TAX NEWS - 2010

European Union Tax: ECJ rules Spanish treatment of dividends incompatible with free movement of capital

The European Court of Justice (ECJ) held on 3 June 2010 that Spain failed to fulfill its obligations under article 56 of the EC Treaty (free movement of capital principle) by imposing a different shareholding requirement under its participation exemption for a Spanish company recipient and a recipient resident in another EU Member State.


Background

Under Spanish legislation, companies that have a substantial holding in the capital of another company may deduct from their taxable income 100% of the gross dividends received from the subsidiary. To benefit from the exemption, the parent company must be resident in Spain and must hold at least 5% of the capital of the resident subsidiary for an uninterrupted period of at least one year. However, if the dividend recipient is a nonresident, the minimum shareholding is 10% (reduced from 20% to 15% in 2007 and then to 10% as from 2009). Thus, unlike a parent company resident in Spain, a parent company from another Member State or a Member State of the European Economic Area (EEA) that holds at least 5% of the payer company but less than the above percentages would have to pay tax in respect of the dividends distributed.

The European Commission took the position that requiring a greater shareholding for a nonresident recipient than a resident recipient is an infringement of the free movement of capital principles in article 56 EC and article 40 of the EEA Agreement and there was no justification for the additional fiscal burden on a parent company from another EU/EEA Member State.


European Court of Justice (ECJ) decision

The European Court of Justice (ECJ) held that the different participation requirements can dissuade companies established in other EU Member States from investing in Spain and, therefore, constitutes a restriction on the free movement of capital under article 56 EC. The complaint relating to the infringement of article 40 of the European Economic Area (EEA) Agreement, however, was dismissed by the European Court of Justice (ECJ) because the European Commission failed to provide information relating to the legislation on dividends distributed to companies established in the EEA EFTA States (i.e. Iceland, Liechtenstein and Norway), leaving the European Court of Justice (ECJ) with insufficient evidence to determine precisely the scope of any potential infringement of article 40. Nevertheless, there should be adequate grounds to consider the Spanish legislation contrary to article 40.


Possible taxpayer action

The ECJ decision confirms the possibility of claiming a refund of any taxes paid. Consequently, EU parent companies (and potentially EEA EFTA parent companies, as noted above) that have received dividends from Spanish subsidiaries based on a shareholding of at least 5% for an uninterrupted period of at least one year would be entitled to obtain the refund for tax paid in respect of the following holding scenarios:

Tax period                      Participation
Before FY 2007                  5%-20%
FY 2007 and FY 2008          5%-15%
FY 2009 and after               5%-10%

Additionally, the arguments in the judgment should apply where an EU parent company with a higher interest than the above has been taxed in Spain due to the distribution of dividends (e.g. EU parent companies not included in the Annex to the EC Parent-Subsidiary Directive). However, such potential application should be analyzed on a case-by-case basis. Moreover, because the ECJ decision does not establish a limit on its temporal effects, applications for the refund of withholding tax paid will not be limited by Spain's four-year statute of limitations.

As from 3 June 2010, EU (and, as noted above, EEA EFTA) parent companies that hold at least 5% of a Spanish subsidiary for an uninterrupted period of one year are entitled to request an exemption from withholding tax at source on dividends paid by the subsidiary. Therefore, Spanish subsidiaries should not withhold tax on dividend distributions to their EU or EEA EFTA parent companies.