ATOZ NEWS: Tax, ATOZ and Taxand Intelligence | June 2012

In times of uncertainty and environment buzzing with sound bites such us “stimulus”, “emergency”, “hope of intervention”, with this issue of the ATOZ Newsletter we hope to prepare you for the one thing that is certain today - change. Allow us to share with you the most current and relevant local and global tax developments and position you so that you can better manage their impact to you and your organization.

At European level, changes continue with the recent announcement of the Germany – Luxembourg DTT renegotiation, which is of significant interest to our readers in real estate. We are also witnessing interesting developments from the court bench. Following the recent opinion of the Advocate General in the Deutsche Bank Case, we encourage portfolio managers to take a close look at the VAT treatment of their commissions and monitor the progress of this matter. The most substantial and positive news on that front is the recent groundbreaking ECJ decision in the EU reclaim cases, which increases considerably the likelihood of recovery of withholding taxes by foreign funds in France and other EU member states.

Positive change carries on to local level. The Luxembourg developments reported in this issue, while not major, clarify certain existing positions, and open the solution space, as in the case of granting of preferential subscription rights.

As you see, change brings opportunities. We hope that the content below will prepare you so that you can take advantage of these opportunities. Enjoy your reading.

Regards,

Christophe Plainchamp, Partner

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On April 23, 2012, Germany and Luxembourg signed a new Double Tax Treaty (“DTT”). The aim of the new DTT is to replace the one signed in 1958, and follow the structure and, for the most part, the content of the OECD Model Tax Convention. For an overview of the main provisions of the new DTT, which will particularly bring along important changes regarding real estate investments through German investment vehicles and hybrid funding into Germany,

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The Hungarian Supreme Court (“the Kúria”) has requested recently a preliminary ruling from the European Court of Justice (“ECJ”) in a case involving a Luxembourg SICAV investing in Hungary (“Franklin Templeton Investment Funds Société d’Investissement à Capital Variable VS. Nemzeti Adó- és Vámhivatal Kiemelt Ügyek és Adózók Adó Főigazgatósága”). The ECJ will have to rule on the Hungarian fiscal regime applicable to distributions of dividends, which provides a full exemption of withholding tax to resident recipients, while certain legal requirements must be met by non-residents in order to benefit from the same favorable regime. By responding to the three following questions, the ECJ will interpret the fiscal treatment at issue in light of the European law in order to determine whether it has to be considered as discriminatory towards non-residents.

Question 1: Is the exemption from tax on dividends granted by the Hungarian legislation to recipients of dividends resident in Hungary compatible with the provisions of the TFEU on the principle of freedom of establishment (Article 56 TFEU / ex-Article 49 EC Treaty), the principle of equal treatment (Article 61 TFEU / ex-Article 54 EC Treaty) and the principle of free movement of capital (Article 63 TFEU / ex-Article 56 EC Treaty)?

As opposed to resident recipients of dividends, the Hungarian fiscal regime requires for non-residents to be exempted from tax on dividends that the holding (proportion of its registered shares) in the capital of the resident company amounted permanently to at least 20% for at least two consecutive years at the time of the dividend distribution (allocation). In the event that the permanent holding of 20% is maintained for less than two consecutive years, the company distributing the dividends is still not required to withhold tax on the dividend to the extent that another person or the party distributing the dividends has guaranteed the payment of the tax.

Question 2: Would there be any effect on the answer to question (1) by considering that:

- Resident recipients of dividends are exempt from tax on dividends under the Hungarian legislation and the tax burden of non-resident recipients of dividends depends on the applicability of the Council Directive 90/435/EEC of 23 July 1990 (common system of taxation applicable in the case of parent companies and subsidiaries of different Member States) or, the Double Tax Treaty between the Republic of Hungary and the Grand Duchy of Luxembourg of 15 January 1990.

- Resident recipients of dividends are exempt from tax on dividends under the Hungarian legislation and non-resident recipients of dividends may either offset such tax against their national tax or bear the final burden, depending on the provisions of their national law.

Question 3: May the national tax authorities invoke Article 65 of the TFEU (ex-Article 58-1 TEC) to justify the fiscal treatment at issue?

Article 65 of the TFEU is an exception to Article 63 of the TFEU, which allows for different tax treatment of non-residents and foreign investments, but with the reservation that this must not represent a means of arbitrary discrimination or a distinguished restriction.

This case is similar to previous cases rendered in relation to the infringement of the free movement of capital (e.g. European Commission vs. Federal Republic of Germany C-284/09 – 20 October 2011 and “Joint cases” C-338/11 to C-347/11 - 10 May 2012) and it can be expected that the ECJ will rule in favor of the taxpayer.

For additional information on this case-law, please contact Keith O’Donnell keith.odonnell@atoz.lu or Mariem Sahraoui mariem.sahraoui@atoz.lu.

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As you may remember from our previous newsletter , the case relates to the VAT treatment of portfolio management services, where a manager takes, at his own discretion and for remuneration, decisions on the purchase and sale of securities and implements these decisions by buying and selling the securities.

The first question of the case is whether such portfolio management is exempt from VAT. The AG’s view in this respect is that such services should not benefit from a VAT exemption.

The second question is whether these services constitute a single service or must be broken down into separate activities with different VAT treatments. The AG concluded that portfolio management services in the present case constitute a single operation as those services’ predominant aspect is the acquisition and use of expertise to make informed decisions. Whether transactions in securities are performed is not important to the customer.

Based on the AG’s conclusions, such management services shall therefore be subject to VAT. Although the AGs opinion is not binding for the Court, we anticipate that the Court will rule based on these conclusions, especially since these conclusions seem reasonable in light of the facts of the case, the European VAT legislation and previous jurisprudence.

Interestingly however, the AG mentioned that, in isolation, transactions services should benefit from a VAT exemption. We therefore suggest to portfolio managers to review their operational processes and underlying agreements, and be prepared ahead of potential changes.

For more information on this topic, please contact Christophe Plainchamp at christophe.plainchamp@atoz.lu or Nicolas Devillers at nicolas.devillers@atoz.lu.

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On 4 July 2011, the Administrative Court of Montreuil had referred the cases to the French “Conseil d’Etat”, France’s Supreme Court administrative jurisdiction, which instructed the Montreuil Court to request a preliminary ruling (Article 267 of the Treaty of the Functioning of the European Union “TFEU”) to the ECJ and pose the following questions:

1. Must the situation of investors be taken into account together with that of investment funds (UCITS)?

2. If so, what are the conditions under which the withholding tax at issue may be regarded as consistent with the principle of free movement of capital?"

The decision of the ECJ was favourable for the taxpayers, confirming that foreign funds that had received dividend payments from French companies and that had been subject to withholding taxes are entitled to the same exemption as French funds under Article 63 of the TFEU. The decision involved taxpayers that were European as well as non-European (US) funds. The Court ruled that the French fiscal regime at issue was discriminatory toward foreign funds.

In respect of the European context, Article 63 of the TFEU foresees that “all restrictions on the movement of capital between EU Member States and EU Member States and third countries shall be prohibited”.

With regards to the French fiscal legislation, Article 119 Bis §2 of the French Tax Code governs the distribution of the withholding tax and makes provision that all dividends distributed to foreign investment funds must be subject to a withholding tax of 30%, pursuant Article 187 of the French Tax Code (used to be 25% before 1 January 2012).

This rate could be reduced in accordance with the bilateral conventions concluded between France and the other countries.

Foreign funds are subject to French withholding tax on French source dividends while domestic funds do not suffer tax.

Hence, the taxpayers claimed to be in a comparable situation to that of French investment funds.

In the case of capitalization investment funds, a European investor (natural person) invests in shares of a French company through a French capitalization investment fund. The French company distributes a dividend of 100 to the French investment fund. This dividend will be perceived as a net income as the fund is not subject to withholding tax; this amount will increase the net asset value of the investor’s portfolio. Should the investor decide to sell the shares, the capital gain will be increased by 100 of dividends received. Pursuant Article 144 Bis of the French Tax Code, capital gains are not taxable in France when investors hold less than 25% of the rights of the investment fund. If the same investor holds the French shares through an EU investment fund (non-French), a withholding tax of 30% (25% before 1 January 2012) is levied from the dividends received or 15%, if a fiscal convention is applicable. Therefore, the investor suffers a loss when the investment is made through a EU investment fund (non-French).

In the case of French distribution investment funds, a French investor (natural person) invests in shares of a French company through a French distribution investment fund. A dividend of 100 is distributed by the French company to the taxable French distribution investment Fund. The French investor receives the dividend and is taxed at 19% (prélèvement libératoire), increased with the social contributions of 13.5% resulting in a global taxation of 32.5%.

With regards to European distribution investment funds, a French investor (natural person) invests in shares of a French company through, for instance, a Belgian distribution investment fund. A withholding tax of 30% (25% before 1 January 2012) is levied on the dividend of 100 at the level of the Belgian investment fund. A dividend of 75 is distributed to the French investor who has to deduct the 32.5%, without the possibility of obtaining a tax credit corresponding to the 25% levied initially at the level of the Belgian investment fund.

The Court noted that the application of such a tax has the effect of discouraging investment. Indeed, in the case Fetersen (C-370-05 - 25/01/2007) the Court stated that restrictions on freedom of movement of capital, stipulated in Article 63 of the TFEU include those likely to discourage non-residents to invest in a member state.

Also, the Court found that the French tax on dividends distributed to foreign funds could not be interpreted in light of Article 65 of the TFEU. This article, as an exception, allows a member state to apply a different regime, where the situations are not comparable as regards to the place of residence or the place where their capital is invested, provided that the exception shall not constitute a means of discrimination or a disguised restriction on the free movement of capital. The Court stated that the French government could not rely on this exception because the situation of domestic and foreign funds is comparable in the sense that both invest in the same French equities in the same manner.

Furthermore, the Court recalled that capitalization investment funds compare themselves at the level of the investment fund since there is no systemic distribution to the investors. In addition, the growth of the net asset value of the investors’ portfolios held by French investment funds is clearly favoured compared to foreign funds.

The French government requested the ECJ to time-limit its decision and argued that the establishment of the regime in dispute had been implemented in good faith and that the litigation is due to “an objective uncertainty” when applying the provisions of European law. Furthermore, the refund of such withholding tax would have serious economic repercussions on the French budget (claims lodged amounted to 4.2 billion as of 31 December 2011).

The Court found that the French government did not specify how the European Law has contributed to an uncertainty that would have caused such discrimination and misunderstanding when implementing Article 63 of the TFEU.

Finally, the Court recalled that its role is to interpret European law as it should have been applied "since its entry into force…and that the financial consequences which might fall on a Member State from a decision do not, by themselves, limit the effects of that decision in time.

It is particularly interesting to note that the case included two US mutual funds, so the application to non-EU funds has taken a significant step forward. The possible distinction between EU and non EU funds was not formally raised before the Court. However, in its conclusions and judgment, the Court strongly suggests that there is no basis to distinguish per se between EU and non EU funds.

The decision will be applied at the national level by the Administrative Court of Montreuil. In addition, the decision has opened an extension of the statute of limitation in France, by which investors can potentially claim for fiscal year 2009.

Although the details of each case need to be examined closely, the likelihood of recovery of withholding taxes by foreign funds in France and other EU member states has increased significantly.

Since the preliminary ruling is binding for all Member States, investors should review their strategy and tactics and file any relevant claims in France and across Europe.

In this case, the French “Conseil d’Etat” had already settled the question, holding that there was no basis for distinguishing between EU and US funds.

Through its specialist team in Luxembourg, Taxand is leading claims worth EUR 1.6 billion across Europe, with Taxand firms in 15 countries, taking responsibility for local claims and litigation.

For additional questions please contact Keith O’Donnell keith.odonnell@atoz.lu and Mariem Sahraoui mariem.sahraoui@atoz.lu.

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Over the past years, the parent-subsidiary Directive 90/435/CEE dated 23 July 1990, which was designed to eliminate tax obstacles in the area of profit distributions between groups of companies in the EU, was amended several times, in order to broaden its scope and improve its conditions. This was achieved by means of updating the list of companies that the Directive covers, relaxing the conditions for exempting dividends from withholding tax (reduction of the participation threshold) and eliminating double taxation for subsidiaries of subsidiary companies.

Given the several changes introduced by the various amending Directives over time, a recast of the parent-subsidiary Directive was published; (Directive 2011/96 which entered into force on 18 January 2012, hereafter referred to as the “new Directive”). The new Directive has abolished and replaced the former parent-subsidiary Directive.

Following the publication of this new Directive, the Luxembourg tax authorities released a circular according to which all references made in Luxembourg legislation to article 2 of the amended Directive 90/435/CEE of 23 July 1990, are now to be understood as a reference to article 2 of the new Directive. The aim here is to make sure that the new provisions can be applied now, pending the formal incorporation into Luxembourg law of the amendments introduced by the new Directive.

Article 2 of the Directive defines the EU entities covered by the Directive and lists in its Annex 1 part A the legal forms covered by the Directive in each of the EU Member States.

Currently, articles 115, 147, 166 & 175 LIR as well as § 60 of the evaluation law and § 11bis of the tax adaptation law refer to article 2 of the amended Directive 90/435/CEE of 23 July 1990. These articles aim at exempting dividends partially (article 115 LIR) or fully from withholding tax (article 147 LIR) or from corporate income tax (article 166 LIR), as well as at exempting related shareholdings from Net Wealth Tax (§ 60 BewG).

Based on the circular, even though the articles of the Luxembourg law mentioned above refer to article 2 of the amended Directive 90/435/CEE of 23 July 1990, one has now to refer to article 2 of the new Directive in order to check whether the conditions of these articles are fulfilled.

This circular is positive as it clarifies the conditions of the Luxembourg participation regime, while pending the implementation of the new Directive into Luxembourg law. It is important to note that since the new Directive is a recast rather than a real amendment of previous amending Directives, the reference to the new Directive will not have any significant impact for tax payers.

For more information on this topic, you can contact Keith O’Donnell at keith.odonnell@atoz.lu or Samantha Nonnenkamp at samantha.nonnenkamp@atoz.lu

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The solidarity surcharge will be increased by 2% for both individuals and companies as of January 1st, 2013.

This means that:

• For companies, the contribution will be increased from 5 to 7%, which will bring the global income tax rate (Corporate Income Tax, “CIT” + Municipal Business Tax, “MBT”) from currently 28,80 % to 29,22% (if we assume a MBT rate of 6,75%, which is the rate applicable in Luxembourg city);

• For individuals with a taxable income up to 150.000 EUR (EUR 300.000 EUR for tax class 2): the contribution will be increased from 4 to 6%;

• For individuals with a taxable income of more than 150.000 EUR (EUR 300.000 EUR for tax class 2), the contribution will be increased from 6 to 8%, which will bring the maximum income tax rate from currently 41,34 % to 42,12%.

It has been announced that the VAT rate would not be increased for the moment (at least not during this legislative period).

Finally, it was announced that the crisis contribution would not be reintroduced.

As in the last three years, the Prime Minister’s speech was focused on restoring budgetary balance, which explains the increase of the solidarity charge. This happens for the second time since 2010. The crisis contribution will however not be reintroduced, which is good news, as this may have happened, given the current economic context. No measures have been announced, designed to ensure that Luxembourg remains competitive; but this may still happen at a later stage in 2013.

For more information on this topic, contact Keith O’Donnell at keith.odonnell@atoz.lu or Samantha Nonnenkamp at samantha.nonnenkamp@atoz.lu.

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