Withholding tax ("WHT") levied on interest payments, dividends and royalty fees often discourages non-resident investors from doing business in Belgium. This is mainly because WHTs are levied on a gross basis and constitute a final tax burden for non-resident investors. If such investors were established in Belgium, they would be taxed on a net basis (after deducting expenses related to such investments and/or tax losses carried forward) and could enjoy specific tax advantages (i.e. exemptions and/or tax credits). Non-resident investors who carry forward tax losses and/or enjoy a beneficial tax regime in the resident state are often precluded from obtaining tax credits with respect to Belgian WHT.
To "solve" this problem, non-resident lenders often include provisions in their loan agreements shifting the additional tax burden to the Belgian borrower. These so-called "tax gross-up clauses", however, undermine the competitive position of foreign financial service providers who are not exempted from WHT by domestic law or treaty provisions. The same applies to cross-border royalty fees, which either make such services less profitable or increase the cost of technology for the licensees.
Taxes withheld on dividends which do not fall under the Parent-Subsidiary Directive are rarely subjected to tax gross-up clauses and can thus significantly decrease the return on investment.
European freedoms vs. withholding taxes: some milestones at the ECJ
Over the past decade, the Court of Justice of the European Union ("ECJ") has been targeting taxation barriers that restrict the fundamental freedoms of the European Union (such as the freedom of establishment and free movement of capital and services). Many ECJ cases address the issue that is inherent to the nature of WHT (i.e. taxation of gross income as opposed to the effective tax burden of the domestic investors).
Recent ECJ case law and an opinion from the Advocate General put further pressure on Member States to reconsider their non-resident tax regimes and to allow companies to claim a refund of excessive taxes withheld on their investment income. Below is a summary of some key points.
Foreign shareholders may not be treated less favourably than domestic shareholders
It has become apparent that Member States may not subject non-resident investors to a higher tax burden on dividends than resident companies enjoying tax advantages such as the participation exemption, the reduced taxable base for UCITS and/or or tax credits (cf. ECJ C-487/08, Commission v Spain; C-540/07, Commission v Italy; C-303/07, Aberdeen; C-379/05, Amurta; C-170/05, Denkavit; EFTA Court E-1/04, Fokus Bank).
The Tate & Lyle decision from 2012 (C-384/11) had already forced the Belgian legislator to introduce a reduced WHT rate on dividends distributed to non-resident receiving companies holding less than 10% of the capital of the distributing company (and, hence, not eligible for the withholding tax exemption under the Parent-Subsidiary Directive) but with sufficient acquisition value for the purposes of the Belgian participation exemption. Following the increase of the participation exemption (from 95% to 100%) under the corporate tax reform, this special WHT rate has even become a full WHT exemption with effect from 1 January 2018.
Taxation of gross interest income violates EU law
The ECJ also held that, although Member States may tax non-residents under a WHT regime (C-282/07, Truck Center), the imposition of WHT cannot amount to taxing a non-resident on a gross basis while residents are taxed on a net basis, after deduction of expenses (C-18/15, Brisal and KBC Finance). The Brisal and KBC Finance case concerned interest payments by a Portuguese borrower, Brisal, to a syndicate of banks including an Irish bank, KBC Finance. Brisal was obliged to withhold a 15% tax on its interest payments to KBC Finance (this being a reduced rate under the double tax treaty). No WHTs were applied to the interest payments to Portuguese lenders, which were, furthermore, taxed on a net basis. The ECJ ruled that non-resident taxpayers should be allowed to deduct expenses "directly related to interest income arising from a financial loan agreement".
Although this decision may leave room for interpretation regarding what expenses are considered to be directly related to the income at stake, it should be regarded as a milestone which, obviously, gave rise to further questions.
The Advocate General's opinion on taxation of loss-making investors and WHT on gross dividend income
One of the questions raised by the Brisal and KBC Finance case relates to the position of loss-making non-resident companies. Since WHTs are levied on a gross basis, non-resident investors can (at least) suffer from a considerable cash-flow disadvantage compared to resident investors in a similar situation. Indeed, the latter are only taxed if they become profitable. Therefore, resident loss-making companies that are subjected to WHT can claim a refund, whereas non-resident loss-making companies have to bear the tax burden effectively and immediately.
The highest administrative court in France ("Conseil d'Etat") recently requested a preliminary ruling from the ECJ with respect to this issue. Three Belgian companies received dividends from French companies which were not eligible for the participation exemption under the Parent-Subsidiary Directive. Since the companies were loss-making, the WHT resulted in a non-recoverable expense. The Belgian companies considered that they had been discriminated against compared to French companies in a similar position and requested a refund of the tax levied.
Advocate General Wathelet (in his opinion of 7 August 2018 in case C-575/17) considers the fact that loss-making French companies are taxed only on the amount of the dividends they receive once they become profitable (and potentially never if they are liquidated before that date), while loss-making non-resident companies are always taxed on a gross basis, to be a serious disadvantage which interferes with free movement of capital. His opinion states that this disadvantage can be justified neither by the object and purpose nor by the coherence of the tax system (taxing non-residents while not (yet) taxing residents is simply discriminatory).
Furthermore, the Advocate General considers the fact that foreign investors cannot deduct expenses directly linked to the dividend income, whereas domestic investors can, to be an unjustified restriction of free movement of capital which cannot be compensated for by the higher tax rate on the net income of domestic companies (thereby adhering to the Brisal and KBC Finance case law).
The ECJ has not yet rendered its decision, but it often follows its Advocate General's opinions. Hence, foreign investors should start assessing the feasibility of potentially taking action (including conservatory measures).
What does all this mean for your company?
If your company receives interest payments, dividends and/or royalty fees from Belgium and its investment is highly leveraged or requires other substantial expenses, and/or your company is making losses, you might consider claiming a refund of the taxes withheld in Belgium.
We will be happy to assist you in assessing the feasibility of taking such action.