Withholding taxes, abuse and EU Directives

Member States should apply the abuse of rights principle to artificial group structures designed to take advantage of the withholding tax exemptions in the Interest and Royalties and Parent Subsidiary Directives.
  • Submitted 4 March 2019
  • Applicable Law Denmark , European Union
  • Topic Tax > Corporate

The ECJ has handed down its judgment in the important cases concerning the application of the Interest and Royalties Directive (IRD) and the Parent Subsidiary Directive (PSD) to interest and dividend flows through group structures. In various joined cases involving Danish subsidiaries paying interest (Case C-115/16 N Luxembourg 1, Case C-118/16 X Denmark, Case C-119/16 C Danmark 1 and Case C-299/16 Z Denmark) or dividends (Case C-116/16 T Danmark and Case C-117/16 Y Danmark) through intermediate holding companies located in the EU (Luxembourg, Sweden or Cyprus), the ECJ has held that the local tax authorities can rely on the abuse of rights principle to deny relief from withholding taxes in appropriate cases and given guidance as to the circumstances in which abusive arrangements might exist. In addition, the ECJ has held that, for the purposes of the IRD, the requirement that the recipient is the “beneficial owner” provides a further basis for denying relief, unless the recipient benefits economically from the interest, which question needs to be determined as a question of EU law.

The judgment appears to give the tax authorities in Member States potentially wide powers to ignore “conduit” arrangements pursuant to the principle of abuse of rights and the meaning of beneficial owner and international groups will need to carefully consider their existing arrangements to determine if they may be affected by these judgments. However, it is ultimately a matter for the domestic courts to determine, on the basis of the ECJ’s guidance, whether in fact the recipients of interest are the “beneficial owners” or whether the principle of abuse applies to the particular facts under consideration.


The first set of cases all involve interest payments from Danish subsidiaries either to Luxembourg or Swedish parent companies. These parent companies were in turn owned by companies resident in third countries or by private equity funds. The Danish subsidiaries paid interest to their EU parent companies free of withholding taxes on the basis that the IRD applied. In each case, the interest was in turn substantially paid on by the recipient to its parent entity. The Danish tax authorities claimed that the IRD did not apply either because the parent companies were not the “beneficial owners” of the interest (as required by Article 1 of the Directive) or on the basis of the application of the principle of abuse of rights.

The second set of cases involved distributions of dividends from Danish subsidiaries either to Luxembourg or Cypriot parent companies. These parent companies were in turn owned by companies resident in third countries or by private equity funds. The dividends were paid without withholding taxes on the basis that the PSD applied. The dividends received by the intermediate holding companies were in turn returned to their shareholders either by way of dividends or loan repayments. Again the Danish tax authorities took the view that the arrangements were abusive such that the provisions of the PSD should not be applied.

The interest cases

The ECJ first considered the meaning of “beneficial owner” in this context, which it considered must have a Community law meaning rather than one based on the domestic law of each Member State. The term should be interpreted as designating “an entity which actually benefits from the interest paid to it” rather than a “formally identified recipient”. It is the entity that “benefits economically from the interest received and accordingly has the power to freely determine the use to which it is put” that is the beneficial owner. Furthermore, the ECJ considered that the OECD Model Tax convention and its commentaries were relevant to the interpretation of “beneficial owner” in this context and that it excludes “conduit companies” and must be interpreted in a way that “enables double taxation to be avoided and tax evasion and avoidance to be prevented”.

The taxpayers nevertheless argued that the lack of any specific domestic anti-abuse principles in Danish law prevented the Danish tax authorities combatting any perceived avoidance. The ECJ rejected this argument, holding that the principle of abuse of rights applied equally to the application of these directives as it applied in other EU contexts. Moreover, a Member State “must refuse to grant the benefit of the provisions of EU law where they are relied on not with a view to achieving the objectives of those provisions but with the aim of benefitting from an advantage in EU law although the conditions for benefiting from that advantage are fulfilled only formally”. In this context, the IRD has the aim of eliminating double taxation of interest and royalty payments between associated companies of different Member States. A group of companies may, therefore, be regarded as an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principal objective or one of its principal objectives is to obtain a tax advantage running counter to the aim of the applicable tax law.

In order to guide the national court in its assessment of the facts of the cases, the court went on to specify the factors that may indicate an abuse of rights:

  • All or almost all of the interest is, very soon after its receipt, passed on to companies which do not fulfil the conditions of the IRD (for example, they are not established in the EU or are not one of the type of entities covered by the IRD). This would be the case where the relevant group is structured in a way that the recipient company must pass the interest onto a third company (not qualifying under the IRD) with the consequence that it only makes an insignificant profit when acting as a conduit.
  • Indicators that the recipient is a conduit would include the fact the sole activity of the recipient is to receive interest and its transmission to the beneficial owners. Absence of actual economic activity may be inferred from its management, its balance sheet, its staff, premises and equipment.
  • Indicators of artificial arrangements may include the way in which the transactions are financed, the valuation of the intermediary company’s equity and the conduit’s inability to have economic use of the interest. Moreover, such arrangements do not need to be contractual in nature but can be inferred where “in substance” the conduit does not have the right to use and enjoy the interest.
  • Such indicators may be reinforced by the simultaneity or closeness in time of the changes to tax legislation which would impose a tax charge and the changes to a group structure to circumvent that charge.

The Court also indicated that it would not prevent that application of these principles if the actual beneficial owner was in a third country with which the Member State of the paying company had a tax treaty providing for double tax relief. However, where the payments of interest would have been exempt if made directly to the actual beneficial owner, that may indicate that the group structure is unconnected with abuse, of course.

Finally, the Court emphasised that “where the beneficial owner of interest paid is resident for tax purposes in a third state, refusal of the exemption in [the IRD] is not in any way subject to fraud or an abuse of rights being found”. In those cases, it would simply be a matter of the provisions of Article 1 of the IRD not being met.

Regarding burden of proof, the Court noted that it is not the task of the tax authorities to identify the actual beneficial owners of the interest. It would be enough for the tax authorities to show that the supposed beneficial owner is a conduit company through which the abuse of rights has been committed. Given the complexities of some of the group structures, it may well be impossible for the local tax authorities to obtain information of the true beneficial owners outside the EU.

The dividend cases

The arguments in the dividend cases were substantially similar, except that the question of the “beneficial owner” of the dividends was not relevant (as that term does not appear in the PSD). The focus was entirely on the question whether the arrangements were abusive and whether, in the absence of domestic anti-abuse provisions, the Danish tax authorities could rely on the principle of abuse. On these questions, the Court reached the same conclusions as it did in relation to the interest cases.

Fundamental freedoms

Finally, the Court considered the question whether the fundamental freedoms would be relevant to the determination of the appeals. Did the right to free movement of capital, for example, prevent the Danish tax authorities from refusing to apply the exemptions in the IRD and PSD?

In cases involving an abuse of rights, the Court was clear that there could be no breach of the fundamental freedoms. Where there is abuse, then the relevant company in a Member State may not claim the benefit of those freedoms.

However, in relation to the interest cases, where disapplication of the withholding tax may be based simply on the EU recipient not being the “beneficial owner” without there being any abuse of rights, then it would be necessary, as a separate exercise, to consider the validity of the Danish withholding tax under the discrimination case law. In that situation, the Court indicated that the Danish rules may have been discriminatory by:

  • Requiring immediate payment of withholding tax on interest payments to a non-resident whilst not requiring a Danish company receiving interest from another Danish company to make an advance payment of corporation tax for two years. The cash flow disadvantage was a restriction on the free movement of capital.
  • The imposition of default interest on non-payment of the withholding tax at a rate higher than non-payment of corporation tax on interest received by a resident company from another resident company would equally constitute a restriction.
  • Failure to take account of the expenditure in the form of interest directly related to the lending which the non-resident recipient has incurred would constitute a restriction where such expenditure may be deducted by a resident company receiving interest from another resident company.


These decisions of the ECJ may have a significant impact on the application of the exemptions from withholding tax in the IRD and the PSD, which have been relied on by existing international group structures to ensure the flow of funds from EU subsidiaries to parent companies outside the EU with minimum taxation. When combined with developments in relation to the application of tax treaties arising out of the OECD’s BEPS project, the seemingly wide interpretation given to the term “beneficial owner” and the general application of the abuse of rights principle may embolden tax authorities to take a more active approach to perceived use of conduits where interest or dividend flows are ultimately directed outside the EU.

However, where fund flows depend on domestic exemptions (rather than those under the EU Directives) to prevent tax leakage, then it is unlikely that this decision will have a significant impact.

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