By way of ruling n. 25490 issued on October 10, 2019 (Supreme Court Ruling 25490 of 10-10-2019), Italy’s Supreme Court upheld the appellate court’s ruling which denied both the dividend withholding tax exemption of the EU Parent Subsidiary Directive n. 435/90/CEE of the Council dated July 23, 1990 (the “Directive”), and the dividend withholding tax rate reduction granted under article 10 of Italy-Luxembourg tax treaty (the “Treaty”), for dividends paid by an Italian subsidiary to a Luxemburg holding company, on the grounds that the recipient of the dividend did not have a place of effective management and control in Luxembourg (with the consequence that the recipient could not be regarded as a resident of Luxembourg, for the purpose of either the Directive or the Treaty), and had not been subject to actual taxation on the dividends in Luxembourg, where it benefited from a participation exemption regime exempting dividends and capital gains from corporate income tax (and, therefore, it could not be regarded as the beneficial owner of the dividends).
The decision is important and confirms the Court’s latest course on the issue of the application of Directive’s dividend withholding exemption, or treaty reduced dividend withholding tax rate, which may be denied unless strict requirements concerning the recipient’s economic substance, actual place of establishment, and beneficial ownership of dividends are met.
The facts of the case can be summarized as follows.
Macquarie Airports (Luxembourg) S.A. (“MALSA”) in Luxembourg, ultimately owned or controlled by Australia’s multinational independent investment bank and financial services company Macquarie Group Limited, was organized for the purpose of acquiring a share of 44.74 percent of the Italian company Aeroporti di Roma S.p.A. (“ADR”), which operates Roma’s airports. The acquisition was carried out in March 2003 and, later in that year, ADR distributed to MALSA a dividend of Euros 14,476,462.
ADR charged a withholding tax on the dividend at the reduced rate of 15 parent pursuant to the tax treaty between Italy and Luxembourg. MALSA filed a petition for refund of the withholding tax claiming the dividend withholding exemption of the EU Parent Subsidiary Directive. Italy’s Tax Agency rejected the request of refund and assessed the full 27 percent withholding tax rate provided for under Italy’s tax code. MALSA filed a petition to the Provincial tax Commission (trial tax court), which upheld the assessment of the additional withholding tax. The Regional Tax Commission (appellate tax court) rejected the appeal and MALSA filed a final appeal to the Supreme Court.
The Regional Tax Court, whose judgement was challenged in the appeal to the Supreme Court, held that neither the withholding tax exemption of the Directive, nor the withholding tax reduction of the Treaty, could apply, for various independent reasons.
First, the Regional Tax Court held that, in order to qualify as a resident of Luxemburg, for purposes of the Directive or the Treaty, MALSA’s place of effective management needed to be located in Luxemburg. Since MALSA was managed out of Australia, where its parent company was established, MALSA did not qualify as a resident of Luxemburg for the purpose of either the Directive or the Treaty.
With regard to the aforementioned argument, one of the requirements for the application of the Directive is that the recipient of the dividend is a company organized in a EU Member State, which, according to the tax laws of that State, is considered to be resident in that State for tax purposes and, under the terms of a double taxation agreement concluded with a third State, is not considered to be resident for tax purposes outside the Community.
From the Supreme Court’s ruling, there appears to be no discussion as to whether MALSA was actually treated as a resident of a third State under a tax treaty between Luxembourg and a non-EU country. Notably, Australia and Luxembourg started the negotiations for a tax treaty only in 2016, and have never had any tax treaty in force to date.
On the other end, under the typical provision of article 4, paragraph 3 of tax treaties modeled after the 2010 OECD Model Income Tax Convention, or earlier models, when a company is a resident of both Contracting States under the internal tax laws of those States, by reasons of the provisions of paragraph 1, then it shall be deemed to be a resident only of the State in which its place of effective management is situated. Again, the Court does not discuss whether MALSA was actually treated as a resident or a third State under a tax treaty between Luxembourg and a non-EU country.
The Supreme Court seems to be content to interpret the provisions of the Directive as requiring that the recipient of the dividend be actually established and effectively managed in its EU country of organization, for it to be considered a genuine arrangement duly eligible for the withholding tax exemption. Indeed, the Court refers to the special anti abuse provision of paragraph 5 of article 27-bis of the Italian Presidential decree n. 600 of 1973, according to which, whenever the EU recipient of the dividend is a company owned or controlled by a company established in a third State, the dividend withholding exemption of the Directive applies solely when the taxpayer proves that the EU company has not been organized for the sole or main purpose of obtaining the Directive’s withholding tax exemption.
The Supreme Court also states that article 10 of the OECD model tax treaty must be interpreted in a narrow way, to avoid a possible abuse of the treaty, and should apply solely when the recipient of the dividend is a genuine arrangement resulting in an actual establishment in the other treaty country.
Next, the Regional Tax Court held that MALSA, lacking a place of effective management in Luxembourg, had to be regarded as a wholly artificial arrangement not eligible for the benefits of either the Directive or the Treaty. The Supreme Court upheld this argument, pointing out that, although a holding company cannot be required to have the same level of economic substance as an industrial or commercial company, whenever it lacks any meaningful connection to the country in which it is legally organized, such as a place of effective management there, and operates as a mere legal conduit for the purpose of the collection and transfer of the dividends to its ultimate owners, it is not eligible for the benefits of the Directive or a tax treaty. According to the Supreme Court, the freedom of establishment and free movement of capital of the EU Treaty do not apply, whenever a company constitutes a wholly artificial legal arrangement, as opposed to an actual genuine establishment in a EU Member State.
Finally, the Regional Tax Court held that, in the absence of actual taxation of the dividend in Luxembourg, the recipient of the dividend does not meet the liable to tax requirement of the Directive, and cannot be treated as the beneficial owner of the dividend under article 10 of the Treaty. MALSA had not paid any tax on the dividends in Luxembourg, under Luxembourg’s participation exemption regime. The Supreme Court upheld also this argument.
In respect of the Directive’s issue, the Supreme Court referred to the provision of the Directive according to which, for the dividend withholding exemption to apply, the recipient of the dividend must be subject to a corporate income tax (which in case of Luxembourg, is the impôt sur le revenu des collectivités in Luxembourg), without the possibility of an option or of being exempt. Generally, that provision has been interpreted as requiring that a company be liable to tax, meaning that it is organized as a separate taxpaying entity falling within the scope of application of a corporate income tax. The fact that a specific item of income might be exempt from tax, as is the case for dividends and capital gains, under a typical participation exemption regime, had never been considered as an obstacle to the application of the Directive. Instead, the Italian Supreme Court, following a new course established in some of its most recent rulings, issued in similar cases, argued that the dividend withholding exemption is granted to avoid the double taxation of the dividend, which does occur, whenever the dividend is exempt from tax in the recipient’s Member State.
In respect of the Treaty issue, the Court held that the Regional Tax Court’s finding that the dividend recipient is not the beneficial owner of the dividend constitutes a finding of fact which cannot be reviewed by court in the absence of a clear error.
On a side issue, the Supreme Court held that a certificate issued by the tax authority of the recipient’s country of organization stating that the recipient of the dividend maintains a place of effective management in that country and is the beneficial owner of the dividend, is not binding, because it concerns factual situations which the taxing authority cannot directly evaluate and assess.
Ruling n. 25490n is consistent with some recent rulings of the Supreme Court’s on the same issues, which attracted significant attention and are commented on this Blog.
As general consideration from ruling n. 25490, it seems clear that EU holding company structures are under significant challenges, and taxpayers should review their specific situations and consider the idea of waiving the opportunity to claim the Directive altogether, ignoring any intermediate holding company which does not meet the new substance requirements that are strictly enforced in the host countries where the operating subsidiaries are located, and directly claim treaty benefits on behalf of the ultimate parent company, for the purpose of obtaining at least the treaty reduced withholding tax rate.
That approach has it now hurdles, but deserves specific attention and is worth the effort, since the risk otherwise is that of potentially owning the much higher domestic withholding tax rate.