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

On June 7, 2012, Poland and Luxembourg signed a protocol (the Protocol) amending the double tax treaty (DTT) initially signed in 1955. The key provisions of the Protocol are outlined below. The Protocol will bring changes regarding the structuring of investments into Polish real estate as Keith O’Donnell and Samantha Nonnenkamp explain below.

The current DTT allocates the right to tax capital gains on shares in companies to the state of residence of the seller. In line with the current OECD Model Tax Convention (“MTC”), the Protocol introduces new rules for the taxation of capital gains derived from the disposal of shares in real estate companies and allocates the taxing right to the state where the immovable property is located. Real estate companies are those deriving more than 50% of their value, directly or indirectly, from immovable property. As a direct consequence, gains derived by Luxembourg companies on the disposal of shares in Polish real estate companies will become taxable in Poland. So far, these gains were only taxable in Luxembourg (country of the seller) and could benefit from an exemption based on the participation exemption regime.

Under the current DTT, dividends trigger a 15 % withholding tax (“WHT”) rate, reduced to 5% provided a 25% stake is held in the share capital of the paying company. The Protocol replaces the reduced rate with a WHT exemption. The exemption applies to dividends paid to a company which is the beneficial owner of the income and which directly holds at least 10% in the share capital of the paying company for a minimum and uninterrupted period of 24 months preceding the date of payment.

The WHT rate on interest and royalties is decreased from 10% to 5%.

These changes are positive developments but the positive impact will be rather limited as the domestic regimes on dividends, interest and royalties are often more beneficial than the provisions of the new Protocol.

The exemption method with progression remains the rule for both Luxembourgish and Polish residents. The Protocol however expands the scope of the tax credit method and thus limits the cases where the exemption method will apply.

For Luxembourg residents, the tax credit method will now apply to capital gains on shares of real estate companies and to income of sportsmen and artists in addition to dividends, interest and royalties, under the current DTT.

For Polish residents, the tax credit method will apply to dividends, income of artists and sportsmen and capital gains besides to interest and royalties. This means that Polish residents will lose the benefit of the exemption of Luxembourg source dividends, such exemption being replaced with a tax credit.

The Protocol denies DTT benefits in case of:

- Income connected to artificial arrangements;

- persons taking advantage of laws, regulations and administrative practices that are qualified as a harmful tax measure by the EU Code of Conduct Group for Business Taxation.

The Protocol amends the provisions on exchange of information to bring them in line with the OECD MTC. Only information foreseeably relevant to secure the application of domestic tax legislation or of the DTT is allowed to be exchanged.

The Protocol will enter into force upon the exchange by both contracting states of their respective instruments of ratification.

It will apply to income and wealth taxes due from the 1st January of the calendar year following the entry into force (i.e. 1st January 2013 at the earliest). Provisions on WHT will apply to revenues allocated as from the 1st day of the 2nd month which will follow the entry into force.

As a positive change, the Protocol reduces the WHT rates applicable to certain types of income. The positive impact of this measure will however in most cases be rather limited given the more favourable rules already applicable at domestic and EU level under certain conditions. The Protocol further aligns the exchange of information provisions to the current OECD MTC. Finally, it may impact negatively investments in Polish real estate and the taxation of Luxembourg source dividends in Polish residents’ hands. We recommend that taxpayers carefully review their investment structures in Polish real estate and in Luxembourg companies to mitigate any adverse tax consequence.

Amongst various steps taken by the Luxembourg government in the recent months to implement its international tax policy, compliance of its DTTs with the OECD standards on exchange of information in tax matters has been subject to many updates. This policy implementation took the form of the recent amendment of a significant portion of the double tax treaties (“DTTs”) concluded by Luxembourg. As of today, 27 ratified DTTs/protocols, representing more than 50% of the Luxembourg DTT network, follow the OECD standards.

The OECD standards on exchange of information in tax matters provide for information exchange upon request, where the information is “foreseeably relevant” for the administration of the taxes of the requesting party, regardless of bank secrecy and a domestic tax interest.

An adaptation of Luxembourg legal framework was necessary to override banking secrecy rules, which would not be in compliance with the OECD standard, and to organize the procedure applicable to the exchange of information. This adaption has been achieved via the adoption of the law of the 31 March 2010, which ratifies the 27 DTTs/protocols and which defines, for these specific DTTs/protocols, the procedure applicable to exchange of information (for previous coverage on the Law, please read our ATOZ Newsletter of March 2010.

DTTs that do not fall within the scope of the Law, i.e. DTTs non compliant with OECD standards on exchange information, remain governed by the general provisions of Luxembourg law, implying that information can only be exchanged when it does not contervene the Luxembourg banking secrecy rules.

Such significant amendment of the Luxembourg legal framework gave rise to numerous disputes in front of the Luxembourg Courts over the past months and weeks, as many information holders challenged the legality/validity of the information requests.

The disputes brought before the judges were mainly debating on the application ratione temporis of the law. The issue is of critical nature to the extent it determines which legal regime applies to the exchange of information request.

The Law remains silent on the date it enters into force. The principle is that, in the absence of any other provision, a law enters into force 3 days after its publication in the official gazette. The Law would then apply as from its entry into force to any request for exchange of information. The Administrative Court (Cour Administrative, CA, February 9, 2012, n° 29655C) ruled however otherwise. It decided that, to the extent the purpose of the legislator was to ensure the efficiency of the exchange of information, it intended necessarily (although implicitly) to link the application ratione temporis of the Law to the application ratione temporis of the treaties/protocols ratified. The CA therefore ruled that a case has to be governed by the Law only in the following circumstances:

- the relevant DTT/protocol is already into force at the time the foreign tax authorities issue the request for exchange of information and,

- the relevant DTT/protocol is already applicable to the tax period covered by the request.

The CA further stated that the above analysis has to be performed separately in case of a single request covering several tax periods:

Example: Exchange of information requests from France, based on the Protocol which applies since October 29, 2010 to tax periods starting on or after January 1, 2010.

• On 13 May 2011, the French tax authorities request information in relation to tax years 2009, 2010 and 2011.

 Application of the Law to tax years 2010 and 2011;

 Application of the standard regime to tax year 2009 (whereby exchange of information is only possible to the extent in line with banking secrecy rules, exceptions being provided only in very limited situations).

The CA confirmed its position in a subsequent decision (May 10, 2012, 29943C) and the lower administrative court (Tribunal Administratif, TA) followed the principles set by the CA more recently (TA, May 24, 2012, n° 30017).

Competent authority for notifying the information injunctions

The Law defines the administration which is competent for notifying an information injunction but does not define the competent person within the relevant administration.

Notified holders of information claimed before courts that exchange of information injunctions issued by the administration in the person of public servants (so called préposés) instead of the head of the Direct Tax Authorities (Administration des Contributions Directes, ACD) had to be declared null.

The CA proved them right (CA, February 9, 2012, n° 29655C). According to the CA, considering that the Law requires that the fine for a violation of the information injunction has to be issued by the head of ACD or its representative, the same requirement applies to the information injunction itself. Thus, the information injunction is only valid when issued by the head of ACD or its representative.

According to the CA, the term ” representative” can only refer to the head of the division “Exchange of information” of the ACD or to any member of the head department of the ACD. Any other public servant (préposé) will not be recognized as an “authorized representative” within the meaning of the exchange of information procedure.

This position was the followed by the TA in a subsequent case (TA, June 11, 2012, n°30017a).

New requirement to state the reasons justifying the information injunction

The issuance of an information injunction is not subject to any specific content conditions, aside from an obligation of notification to the information holder. During the drafting process of the Law, the CA commented on the Law in an opinion dated October 29, 2009 and recommended that an obligation to state the reasons of the injunction should be added in the Law in order to avoid any breach in the rights of defense. Neglecting the CA’s recommendation, the Law did not provide for such an obligation.

The TA applied the comments issued by the CA during the drafting process in a case involving the Sweden-Luxembourg DTT (TA May 23, 2012, n°30177). It ruled that the injunction must enable its addressees to verify if the conditions of the information request are complied with. As a consequence, an information injunction merely stating that the underlying request complies with the legal conditions would fail to state its grounds in a satisfactory manner and should be considered as null.

An additional important piece of the Luxembourg exchange of information request procedure consists in the definition of the information that can be requested. In this context, a recent case brought in front og the CA (CA, May 24, 2012, n°30251C) brought the latter to explain the condition of foreseeably relevance. It did so by overruling a decision of the lower court (TA, March 20, 2012, n° 29592a).

On the basis of the OECD commentaries and on the OECD manual on exchange of information, the CA ruled that an information request is foreseeably relevant if (i) it relates to one or several specific taxation cases or to given taxpayers and (ii) it states the identity of the person under tax investigation. Exchange of information can validly relate to a third party, but only to the extent that the information is relevant to the taxation of one given taxpayer and such taxpayer is identified in the request. Any request failing to satisfy these conditions is null.

In the case at hand, a notification was addressed to a Luxembourg bank to request an information on a Malaysian company. The request designated the Malaysian company as foreign taxpayer under investigation for taxation purposes in Sweden. The request also detailed that it was aimed at identifying the financial flows between the Malaysian company and Swedish tax residents, who were not identified in the request. The information holder argued about the incoherence in order to claim that the information requested was irrelevant.

The CA proved the information holder to be right and declared the injunction null. In the light of the above mentioned principles, the CA reasoned as follows:

- If the request designates the Malaysian company as a foreign taxpayer subject to taxation in Sweden, then the request has to detail the grounds of such Swedish taxation.

- If the actual purpose of the request is the taxation of Swedish taxpayers, then the request has to identify such taxpayers and clearly state that the Malaysian company is involved as a third party holding relevant information for Swedish taxation purposes.

The case is also interesting to the extent it makes clear that exchange of information is not limited to residents of both contracting states.

Fair trial vs. confidentiality of the request for exchange of information

In the above quoted case (TA, February 6, 2012, n°29592), the holder of information argued that he was unable to verify the relevance of the requested information to the extent (i) the injunction did not state its grounds and (ii) he has not been provided with the underlying request.

The TA acknowledged that the information provided in a request is generally understood as being covered by confidentiality rules. An administrative authority can validly refuse to provide the taxpayer or the holder information with the request for exchange for information itself, based on its confidential nature.

The treaty however authorizes the disclosure of information to persons being involved in the assessment, collection, enforcement, proceedings of taxes covered by the request. This means that information may be disclosed to (i) the taxpayer and (ii) to judicial authorities charged with deciding whether the information should be released to the taxpayer or his proxy.

On the basis of the above, the TA ruled that:

- an authority allowed to disclose information in public proceedings is not entitled anymore to argue non-disclosure based on confidentiality rules;

- refusing the taxpayer/his proxy access to the information in the course of judicial proceedings would contravene the principle of fair trial.

The TA instructed the Luxembourg authorities to deposit the request for exchange of information to the court to enable the holder of information to be informed of its contents.

The Luxembourg judges play and will most probably keep on playing a key role in exchange of information matters. They bridge the gaps of the Law, clarifying and complementing it on aspects as essential as the period for which request are valid under the Law. The case law clarified the procedure of issuance of an information injunction. It clearly defined the authority competent for issuing the injunction and added a requirement for the issuing authority to state its reasons. Furthermore, when being seized of an information injunction, the judge is indirectly called to verify the legality of the underlying request. As such, the Luxembourg judge is called to define and appreciate the conditions of foreseeably relevance of the information requested, as set out by international standards. The foreseeably relevant nature of an information request is probably one of the issues of the procedure of information exchange which will give raise to the most numerous disputes in the coming months, before a clear and accepted standard is defined.

In the meantime, the OECD has again amended its exchange of information standards: an update of the OECD Model Tax Convention was released on 18 July 2012, which amends article 26 (exchange of information) in such a way that it now explicitly allows for group requests. This means that based on the new Model, the tax authorities will be able to request information from a group of taxpayers, without naming them individually, to the extent the request is not a ’fishing expedition’. Should this change be adopted by Luxembourg and its treaty partners in future, the procedure of exchange of information will be subject to some amendments.

On the 30 April 2012, the Danish government received formal notice from the European Commission, concerning the withholding tax regime that is currently applied by Denmark to foreign UCITS, which does not allow UCITS resident in other EU Member States or within the EEA to obtain an exemption from dividend withholding tax.

In the opinion of the Commission, the current regime infringes the free movement of capital as well as the free movement of services within the EU because it prevents Danish investors from investing in foreign UCITS, as well as preventing foreign UCITS from selling their services to Danish customers. Consequently, such rules are to be considered contrary to what is prescribed in the TFEU.

It is relevant to note that the Commission served the letter of formal notice to the Danish Government prior to the delivery of the Santander ruling of the 10 May 2012, whereby the ECJ concluded that the French rules on withholding tax on dividends distributed to foreign UCITS constituted a violation to the free movement of capital.

On 3 July 2012, the Danish Ministry of Taxation issued a statement to the Danish Parliament, accounting for the Danish position. The justification of the safeguard of the balanced allocation of taxing powers between the Member States was raised. However, case-law including the recent Santander case has consistently rejected this justification. The defence of coherence of the tax system was also raised, with the Ministry of Taxation claiming that a withholding tax exemption can be allowed only where there is taxation at investor level. As a consequence, the Danish investor is not in a position comparable to the non-Danish investor and so there is no issue of discriminatory treatment.

Whilst there are to some extent, some unique characteristics in the Danish regime, it is questionable to what extent this may be sufficient to allow the existing Danish withholding tax dividend regime applicable to foreign UCITS to prevail whilst not be compliant with EU law. The formal notice will increase the pressure on the Danish authorities, although to-date they have not shown any inclination to concede, notwithstanding what looks like a very weak position.

In a further development, the Danish Ministry of Taxation has also reduced the interest rate applicable to withholding tax refunds from 7.45% to 1.3% p.a. with effect as of 1 July 2012, irrespective of the date of the claim. Furthermore, a 6 month grace period during which no interest is accrued was introduced. This will make it easier for the Danish authorities to delay repayment of claims. It is likely that the external cost of borrowing for Denmark will remain higher than the interest rate it is giving on claims, making delays a profitable proposition for the Danish treasury.

This decision on the part of the European Commission follows a trend already set down by the ECJ in its rulings. Taxand is working on reimbursement claims in various European jurisdictions and is closely following recent developments occurring in the various Member States in this regard.

In a further development in the withholding tax reclaims field, Taxand has received the first positive decision for a refund to a US fund from Poland.

On the 25th of July 2012, the Polish tax authorities agreed to refund the withholding tax that had been unduly paid by the fund, in violation of the free movement of capital. In this case, the proceedings had not reached the courts, since the decision to grant the refund had been taken at first instance, at the level of the tax authorities.

The importance of this decision lies in the fact that the Polish tax authorities agreed with the arguments raised to challenge the imposition of withholding tax on the US fund. The tax authorities agreed that the US fund could be considered comparable to a Polish fund and so it should be afforded the same treatment, and that there was no justification to restrict the free movement of capital.

Although the amount reimbursed is minimal (PLN 117/EUR 28 it is important that the tax authorities have been willing to apply the principles that have already been developed by the ECJ in a string of cases, in order to reach a ground-breaking conclusion.

It is relevant to note that whilst the law in Poland is not based on precedent, and so it does not serve as a guarantee for further reimbursements, this decision can be used to strengthen the arguments for future claims.

By way of the Deutsche Bank Case (C-44/11) the European Court of Justice (ECJ) was recently deliberating a preliminary ruling regarding the treatment of portfolio management services rendered to private investors. The ECJ has just released their opinion, rejecting Deutsche Bank’s partial VAT exempt treatment position, and ruling that portfolio management services are in fact subject to VAT.

Deutsche Bank was instructed by private investors to manage securities, at its own discretion and without obtaining prior instruction from them, in accordance with the investment strategy variants chosen by them and to take all measures which seemed appropriate for those purposes. As it is current practice in the sector, the investors paid an annual fee based on the value of the assets under management. That fee mainly included a share for asset management and a share for buying and selling securities.

Deutsche Bank reported portfolio management services as VAT exempt in its VAT returns. This position was based on the VAT exemption applicable to transactions in securities or the negotiation of such transactions.

In its reasoning, the ECJ held that portfolio management services basically consist of a combination of a service of analysing and monitoring the assets of investors and purchase and sale of securities. While it can be defended that those two elements of the portfolio management service may be provided separately. The Court held that the average client investor seeks precisely a combination of those two elements and as they are so closely linked, they form, objectively, a single economic service.

As it is established jurisprudence that the VAT exemptions must be interpreted strictly, the ECJ held that neither the VAT exemption applicable to transactions in securities, or the negotiation of such transactions, nor the VAT exemption applicable to the management of investment funds could cover portfolio management services rendered to private investors. Such service as a whole must therefore be considered subject to VAT.

This ruling has negative impact to managers of private portfolios since up to now part of the service of portfolio management was VAT exempt; going forward it will be reflected in their pricing strategies and the margins of their portfolio management services.

The situation however is not beyond hope since, interestingly, in its conclusions. The Advocate General had mentioned that, in isolation, transactions services should benefit from a VAT exemption. Depending on operational processes and underlying agreements, there might still be opportunities to achieve a VAT exemption on part of the services rendered to private investors. We therefore suggest that portfolio managers review their operational processes and underlying agreements.

The current practice in Luxembourg is to consider brokerage services linked to the sale of properties via share deals as VAT exempt. This relies on a VAT exemption foreseen in the European VAT legislation applicable to transactions, including negotiation, in shares and other securities. The practice was however recently threatened by a case brought to the European Court of Justice (C-259/11 DTZ Zadelhoff vof vs. Staatssecretaris van Financiën).

DTZ Zadelhoff vof, a real estate brokerage and consultancy business provided services to companies holding, indirectly, all the shares of companies owning properties in the Netherlands. DTZ Zadelhoff vof was instructed by these companies to find purchasers for the properties. DTZ Zadelhoff vof considered the services consisting of finding buyers for the properties as VAT exempt and did neither charge nor paid VAT.

As stated above, the European VAT legislation applies a VAT exemption to transactions, including negotiation but not management or safekeeping, in shares, interests in companies or associations, debentures and other securities, but excluding documents establishing title to goods, and certain rights or securities.

The European VAT legislation however also offers Member States the option to consider as shares or interests equivalent to shares giving the holder rights of ownership or possession over (part of) immovable property as tangible property.

The good news is that in the above mentioned case the Court has ruled that the VAT exemption should be applied to transactions which are designed to transfer shares in companies holding properties.

However, the exemption should not be available in Member States which have implemented the option to consider, shares or equivalent interests giving the holder rights of ownership or possession over (part of) immovable property as tangible property.

Fortunately, Luxembourg has not implemented this option. Luxembourg companies paying brokerage fees within the framework of share deals still benefit from a VAT exemption. We however draw your attention to the fact that certain conditions must be met to apply the VAT exemption.

While the lack of liquidity has been stifling growth in the real estate market, experts agree that there are plenty of opportunities presented in both Southern and Northern Europe. When evaluating them, one must keep in mind conventional and fresh imperatives such as: THE RETURNS MIGHT BE WORTH THE RISK, ONE SIZE FITS NONE, CULTURE MATTERS and THE INVESTORS ARE IN THE DRIVING SEAT.

During the recent PEI PERE Summit in London (June 7-8, 2012), the Global Real Estate team of Taxand, represented by Keith O’Donnell, Managing Partner of ATOZ, Taxand Luxembourg and Global Real Estate Leader of Taxand, Henk de Graaf, Partner VMW, Taxand Netherlands and Sara Jacobsson, Partner Skeppsborn Skatt, Taxand Sweden had the opportunity to facilitate a panel, titled “Northern vs. Southern Europe: different markets and investors, equal opportunities?” The panelists included the following industry experts: Erika Olsen, Tenzing, Andrew Allen, Aberdeen, Peter Todd, Resolution and Simon Mallinson, Invesco. 

To find out what and where are the PERE opportunities in the next 18 months, who is likely to benefit, and how to achieve predictable returns through structuring, please review the key takeaway points from the conversation HERE.
 

“In the wake of the financial crisis, countries realized their urgent need to unlock new sources of revenue, as well as increase their efforts to collect revenue, particularly by fighting against tax evasion. In an increasingly global economy, one crucial element of success in fulfilling such needs is a country’s ability to obtain information about its taxpayers across borders. Thus, although the possibility to exchange information has been available pursuant to a variety of instruments for quite a long time, there have been significant changes to the information exchange landscape in just the last few years. All major jurisdictions with bank secrecy rules have been forced to limit the application of those rules in case of cross-border exchange of information requests. Since 2002, more than 500 taxpayer Information Exchange Agreements have been signed.”

Given this well-defined trend, the ATOZ Chair for European and International Taxation at the University of Luxembourg held a conference, examining the rights and procedures established in the different bilateral and multilateral agreements, providing for the exchange of information, as well as the mutual assistance directives at the level of the European Union. The excerpt above comes from the book, “Exchange of information and bank secrecy,” which is the compilation of the content presented at the conference.

The ATOZ Chair for European and International Taxation facilitated a seminar on Profit Attribution to Permanent Establishments, titled "The New Authorized OECD Approach". The subject was introduced and developed by Dr. Andrey Afanasiev - ArcelorMittal, Dr. Werner Haslehner - LSE, Philippe Neefs - KPMG, Elmar Schwickerath- E&Y as panelists, and Prof. Dr. Alexander Rust from Université du Luxembourg as moderator.

ATOZ, a founding member of Taxand is pleased to announce the results of the second annual Taxand Global Survey: "Taxand the CFO: Understanding Tax Changes as Economies Worldwide Drive Efficiency". The survey was conducted with an exclusive selection of our large, multinational clients located across the Americas, Europe and Asia, in order to examine the pressing tax challenges affecting businesses today. See highlights of the survey results below, and Taxand’s Take on some of the key issues revealed in the report.

• Tax Moves Up Board Agendas - unprecedented change at rapid speed increases the importance of tax by 16%

• Multinationals Battle for Investment - now the largest growing concern for multinationals (an increase of 5%)

• Harmonisation - the Double-Edged Sword - 75% multinationals desire tax harmonisation. At what cost?

• Increased Dialogue Between Authorities and Multinationals - 84% multinationals cite improved relationship with tax authorities

•The Rise of Citizen Activism - 72% multinationals believe public exposure is/has been detrimental to company reputation

• Increased Pressure on Tax Resources - 6% increase in multinationals with tax resources under stress

• Multinationals: "Tax is Not the Answer" - 76% of our respondents believe that economic woes cannot be solved by tax policy.

• Multinationals must ensure sufficient resources are allocated appropriately to meet rising demands from tax authorities

• Be prepared to report, be quick to respond, and use all tools in disputes

• To ward off unwanted scrutiny, multinationals should establish protocols, regularly document the status of tax audits and focus on accurate record-keeping

• Only engage in commercially driven transactions and beware of retrospective legislation

• Keep abreast of change and consider operational structures to maximise competitive moves for investment

• Multinationals beware of the political will for information exchange, and the consequent compliance costs