Fidelity wins EU court challenge to Danish withholding tax on dividends paid to foreign funds

By Davide Anghileri, University of Lausanne

The Court of Justice of the European Union (ECJ) has ruled in a case brought by Fidelity mutual funds that Denmark’s withholding tax on dividends paid to foreign funds is invalid.

A State may not impose withholding tax on dividends distributed by a company resident in that Member State to a non-resident undertaking for collective investment in transferable securities (UCITS) if dividends distributed to a UCITS resident in the State are exempt from such tax, the EU court concluded June 21.

The court said that its holding especially applies where an undertaking makes a minimum distribution to its members, or technically calculates a minimum distribution, and withholds on that actual or notional distribution the tax payable by its members.

The facts

The case (C-480/16), brought by Fidelity Funds, Fidelity Investment Funds, and Fidelity Institutional Funds and joined by NN(L) SICAV as intervenor, relates to Fidelity investment funds with registered offices in the United Kingdom and Luxembourg. The UCITS claimed repayment of withholding tax levied on dividends received from Danish companies between 2000 and 2009, based on EU law.

The withholding tax repayment was denied as, under the Danish legislation, to be exempt from withholding tax, a UCITS must be resident in Denmark and have Article 16 C fund status.

 Before 1 June 2005, to obtain Article 16 C fund status a UCITS was required to make a minimum distribution to its investors, while after that date it was required to make a minimum distribution which was taxed in the hands of its members by means of a deduction at source made by that undertaking.

The taxpayers argued that this different treatment was contrary to the free movement of capital and requested a refund of the tax levied. They also argued that the minimum distribution requirement is contrary to the freedom to provide services.

Free movement of capital

The ECJ stated that the freedom in the case at stake is the free movement of capital as the national legislation at issue concerns the tax treatment of dividends received by UCITS.

The court noted that by levying a withholding tax on the dividends paid to non-resident UCITS and giving only resident UCITS the possibility of obtaining an exemption from that tax, the Danish legislation results in the dividends paid to non-residents being treated disadvantageously.

Hence this disadvantageous treatment may discourage, on the one hand, non-resident UCITS from investing in Danish companies and, on the other hand, investors resident in Denmark from acquiring shares in non-resident UCITS, the ECJ said.

Therefore, the ECJ stated that the Danish legislation constitutes a restriction on the free movement of capital, prohibited in principle by Article 63 TFEU.

Allocation taxing rights

Furthermore, the court pointed out that the preservation of the allocation of the power to impose tax cannot be used to justify the restriction where a Member State has chosen, as in the situation at stake, not to tax resident UCITS in receipt of nationally-sourced dividends.

Additionally, the ECJ explained that a Member State cannot rely on the argument that there is a need to ensure a balanced allocation between the Member States of the power to tax as the Danish legislation does not prevent conduct capable of jeopardising this right, but, rather, compensates for the lack of a power of taxation resulting from the balanced allocation of such powers between Member States.

Moreover, the different treatment also cannot be justified by the need to safeguard the coherence of the tax system. The court pointed out that there is not a direct link between the tax advantage in the form of an exemption of resident UCITS and immediate taxation of dividends in the hands of the investors.

In fact, the Danish legislation makes the exemption from withholding tax for UCITS resident in Denmark conditional on an actual or notional minimum distribution to their members, who are liable to withholding tax, deducted on their behalf by those undertakings.

The advantage thereby granted to UCITS resident in Denmark, in the form of an exemption from withholding tax, is, in principle, offset by the taxation of the dividends, redistributed by those undertakings, in the hands of their members, the court said.

Internal coherence

In addition, the ECJ affirmed that the Danish legislation goes beyond what is necessary to safeguard the coherence of the Danish tax system.

In fact, the internal coherence of the Danish tax system could be maintained if non-resident UCITS, which satisfy the conditions of Article 16 C, were eligible for exemption from withholding tax, provided that the Danish tax authorities ensure, with the full cooperation of such UCITS, that the latter pay a tax that is equivalent to the tax which Danish Article 16 C funds are required to retain, as a withholding tax, on the minimum distribution calculated in accordance with that provision.

Allowing such UCITS to enjoy that exemption, under those conditions, would be less restrictive than the current system, the court said.

Finally, the court added that the refusal to grant non-resident UCITS which satisfy the conditions of Article 16 C of the exemption from withholding tax leads to a series of charges to tax on the dividends paid to their members resident in Denmark, which runs precisely counter to the objective pursued by the national legislation.

Thus, the ECJ stated that the restriction resulting from the application of the Danish tax legislation could not be justified by the need to safeguard the coherence of the tax system and is contrary to the free movement of capital.