2.4.3.3 Interest and Royalty Directive

The IRD1 legally avoids double taxation of interest and royalty payments in certain group relations by providing an exemption from withholding tax on such payments. The Directive seeks to ensure that transactions between companies of different Member States are not subject to less favourable tax rules than similar transactions between companies of the same Member State.2 The IRD seeks to ensure that interest and royalties are taxed once in a Member State.3 The IRD does not cover interest and royalty flows within one Member State, nor does it cover the EEA or interest and royalty flows between Member States and third countries.

In order for the IRD to apply, there must first be a company of a Member State4 or a permanent establishment in a Member State.5 The requirements imposed on a company in this respect are similar to those imposed on a company of a Member State for the purposes of the PSD. One difference is that the list of legal forms is much shorter than in the PSD.6 Next, a certain affiliation is required between the recipient and the payer of the flow of income. For the application of the IRD, there are three situations in which association exists.7 Firstly, a company is associated with a second company if the first company has a direct minimum holding of 25% in the capital of the second company (a parent-subsidiary situation). Secondly, an association exists if the second company has a direct minimum participation of 25% in the capital of the first company (a subsidiary-parent situation). The third way in which companies may be associated as referred to in the IRD is when a third company has a direct minimum holding of 25% in the capital of two companies (a sister situation). Member States have the option – as with the PSD – to replace the criterion of a minimum holding in the capital with a minimum percentage of voting rights. The IRD only applies to direct interests: an interest flow between a sub-subsidiary and its parent company does not fall within its scope. The EC presented a proposal to amend the IRD in 2011.8 One of the proposals was to align the shareholding threshold with that in the PSD. To this end, the 25% threshold of the interest of the direct holding would be reduced to a 10% threshold of the interest of the direct or indirect holding. The new threshold should prevent economic distortions that may result from differences in the scope of application of the two directives.9 The proposal to amend the Directive has not yet achieved unanimous acceptance.

A Member State has the possibility not to apply the Directive if the conditions laid down in the Directive have not been fulfilled for an uninterrupted period of at least two years.10 This seems to refer to a holding period, rather than a waiting period.11 The minimum holding period may prevent intra-group restructurings specifically for the purpose of obtaining the benefits of the Directive. As in the PSD, it also seems possible for a Member State to introduce a shorter holding period than two years, as the minimum holding period is an optional provision.

The more limited scope of the IRD (25%) compared to the PSD (10%) seems to be explained by the different treatment of dividends compared to interest and royalty flows. An important difference in tax treatment between dividends versus interest and royalty payments is that in most countries dividends are not deductible from taxable profits, whereas interest and royalty payments are generally deductible. As a result, dividends are more likely to be subject to economic double taxation. Like the PSD, the IRD does not provide for a real group definition. Finally, the IRD has a relatively narrow scope of application, as it only applies to direct interests, while interest and royalty payments do not necessarily only occur in such relationships.12