ECJ renders decision in Fidelity Funds case (C-480/16): EU free movement of capital entitles non-resident mutual fund to refund of Danish dividend withholding tax, if it meets Danish distribution requirements.
Today, the ECJ rendered its decision in the landmark “Fidelity Funds” case. The ECJ rules that the free movement of capital precludes a Member State’s tax regime under which its resident “UCITS” (EU regulated mutual funds) are entitled to exemption from dividend withholding tax on dividends received from resident companies, because they make (or calculate) minimum distributions which are subject to a substitute withholding tax levied by such UCITS from their unitholders, while non-resident UCITS that make (or calculate) and tax such minimum distributions are not entitled to such exemption.
The case facts
Fidelity Funds (“Fidelity”), a UK based “Undertaking for Collective Investment in Transferable Securities” (“UCITS”, an EU regulated form of a mutual fund), had filed reclaims of Danish withholding tax levied from dividends received by it from Danish companies between 2000 and 2009. In the ensuing legal proceedings the Danish Eastern Regional Court referred the case to the ECJ for a preliminary ruling on questions of EU law.
Under Danish law, Danish UCITS are subject to withholding tax at source on dividends received from Danish companies, unless they:
- are covered by article 1(1)6 of the Law on corporation tax (and therefore resident in Denmark) and
- make minimum distributions, or calculate minimum distributions (where actual payment is deferred), taxed in the hands of its unitholders by means of tax at source levied by the UCITS. The minimum distribution being the sum of net revenue for the year minus losses and expenses (effectively the entire annual net revenue). Fidelity argued that they are unable, by their very nature as a UK fund, to meet the first condition which effectively requires that they be resident in Denmark. This is a violation of the free movement of capital.
Fidelity further argued that the second condition is contrary to the freedom to provide services, but that they have no incentive to satisfy this condition as they would still be ineligible, for failing to meet the first condition.
Opinion of the Attorney General
The ECJ’s Attorney General (Mengozzi) concluded, on 20 December 2017, that: • The Danish tax legislation at issue is to be examined in light of the free movement of capital only (as the freedom to provide services is, in light of the purpose of that legislation, only secondary). • There is a difference in tax treatment, which may discourage non-resident UCITS from investing in Danish companies and Danish resident investors from acquiring shares in non-resident UCITS, and which is a restriction of the free movement of capital which is contrary to article 63 TFEU. • The violation of article 63 TFEU is not acceptable under EU law because the difference in treatment concerns situations which are objectively comparable. • The violation of article 63 TFEU is not justified by the need to ensure a balanced allocation of taxation powers (where a member state has chosen not to tax a resident UCITS, it cannot rely on this argument) • The violation of article 63 TFEU might have been justifiable by the need to safeguard the coherence in the tax system (because the direct link between the tax advantage that is the exemption from withholding tax and its offsetting by means of the immediate taxation of the profits distributed in the hands of the UCITS’ unitholders would vanish if that exemption were also granted to UCITS which do not make minimum distributions to their unitholders). However, in order for a restriction to be accepted, it must also be appropriate and proportionate in light of the aim of safeguarding the coherence of the tax system. • As it cannot be ruled out that non-resident UCITS may voluntarily satisfy the distribution conditions in Danish legislation, they should – in such case – also enjoy the exemption from tax at source, provided that the tax authorities of that member state ensure, with full cooperation of the UCITS, that the UCITS pay a tax that is equivalent to the tax which Danish UCITS are required to retain. • Therefore the free movement of capital precludes a Member State’s tax regime under which its resident “UCITS” (EU regulated mutual funds) are entitled to exemption from dividend withholding tax on dividends received from resident companies, because they make (or calculate) minimum distributions which are subject to a (substitute) withholding tax levied by such UCITS from their unitholders, while non-resident mutual funds that make (or calculate) and tax minimum distributions are not entitled to such exemption. • However, in the end this conclusion cannot benefit Fidelity as it did not even attempt to meet the Danish minimum distribution requirements.
The ECJ´s decision
The ECJ follows the opinion of the AG. In respect of the objectively comparability, the ECJ interestingly notes that, in view of the objective of shifting the level of taxation from the investment vehicle to the unitholders, it must be considered that a non-resident UCITS may have unitholders who are resident in Denmark for tax purposes and from whose income that Member State may exercise its taxing power. From this point of view, a non-resident UCITS is in a situation objectively comparable to a UCITS resident in Denmark. The fact that Denmark cannot tax non-resident unitholders on dividends distributed by non-resident UCITS, is consistent with the logic of moving the tax level from the vehicle to the unitholder.
On the matter of justification by the need to ensure a balanced allocation of taxation powers, the Court also follows the AG and adds that dividends distributed by companies resident in Denmark to non-resident UCITS have already been subject to taxation in Denmark in respect of the profits of the distributing company (Danish CIT on the profits before they are distributed). The fact that the taxation of dividends is carried forward at the level of the shareholders of the resident UCITS can therefore not justify the restriction at issue in the main proceedings.
On the matter of justification by the need to preserve the coherence of the tax system, the Court also follows the AG (the Danish legislation is not appropriate or proportional to the purpose) and adds that the internal consistency of the tax scheme at issue could be maintained if non-resident UCITS who satisfy the minimum distribution conditions could benefit from exemption from withholding tax, provided that the Danish tax authorities ensure, with the full cooperation of these bodies, that they pay an equivalent tax to that which Danish UCITS must withhold as a withholding tax on the minimum distribution.
This decision is likely to impact the Dutch DWT (as well as DWT levied by other member states) levied from non-resident (EU or non-EU) mutual funds, who have also filed claims which the Dutch Supreme Court has referred to the ECJ for a preliminary ruling. It remains to be seen whether the Dutch Supreme Court feels it will be able to render its decision based on the ECJ Fidelity ruling, or whether it sees other reasons to await the ECJ’s ruling. In any event, this decision significantly improves non-resident mutual funds’ (including those outside the EU) chances of reclaiming DWT in EU member states.
3 December 2018 update:
**On 3 December 2018, in Dutch cases similar to the Fidelity Funds case, the Dutch Supreme Court has decided to revoke one of three pending preliminary questions. The question revoked concerns the question whether not granting a refund of DWT because non-resident investment funds are not subject to Dutch dividend withholding tax (because of their non-residence) is a violation of the free movement of capital. It is now clear that not granting a refund for this reason is a violation of the free movement of capital. The questions maintained are whether: **
- Not granting a refund of DWT on the basis that the unitholders have not demonstrated that they meet the same conditions that resident unitholders of resident investment funds are required to meet is a violation of the free movement of capital
- Not granting a refund of DWT on the basis that the non-resident investment fund does not distribute its return on investment to its unitholders within 8 months following the end of the year in which the return on investment was realized is a violation of the free movement of capital