4.3.3.2 Cross-border interest and royalty payments in the EU

The IRD1 aims to put cross-border interest and royalty payments on a par with domestic payments. Transactions between companies of different Member States should not be treated less favourably than the same transactions carried out between companies of the same Member State.2 First, the IRD aims to prevent juridical double taxation of interest and royalty payments in specific situations.3 The EC states that interest and royalty payments should be subject to tax once in a Member State.4 In bilateral and multilateral agreements double taxation is not always eliminated.5 The main reason for this is the fact that under tax treaties the credit in the residence state is limited to the amount of corporate tax that state would levy itself on the interest and royalty income (ordinary credit).6 If due to application of an ordinary credit system only part of the withholding tax is credited, juridical double taxation remains.7 This is often the case, as the withholding tax at source is usually levied on a gross basis (without deducting costs incurred in earning the interest or royalty income), whereas the credit granted by the residence state is normally calculated on a net basis (after deducting costs incurred).8

In order to avoid double taxation, the Directive requires that interest or royalty payments arising in a Member State should be exempt from any taxes imposed on those payments in that state.9 Next to preventing double taxation, the IRD aims to eliminate burdensome administrative formalities as well as cash-flow problems.10 Apart from that, the IRD includes an anti-avoidance rule.11 Non-deductibility of interest for the paying company is not within the scope of the Directive.12

Two conditions must be satisfied in order for the IRD to apply to a payment that qualifies as interest or royalties under the IRD definition:

A Member State has the option not to apply the IRD if the conditions set out in the Directive have not been met for an uninterrupted period of at least two years.15 With this option states can ensure that the association is genuine and is not structured to benefit from the Directive.16

It is notable that the threshold requirement of the IRD is not in line with the requirement of the PSD. This is one of the topics that is discussed in a 2009 report on the functioning of the IRD.17 According to the EC, the different group definitions increase the planning and compliance costs of companies involved in cross-border operations. Moreover, they can lead to incongruous results, for example if an interest or royalty payment is reclassified as a profit distribution.18 In 2011, the EC put forward a proposal to amend the IRD.19 Inter alia, it was proposed to bring the shareholding requirement in the IRD in line with the requirement in the PSD. The 25% threshold of the stake in a direct holding would therefore be reduced to 10%. With the new threshold, the EC aims to avoid economic distortions due to the differences in the scope of both directives.20 For the time being, the proposal to amend the Directive has not been adopted.

The tax exemption in the source state as provided by the IRD is also available for cross-border intra-EU payments made or received by permanent establishments of associated companies of different Member States.21 This can lead to the elimination of juridical double taxation in triangular or quadrangular situations.22 If interest and royalties are paid by or to a permanent establishment in a third state of a company of a Member State and the business is wholly or partially carried on via the permanent establishment, the IRD does not apply.23