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ECJ: Advocate General finds 5% add-back of tax credits for withholding tax abroad compatible with Parent-Subsidiary Directive – details

On 24 January 2008, Advocate General Eleanor Sharpston of the European Court of Justice (ECJ) gave her opinion in the case of Banque Féderative du Crédit Mutuel v. Ministre de l'Économie, des Finances et de l'Industrie (C-27/07). Details of the opinion are summarized below.

(a) Facts.

Community legislation

Under Art. 4(2) of the Parent-Subsidiary Directive 90/435/EEC (Directive), Member States opting for the exemption method may provide that "any charges relating to the holding and any losses resulting from the distribution of the profits of the subsidiary may not be deducted from the taxable profits of the parent company. Where the management costs relating to the holding in such a case are fixed as a flat rate, the fixed amount may not exceed 5% of the profits distributed by the subsidiary".

Art. 7(2) of the Directive provides that the application of domestic or agreement-based provisions designed to eliminate or lessen economic double taxation of dividends, in particular provisions relating to the payment of tax credits to the recipients of dividends, shall not be affected by the Directive.

Art. 1(2) of the Directive permits the application of domestic or agreement-based provisions required for the prevention of fraud or abuse.

French legislation

France has opted for the exemption method under Art. 4(1) of the Directive. Under a French administrative circular, the base for 5% add-back, i.e. the percentage of the total revenue from the holdings added back to the parent company's taxable income after the exemption of the net profits from such holdings, provided for under Art. 216 of the French Tax Code (Code Général des Impôts, CGI), consists of the gross amount of distributed dividends including domestic and foreign tax credits.

By virtue of an extra-statutory concession, if a withholding tax is levied on the dividends paid by a resident parent company to its non-resident shareholders, out of dividends received from its non-resident subsidiaries in the previous 5 years, the resident parent company may set off the credit for the withholding tax levied abroad on the inbound dividends against the French withholding tax on outbound dividends.

(b) Issue.

The issue was whether or not, in case where the extra-statutory concession did not apply (e.g. the 5-year limitation was not met), the taxation resulting from the add-back of 5% of the gross amount of distributed dividends (including tax credits for withholding tax) was precluded by Art. 7(2) of the Directive, or was contrary to the objectives of Art. 4 of the Directive.

(c) Advocate General's Opinion.

Compatibility with Art. 4(2)

At the outset, AG Sharpston considered whether the national legislation at issue was in principle contrary to Art. 4(2) of the Directive, i.e. whether the term "profits distributed by the subsidiary", contained in that provision, referred to (i) the net amount of dividends actually received by the parent company (after deduction of the withholding tax) or (ii) the gross amount of dividends, i.e. the amount actually received increased by the amount of the tax credit made available by France (as prescribed by the French administrative circular).

AG Sharpston rejected the Commission's argument that it followed from the ECJ's judgment in Océ van der Grintenthat the tax credit cannot be regarded as distributed profits, since that case dealt with the tax credit for the relief of economic double taxation, as opposed to the relief of juridical double taxation which is at issue in this case.

Further, the AG rejected the plaintiff's argument that, since a tax credit provided for by a double tax convention in order to compensate for the reduction in the amount of the dividend due to withholding tax takes the form of a credit by the State, it could not be in the nature of a dividend or, therefore, of a distributed profit within the meaning of the Directive. The AG found that the plaintiff's argument that the withholding tax, although legally payable by the distributing company, is in fact borne by the recipients of the dividend, actually supports the opposite conclusion. The AG also observed that the lack of fiscal neutrality was due to the withholding tax in the Member State of the subsidiary, and that total fiscal neutrality may not be achievable for so long as transitional provisions can be invoked by some Member States.

Finally, the AG concluded that where a Member State had opted under Art. 4(2) of the Directive to provide that any charges relating to a parent company's holding in a subsidiary of another Member State and any losses resulting from the distribution of the profits of the subsidiary may not be deducted from the taxable profits of the parent company, it was not contrary to that provision for the management costs relating to the holding to be fixed as 5% of the total revenue from the holdings, including tax credits compensating for withholding tax levied on the dividend in accordance with Art. 5(2), (3) or (4) of the Directive

Compatibility with Art. 7(2)

The AG observed that Art. 7(2) has no relevance for the case, since the national legislation at issue is not designed to eliminate or lessen economic double taxation.

Compatibility with Art. 1(2)

In response to the French Government's argument that the 5-year limitation was designed to combat the risk of fraud and to facilitate fiscal supervision, the AG, referring to the ECJ's judgment in Leur-Bleum, observed that a general presumption of tax evasion or tax fraud cannot justify a fiscal measure, which compromises the objectives of a directive.

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