By Davide Anghileri, University of Lausanne
The European Court of Justice, in a decision issued 25 July (case C-553/16), struck down a Bulgarian law that requires interest to be paid on unpaid withholding tax only in cross-border situations and that provides that the interest is not recoverable.
TTL, a company resident in Bulgaria, concluded contracts for the leasing of rail tankers with three unrelated companies resident in three different EU countries from 2007 to 2010. Payments were made by those companies in exchange for the leasing.
TTL determined that the payments were covered by double taxation conventions entered into between Bulgaria and each of the EU member states concerned. Thus, TTL did not deduct withholding tax.
The three non-resident companies did not request a decision on the applicability of the relevant double taxation conventions. However, they submitted to the Bulgarian company evidence of compliance with the requirements for the application of those conventions. Hence, TTL was able to certify that the requirements for the application of the double taxation conventions were fulfilled.
After a tax inspection, the Regional Directorate of the National Revenue Agency of Sofia, Bulgaria, issued a tax adjustment notice. The notice recognized the existence of a tax debt, together with interest.
The notice established that the requirements for the application of the double taxation conventions were fulfilled for the three non-resident companies, except for one case, where the income paid by TTL should have been subject to withholding tax in Bulgaria at the rate of only 5%, corresponding to 1.140 Euros plus interest at 36.500 Euros.
Although it was subsequently established that the withholding tax was not due, the interest was not reimbursed.
Bulgarian withholding tax law
The tax authority had applied Bulgarian law on corporation tax, which provides that payments received by non-resident legal person from domestic sources, where not obtained through a permanent establishment in Bulgaria, are subject to withholding tax which extinguishes the tax debt.
Under Bulgarian law, a resident company that makes payments to a non-resident person who in principle is subject to withholding tax must pay default interest in the event of non-payment.
Such interest runs from the tax payment due date until the date the non-resident person furnishes evidence that a double taxation convention applies to exempt or reduce withholding tax. Furthermore, the payment of such default interest only applies to cross-border transactions and that interest is not recoverable.
Taxpayer challenge
TTL challenged the tax adjustment before the Administrative Court of the City of Sofia, which was dismissed by judgment of 3 December 2014. TTL then appealed to the Supreme Administrative Court, which asked the ECJ to determine whether the Bulgarian legislation is incompatible with EU law.
The ECJ concluded that the Bulgarian law violates EU concepts of freedom to provide services.
The ECJ reasoned that under Bulgarian law there is a difference in treatment between resident and non-resident companies that pay out income in return for provision of services such as in this case involving the leasing of rail tankers. A cross-border situation in which a resident company exercises the freedom to provide services under Article 56 TFEU is therefore treated less favourably than a national situation, the court said.
Legislation that is likely to discourage resident companies from using leasing services of companies established in other member states thus constitutes an obstacle to the freedom to provide services, the court said.
Further, the court said the law was not appropriate to ensure the collection of withholding tax on cross-border payments or ensure the effectiveness of fiscal supervision in cross-border situations. Furthermore, in a situation such as that at issue, there is no connection between the amount of interest payable, on the one hand, and the amount of tax payable, of which there is none, or the seriousness of the delay in providing those documents to the tax authorities, on the other, the court said.
The ECJ also determined that a penalty goes beyond what is necessary to attain the state’s objectives, given that the amount of interest accrued may prove to be excessive compared to the amount of tax payable and given that there is no possibility for that interest to be reimbursed.
Davide Anghileri
Davide Anghileri is a PhD candidate at the University of Lausanne, where he is writing his thesis on the attribution of profits to PEs. He researches transfer pricing issues and lectures for the Master of Advanced Studies in International Taxation and Executive Program on Transfer Pricing.
Anghileri, a Contributing Editor at MNE Tax, previously worked as a policy advisor to the Swiss government on BEPS issues.
Davide can be reached at [email protected].
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