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In these six cases questions were raised concerning the conditions for entitlement to withholding tax exemptions on dividend and interest payments provided for in the PSD and RID where they are obtained by European holding or financing companies controlled by entities not eligible for the benefits of the directives.

In the context of the above directives, the CJEU has ruled on the following main questions: (i) reliance on the general principle that abusive practices are prohibited; (ii) the concept of abuse of rights and the indications of its existence; (iii) the concept of “beneficial owner” as an independent clause for refusing the application of the  directives; and (iv) the fact that the recipient is actually being subject to tax as a condition for entitlement to the exemption.

In those judgments, as we shall see below, the CJEU clarified (and went beyond) its traditional reference to “wholly artificial arrangements” as indicative of a structure set up for abusive ends and completed it with a description of specific elements of artificiality and abuse that come closer to the BEPS action plan, by referring for example to the essential aim of transactions and, indeed, to the concept of beneficial owner.

Although these new elements brings concept uniformity and blurs the boundaries between the various sources in the international tax field, they may also add confusion for countries like Spain which already have specific anti-abuse clauses in their legislation to combat improper use of the directives, and also have general clauses (strengthened by approval of the ATAD directive) that may be relied on against abusive structures. In the light of these judgments, it can be anticipated that the analysis of the relationship between the different types of anti-abuse clauses will be debated in the coming years.

In particular, the reference to the concept of beneficial owner in the case of dividend payments (only mentioned, but not fully explained, in the judgment in cases C-116/16 and C-117/16) is, in our view, particularly controversial. This is not simply due to the various shades of interpretation that have been given to the concept in this area (dividends) as opposed to royalty and interest payments, but also because, if misunderstood, it could lead to the exemption being questioned in relation to dividend distributions to European holding companies which by reason of their business justification do not fall within the anti-abuse legislation in the Spanish Nonresident Income Tax Law or in the General Taxation Law, but redistribute all or part of their income to their shareholders.

In any event, we must not forget that these judgments relate to the specific facts of the cases brought to the Court, which had particular features as regards the business grounds for the structure (or the lack of them) and seem to also consider the fact that the structure was put in place as the result of a change to the law. Therefore, an examination of each case on its own merits and according to the specific legislation applicable to it will continue to be needed, regardless of whether the ultimate shareholder  fulfills or not the requirements to be entitled to the benefits of the directives.

Summary of the key points to take home from the two CJEU judgments:

The general principle that abusive practices are prohibited

The court emphasized the general principle of EU Law that abusive practices are prohibited and held that the member states need not have adopted provisions of this type in their domestic law or in their double tax treaties (DTTs) to be able to refuse any practice that implies being able to benefit improperly from the advantages provided by either directive (PSD or RID).

In the case of dividend distributions, the fact of it not being necessary to apply a provision of domestic law or a DTT to refuse entitlement to rights provided for by the PSD means that, in principle, the CJEU is not giving a preliminary ruling on the scope or interpretation of the concept of “beneficial owner” (set out in the RID but not in the PSD). As we shall see below, however, this concept does appear to play a role in defining the contours of a possible abuse.

Additionally, although the CJEU had previously argued in other cases that too broad an interpretation of the anti-abuse clauses in the directives could run counter to the right to freedom of establishment (by establishing different treatment than for the dividends distributed to local parent companies in similar circumstances), the CJEU is now arguing that that it is not lawful to rely on European freedoms where the existence of an abusive structure has been observed. 

Abuse of rights and indications of its existence

Applying its earlier case law, the CJEU recalled that an abuse of rights lies in two elements: (i) the objective circumstances showing that the aim sought by the directives is not achieved even though the formal requirements are fulfilled; and (ii) the intention to obtain a tax advantage by artificially creating the conditions for it.

Consistently with this argument, the CJEU listed a few of the factors that could be treated as the constituent elements of abuse of rights (“indications of an artificial arrangement”) such as the transfer of dividends or interest received in very short periods of time to non-European companies, the intermediary companies being devoid of any economic justification or any real economic activity (besides re-transferring the income received), the purely formal nature of the group's structure, the valuation of the intermediary companies’ equity or the existence of contracts giving rise to flows of funds among the various companies involved. According to the CJEU, the existence of an economic activity is, in turn, determined in particular by reference to the intermediary company's management structure, to the items on its balance sheet, to its cost structure, to the expenditure actually incurred, to the staff it employs and to the premises and equipment that it has.

Specifically in relation to applying the RID, the CJEU explained that it may be confirmed that a structure is artificial where the company receiving the interest, which it then passes to a third company not fulfilling the requirements in the directive, only makes an insignificant taxable profit and therefore its main function is to enable the flow of funds from the debtor company to the beneficial owner of those funds.

In both judgments the CJEU had first recalled that an attempt by a taxpayer to claim the most favorable tax regime cannot in itself set up a general presumption of abuse. And if -in relation to dividends- we apply earlier judgments such as  Deister Holding (C-504/16 and C-613/16) or  Eqiom and ENKA (C 6/16), nor can this presumption be set up by the simple fact that certain companies established in the EU are holding companies or are controlled directly or indirectly by persons resident in third states. This argument no longer holds up, however, where the structure is artificial in the terms discussed above and its essential aim is to obtain a tax advantage.

On the subject of the burden of proof, the court specified that the taxpayers must evidence that they fulfill the objective requirements in the directives, whereas the national tax authorities have the burden of proving the existence of abuse of the rights provided for by these directives (although the CJEU relieves them of the task of identifying the ultimate beneficial owner, which it considers may be difficult and, in any event, is immaterial for the analysis).

It must be remembered that Spanish legislation already sets out the option to refuse entitlement to the rights provided for in both directives where the recipient of the dividends and royalties is controlled by non-EU residents and there are no underlying business reasons for setting it up or for its operations (in the case of interest, the exemption for European recipients came before the RID and no reference is made to it in the Spanish law).

Concept of beneficial owner

In these judgments, the CJEU narrows down the concept of “beneficial owner” of the interest as envisaged in the RID –which it assumed needed a uniform definition in domestic law and DTTs- and defined it as “the entity which benefits economically from the interest received and accordingly has the power freely to determine the use to which it is put”. It mentioned in particular the OECD Model Tax Convention and its commentaries for interpreting this concept. The Court therefore ruled that the exemption of interest payments from any taxes must be “restricted solely to (...) the entities which actually benefit from that interest economically”, and left out of that category any type of instrumental or intermediary company (agents, trustees or authorized signatories).

In relation to dividends, despite not entering into a detailed analysis of the concept of beneficial owner in the context of the PSD (which does not refer to it), the CJEU appears to adopt similar interpretations to those of the RID, including the option of refusing entitlement to the right provided for in the directive if the beneficial owner of a dividend payment resides in a third country, which must be the case even if no abuse of the law has been observed.

To justify independent use of the concept of beneficial owner to refuse the advantages provided for by the PSD, the CJEU gave an argument which is questionable in our view. It argued that entitlement to the exemption in these cases (where the “beneficial owner” resides in a third country) could result in the dividends “not actually being taxed in the European Union”. In our view, however, the directive's goal is not to ensure a minimum amount of taxation in the case of dividends distributed by European subsidiaries, but instead to remove the different treatment than for domestic dividends and not add any further tax to that already paid by the subsidiary on the underlying profit. It is another matter whether a person with no entitlement is attempting to benefit from a directive, but that analysis must be made from the standpoint of an abuse of rights which, as the CJEU itself recalled, is a different and separate concept from that of beneficial owner (a concept, we must stress again, not appearing in the PSD, which defines the “parent company” status objectively).   

The CJEU concluded moreover that in both cases (dividends and interest) it is immaterial whether the real or ultimate beneficial owners reside in a country with a DTT, because this does not exclude abuse (unless the payments would also have been exempt had they been made directly) and in fact these companies could have chosen a direct investment and financing channel which would have made the DTT applicable.

Requirement of actually being subject to tax

In relation to the RID, the court argued that the requirement to be subject to the tax is not fulfilled if the company actually receiving the interest (in the examined case, a Luxembourg SICAR private equity/venture capital vehicle) is exempt from tax on that interest. For a similar analysis in relation to dividends see the CJEU’s judgment in the Wereldhave Belgium case (C-448/15).