4.3.2.2 Cross-border dividend taxation in the EU

The relevance of the elimination of tax obstacles on cross-border dividends and other profit distributions within the EU has been recognized long ago. As early as in 1969, the first proposal for a directive in this regard was drafted. In 1990, the PSD1 was adopted. The PSD aims to facilitate the grouping together of companies of different Member States.2 In this respect the preamble states that the grouping together of companies should not be hindered by restrictions, disadvantages or distortions arising in particular from the tax provisions of the Member States.3 Before the entry into force of the PSD, the tax provisions with respect to the relation between parent and subsidiary companies in different Member States differed a lot from one Member State to another. Additionally, they were mostly less favourable than the rules that applied to parent and subsidiary companies within one Member State. Cooperation between companies of different Member States was put at a disadvantage compared with cooperation between companies of the same Member State due to the different rules. Therefore, the EC argued that this disadvantage should be eliminated by introducing a common system facilitating the grouping together of companies.4

To eliminate the tax problems that may arise due to the distribution of profits in an intra-group context, the PSD contains a provision which exempts dividends and other profit distributions5 paid by subsidiary companies to their parent companies in another Member State from withholding taxes. Moreover, the PSD eliminates economic double taxation of such income at the level of the parent company via either an exemption from corporate income tax or a tax credit. By giving a choice between an exemption or a tax credit at the level of the parent company, both CIN and CEN can be respected.6

To avoid situations of double non-taxation that can result from mismatches in the tax treatment of profit distributions between Member States, the PSD includes a specific linking rule.7 This rule provides that the Member State of the parent company and the Member State of its permanent establishment should not allow those companies to exempt received distributed profits, to the extent such profits are deductible by the subsidiary of the parent company.8 This logically solely applies to countries that opt for CIN, as under CEN there would be no need for such a linking rule. If the profits distributed by the subsidiary are deductible in the Member State of the subsidiary, there is also no underlying corporate income tax to credit.9

Under the PSD, the number of legal entities in principle (depending on the amount of the tax credit) does not impact the total tax due on profit distributions within a group of companies in different Member States. The PSD thus avoids juridical and economic double taxation.10 In essence, the PSD therefore prevents excessive taxation in a group.11 This can also provide tax avoidance opportunities, as an EU entity that is established in a country that does not levy withholding taxes could be interposed to circumvent withholding taxes on dividend payments to entities in third countries. In that regard, the PSD includes a general minimum anti-abuse provision to ensure that its application does not lead to double non-taxation.12

Two conditions must be satisfied for the PSD to apply to a distribution of profits from one company to another:

Under the PSD, Member States are free not to apply the Directive to companies that do not meet the requirements – of being a parent company or a subsidiary – set out in the Directive for an uninterrupted period of at least two years.17 This anti-abuse provision aims to prevent temporarily concentrating non-qualifying holdings in one hand to benefit from the Directive.18

The PSD does not address the issue of realized or unrealized capital gains and losses.19 As dividends and capital gains are economically to a large extent ‘two sides of the same coin’ this is odd. In this regard the Directive can be said to be ‘incomplete’.20 Additionally, liquidation distributions are not within the scope of the PSD at the parent level.21 However, they seem to fall within the scope of the exemption from withholding taxes at the level of the subsidiary.22

In the relationship between a head office and a permanent establishment, juridical double taxation can result if the country of the head office and the country of the permanent establishment both tax profits of the permanent establishment. The profit transfer from a permanent establishment to its parent company as such is a non-tax event.23 Therefore, the issues the PSD aims to solve, do not play a role in a head office-permanent establishment situation as such. However, if the head office and the permanent establishment are part of a group of companies, the PSD becomes relevant if profits are distributed. Permanent establishments of qualifying companies were initially not within the scope of the PSD.24 This led to the question whether an abolition of withholding tax and/or corporate tax would be required in the following situation: parent company A (situated in Member State A) holds the shares in subsidiary company A2 (situated in Member State A), while the shareholding is effectively connected with a permanent establishment in Member State B (see figure 4.1). In that situation Member State A might claim it is a domestic transaction which is not in scope of the Directive. Additionally, it was not clear whether Member State B should refrain from taxing the dividends received, as it is not the state of the parent company.25

The same question arose in a situation in which parent company A (situated in Member State A) holds the shares in subsidiary company C (situated in Member State C), while the shareholding is effectively connected with a permanent establishment in Member State B. In that case Member State B would not be the state of the parent company (see figure 4.2).

For both aforementioned situations the PSD currently provides for the obligation to refrain from levying a withholding tax, as well as the obligation to refrain from corporate taxation or provide a tax credit at the permanent establishment level.26 For completeness sake, if a permanent establishment to which the shareholding in the subsidiary can be allocated and the subsidiary are situated in Member State B (i.e., both situated in the same Member State), the PSD does not fully apply to a profit distribution to the parent company in Member State A (see figure 4.3).27 In that situation there is partially no cross-border element, which is required to prevent Member State B from taxing the dividend at the level of the permanent establishment as well as to prevent the withholding tax at the subsidiary level. The internal taxation may still be prohibited under the freedom of establishment.28 Additionally, Member State A would be required to refrain from taxing the dividend or would be required to provide a credit.