Luxembourg Trillion Dollar Fund Industry Faces Tax Legal Test
By Joe Kirwin
Luxembourg's trillion-dollar asset fund industry faces a crucial EU court test in a Danish dispute concerning cross-border interest and dividend payments.
In a series of European Court of Justice cases (C-114/16, C-115/16) that pose a risk to the $3 trillion Luxembourg-based fund industry, ECJ Advocate General Juliane Kokott advised on the conditions for when cross-border payments can and can't be taxed at source.
The ECJ AG said the EU Interest and Royalties Directive doesn't allow EU national tax authorities to impose taxation at the source of cross-border payments without identifying who it believes is the beneficial ownership of the funds.
In a separate AG opinion (C-299/16), Kokott took a similar legal line when it comes to beneficial ownership and dividend cross-border payments as it concerns the EU Parent-Subsidy Directive. The AG's opinions aren't binding on the ECJ but are usually followed by the EU high court.
The March 1 cases stem from a legal dispute between Danish tax authorities and Danish industrial company Z Denmark, which shifted interest and dividend payments to its subsidiary Z Luxembourg before the money was transferred onto a capital fund outside the EU.
The Danish tax authorities, with the support of the Danish Ministry of Taxation, imposed a withholding tax on the cross-border payments because they believed the funds were being funneled offshore through the Luxembourg subsidiary without being taxed.
Z Denmark appealed to the West Region Court of Appeal, which referred the cases to the ECJ concerning both the EU Interest and Royalties Directive and the EU Parent Subsidiary Directive.
In the case of C-115/16 and the legal dispute involving the EU Interest and Royalties Directive, Kokott said the Danish authorities could not impose a withholding tax on the cross-border payments to the Luxembourg entity unless Z Luxembourg “was acting not in its own name and on its own account but for and on the account of the third party when transferring the funds outside of the EU.” Kokott said the same principle applied in the C-299/16 case involving dividend payments.
Tax Abuse However Kokott also said that “there is tax abuse in the case of artificial structures, without economic substance or created only to avoid taxation” when it concerns cross-border payments from a multinational company to a subsidiary before being shifted outside the EU. There wasn't enough evidence to determine if this was the case with the Danish company cross-border payments, Kokott said.
In another important conclusion drawn by the AG, Kokott advised that companies couldn't rely on the Organization for Economic Cooperation and Development (OECD) Model Tax Convention as a legal basis vis a vis the EU Interest and Royalties Directive or the EU Parent-Subsidy Directive for arguing that cross-border payments should not be taxed at source.
“The notion of beneficial owner must be interpreted autonomously into EU law, independent of comments on Art. 11 of the 1977 OECD Model Convention or later versions,” Kokott said.
Luxembourg Fund Industry Risk
The AG opinion was welcomed by Stine Andersen, a tax lawyer with the Danish law firm Kromann Reumert, which represented the companies.
“If the ECJ were to back the Danish tax authorities’ interpretation it could potentially be very damaging for funds operating out of Luxembourg, including the many funds established there for reasons not related to tax,” Andersen told Bloomberg Tax in a March 5 email statement. “It could also create uncertainty more generally within the internal market concerning source taxation.”
Raymond Krawczykowski, a head of cross-border tax at Deloitte in Luxembourg, told Bloomberg Tax the AG opinion position concerning the OECD Model Taxation is particularly important for the future application of EU law.
“Given the introduction by the OECD of the Principal Purpose Test in the multilateral instrument, the latter might impose stricter rules to benefit from tax treaties in the future,” Krawczykowski told Bloomberg Tax in a March 7 email. Tommaso Faccio, a company tax lecturer at the University of Nottingham, told Bloomberg Tax the pending case is a prime example of the need to clamp down on profit-shifting via Luxembourg.
“The reality is that the decision to set up the firm [in Luxembourg] was taken by the fund and this goes to the center of the problem of tax avoidance through profit shifting,” Faccio told Bloomberg Tax in a March 5 email. “The days where your unique competitive advantage is that you can facilitate tax avoidance structures should be put to an end. Luxembourg's success has resulted in significant losses for the rest of EU member states.”
For the past seven years, the EU has been negotiating a revision to the EU Interest and Royalties Directive to give EU member states more power to prevent tax abuse of cross-border interest payments. However, the revisions have been blocked in the Council of Economic and Finance Affairs since the European Commission made the revision proposal in 2011. The most recent effort to progress on the issue occurred in 2015 when an effort was made to adapt the legislation to give EU member state tax authorities more power to impose anti-tax abuse measures.
Jeppe Kofod, a Danish member of the European Parliament and a prominent member of the institution's Luxleaks and Panama Papers investigative tax committees, refused to comment on the specifics of the two ECJ Danish cases. However, he criticized EU member nations for failing to progress on the revision of the EU Interest and Royalties Directive to prevent multinational company profit shifting and tax avoidance.
“It is clear the current systems of corporate taxation in Europe are broken,” Kofod told Bloomberg Tax in a March 6 email. “Overlaps between differing national systems, third-country agreements and untold loopholes make Europe a prime target for aggressive tax planning.
“We have seen a wealth of these cases and they all underscore the fact that we need wholesale reform of business taxation in Europe,” Kofod said.
According to the Association of the Luxembourg Fund Industry, at the end of 2017 asset funds domiciled in the country totaled 4.15 trillion euros ($5.146 trillion), by far the largest in the EU even though the EU member nation is one of the smallest.