EU tax: AG opines on Italian withholding tax on dividends

On 16 July 2009, European Court of Justice (ECJ) Advocate General (AG) Kokott issued her opinion in Commission v. Italy, recommending the ECJ find that Italy's dividend withholding tax rules infringe the freedom of capital principle under the EC Treaty, while allowing for the possibility of non-infringement in some EEA Treaty circumstances. The European Commission initiated infringement proceedings against Italy in 2007.

Since 1990, the EC Parent-Subsidiary Directive has played an important role in the tax laws of the EU Member States. According to the directive, a source state may not impose withholding tax on dividends distributed to qualifying parent companies provided certain minimum participation requirements and, where applicable, holding periods, are met. At issue in Commission v. Italy is what happens if the minimum participation is not held and, therefore, the directive is not applicable.

Italian tax law distinguishes between dividends distributed to Italian parent companies and dividends distributed to a non-Italian parent company: the withholding tax imposed differs depending on where the parent is seated. Dividends distributed to an Italian parent are taxed much lower than dividends distributed to a parent company located in the EU or EEA (i.e. the EU Member States, plus Iceland, Liechtenstein and Norway).

The Italian government defends this disparity in treatment on the grounds that all of Italy's tax treaties provide relief for withholding tax. The issue of whether treaty-based double tax relief justifies a higher withholding tax has not been answered by the ECJ, although the Court has consistently rejected the argument that parent companies will not suffer double taxation when unilateral relief is available. AG Kokott concluded in the case that the higher withholding tax on intra-EU dividends violates the free movement of capital principle. Her primary reason for this conclusion is that, even if the state where the recipient is resident would fully credit the Italian withholding tax, certain situations still could result in disadvantageous treatment. In principle, tax treaties provide for an ordinary tax credit rather than a full tax credit.

Consequently, if the country of the recipient has a tax rate lower than the 27% Italian withholding tax, some of the withholding tax will not be available for set off in calculating corporate income tax liability. Further, even if the tax rate in the state of the recipient exceeds 27%, it is possible that the recipient will not be able to obtain relief from double taxation in that year, for example, if the recipient company is in a loss-making position.

Another reason for AG Kokott's conclusion is that Italy does not have a tax treaty with Slovenia – an EU Member State – which means that dividend recipients in Slovenia will be treated worse than recipients in other EU Member States. This exclusion constitutes an additional infringement of the free movement of capital principle.

These infringements cannot be justified on the grounds that it is designed to prevent abuse because the EU mutual assistance directive creates a system for the exchange of information between EU Member States to enable them to acquire all information regarding tax matters in cross-border situations.

With respect to the EEA, AG Kokott concludes differently. Although the free movement of capital provision in the EEA treaty has the same meaning as the principle in the EC treaty, the mutual assistance directive is not applicable to Norway, Iceland and Liechtenstein. The internal market of the EU with Norway, Liechtenstein and Iceland is therefore not comparable with the internal market of the EU itself. For example, Italy does not have a tax treaty with Liechtenstein, so there is no guarantee that Liechtenstein will provide the necessary information to help Italy prevent fraud. AG Kokott therefore accepts the absence of an exchange of information mechanism as a justification for the infringement under the EEA Treaty.

With respect to Norway and Iceland, the Italian government argued that, despite the exchange of information articles in Italy's tax treaties with the two countries, it is unable to obtain the necessary information. AG Kokott concluded on formal grounds that, because the European Commission failed to argue why the provisions of these tax treaties are compatible with article 26 of the OECD model treaty and therefore the exchange of information would be sufficient, Italy's infringement of the freedom of capital provision of the EEA treaty was justified.

What conclusions can be reached about AG Kokott's opinion in this case? First, if the Italy-Iceland and Italy-Norway treaties contain provisions comparable to article 26 of the OECD model treaty, the infringement cannot be justified. Both treaties contain an exchange of information provision that is very much in line with article 26. Thus, Italy is not allowed to levy a higher withholding tax on dividends paid to Iceland or Norway than it levies in domestic situations.

Even if the exchange of information provisions in these treaties are not comparable to article 26 of the OECD model, it is still possible that the ECJ will judge differently in the case. This is mainly because AG Kokott's reference to the "A" case might be incorrect. The "A" case involved Switzerland, which is not an EU or EEA Member State, so the free movement of capital provision of the EEA treaty is, although applicable, not as strong as within the EEA. In that situation, the ECJ must determine whether a limited "exchange of information" provision will be sufficient to block Italy's contention that the infringement can be justified on the basis of the prevention of abuse.