption and therefore refund. We believe that ultimately the French government is likely to eliminate the discrimination by amending the withholding tax rules to make them apply to French-resident investment funds.
What do these developments mean for investment funds?
The Court ruling on the position of both EU and non-EU investment funds investing into European companies will be welcome news for investment funds that have been subjected to discriminatory withholding taxes on dividends from EU Member States.
The Court also rejected France's request to limit its decision to claims filed with the French tax authorities before May 10, 2012. Investment funds should contact PwC for help filing claims for refunds in respect of French withholding taxes paid after 2008.
A number of other key EU countries, including Austria, Belgium, Denmark, Finland, Germany, Italy, Spain and Sweden, similarly subject investment funds to discriminatory dividend withholding taxes. This new ruling clearly opens up the opportunity for funds to safeguard their rights and to file refund claims within the applicable local statutory time limitations ranging from three months to five years.
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