In this article on the Fokus Bank Case ruled by the EFTA Court, we look in detail at the case and its possible ramifications.
On November 23, 2004 the EFTA Court decided in the so-called Fokus Bank case. I believe that this decision has huge potential repercussions for withholding taxes in the European Economic Area (hereafter EEA) and hence in the European Union.
According to Norwegian national law during 1997 and 1998 dividends paid out by a company residing in Norway to shareholders residing in Norway were taxable as general income, while dividends paid out to shareholders not residing in Norway were taxed at 15 percent. To avoid economic double taxation shareholders with general tax liability in Norway were granted an imputation tax credit against the tax assessed on general income. This tax credit corresponded to the amount of the tax paid by the company on the dividends that have been distributed. Shareholders residing abroad were not granted an imputation tax credit. Neither Norway's tax agreement with Germany or with the United Kingdom entitled taxpayers residing in those two countries to the same imputation tax credit as taxpayers residing in Norway. In 1997 and 1998 Fokus Bank ASA, resident for tax purposes in Trondheim, Norway, distributed dividends to its shareholders. Among those shareholders were two companies residing in Germany and the United Kingdom respectively. Immediately before the decision to pay out dividends was taken, these companies sold their shares in Fokus Bank to companies residing in Norway, and exercised an option to buy back the shares shortly after the dividend payments had been completed. Fokus Bank did not withhold dividend tax on the dividends paid on the transferred shares. In 2001 the Trondheim overligningsnemnd (the Trondheim Tax Assessment Appeals Board) found that the foreign shareholders had to be regarded as the owners of the shares at the time of distribution of the dividends. In 2003, Trondheim kemnerkontor (the Trondheim Tax Collection Office) held Fokus Bank liable for the dividend tax resulting from this reclassification of ownership. Fokus Bank appealed against this decision and finally the Frostating lagmannsrett (Frostating Court of Appeal) referred the following questions with regard to the above to the EFTA Court:
The EFTA Court reduced these questions to the question of whether Article 40 of the EEA Agreement (hereafter EEAA) precludes legislation whereby shareholders residing in Norway are granted a tax credit on dividends paid by a Norwegian company, whereas shareholders residing outside Norway are not granted such a tax credit. The EFTA Court subsequently confirmed that this is precluded, based on the following considerations:
In the second part of this article I will give a brief introduction to the EEA, the EFTA Court and their relation with the European Union and the ECJ. Thereafter, I will go into the significance of this decision in a broader context. I will deal with the relation between this case, Anneliese Lenz and Petri Manninen, the question what this decision means for dividend withholding tax regimes within the EEA and the European Union and whether these consequences could also apply with regard to the taxation of cross border interest and royalty payments.
The EEA consists of the E.U. member states plus the EFTA states (Norway, Iceland and Liechtenstein). More general information about the EEA and EFTA can be found at http://secretariat.efta.int/Web/EuropeanEconomicArea/introduction.
The aim of the EEA Agreement is to promote a continuous and balanced strengthening of trade and economic relations between the EEA member states with equal conditions of competition, with a view to creating a homogeneous European Economic Area. In order to attain these objectives the agreement provides for the free movement of goods, persons, services and capital.2 The free movement of capital means that there should be no restrictions between the member states on the movement of capital belonging to persons resident in EC member states or EFTA states and there should be no discrimination based on the nationality or on the place of residence of the parties or on the place where such capital is invested.3
The free movement of capital as worded in the EEAA essentially reflects the wording of the free movement of capital under Article 56 of the EC treaty.4 However, it does seem to be worded more narrowly (and perhaps more accurately) with regard to third countries than the EC treaty, since it seems to only confer rights to residents of the EEA.5
As the EFTA Court itself considered, Article 6 of the EEAA determines that the provisions of the EEAA, in so far as they are identical in substance to corresponding rules of the EC Treaty, shall be interpreted in conformity with the relevant rulings of the Court of Justice of the European Communities given prior to the date of signature of the EEAA. With regard to subsequent case law, the EEA Joint Committee (body responsible for the management of the EEAA) keeps under constant review the development of the case law of the Court of Justice of the European Communities and the EFTA Court. If a difference in case laws of the two courts are brought before the EEA Joint Committee and if the Committee is unable to preserve the homogenous interpretation of the EEA then further procedures will be applied with the aim of preserving homogeneity.6
One only has to look at the format of the EFTA decision to see the similarities in the judgments of the ECJ and the EFTA Court: first the facts of the case, then the questions of the national court, the relevant national law, relevant EEA law, arguments of the parties before the EFTA Court, considerations of the EFTA Court, and finally the payment of costs and the EFTA Court ruling. When subsequently looking at the EFTA Court considerations, it is not only the references to the ECJ decisions that remind one of the homogeneity, but also the line of argument. First, the Court determines that is has jurisdiction, it then finds the restriction/discrimination and looks for possible justifications. Also, the manner of identifying discrimination, and dealing with coherence, leads one to the conclusion that this decision could have been taken by either court.
Although the EFTA Court relied heavily on the ECJ decisions in the Anneliese Lenz case and the Petri Manninen case, and might have had difficulty in coming to a decision if the ECJ had not paved the way in these cases, there is an essential difference between these cases and Fokus Bank: both Anneliese Lenz and Petri Manninen concerned outbound investments, whilst Fokus Bank concerned inbound investments.
Anneliese Lenz7 lived in Austria and invested in companies resident in Germany. Had those companies been resident in Austria, Mrs. Lenz would have qualified for a choice of either being taxed at a fixed rate of 25 percent or at the general tax rates, but on only half the dividend. Instead, she was expected to pay the full rate of tax over the full dividend. Petri Manninen was resident in Finland and invested in a Swedish listed company. Had he invested in a Finnish company, he could qualify for an indirect income tax credit on the dividends he received. In both cases the ECJ determined that Austria and Finland had to apply their domestic measures for the prevention of economic double taxation not only to investments in resident companies, but to all E.U. companies.
Although these ECJ decisions must have been of great assistance to the EFTA Court, it still had to decide on a situation that has not yet been before the ECJ. In deciding for the taxpayer the EFTA Court has gone further than the ECJ, as will be explained later in this article.
It is possible to take both a narrow or a broad view of the consequences of the Fokus Bank decision. Under the narrow view, the decision only has consequences for EEA member states which have a system similar to Norway of taxing dividends. Under a more extensive view, the Fokus Bank decision not only impacts systems similar to the Norwegian one but affects all withholding taxes on dividends where the source state provides for (some) relief from economic double taxation for resident shareholders. Finally, taking it one step further, one may wonder whether Fokus Bank is not the end of all taxation at source on a gross basis. I will look at each of these points of view.
Dividends paid out by a company residing in Norway to shareholders residing in Norway are taxable as general income. To avoid economic double taxation, resident shareholders are granted an imputation tax credit against the tax assessed on general income. This tax credit corresponds to the amount of the tax paid by the company on the dividends that have been distributed. So if a Norwegian company, Xco, made a profit of 100, it paid tax of 28 and could distribute 72. The Norwegian resident(s) receiving the 72, would be taxable at a rate of 28 percent over 72, but would at the same time receive a credit of 28 percent over 72, thereby owing nothing to the Norwegian tax authorities. Such a system is generally referred to as a full imputation system.
The imputation system has various forms. Some systems may involve first grossing the dividend received to the original gross amount (100 in the above example) and then calculating and crediting the tax on the basis of the grossed up amount; a system like the old U.K. ACT system and the French Avoir Fiscal involving some payments in combination with the dividend received. Some systems only give partial relief for the underlying tax paid, for example, by only giving partial payments in combination with dividends received or by lowering the creditable tax rate. These systems have in common that they try to (partially) eliminate economic double taxation of profits and profit distributions.
To the extent that EEA member states have such imputation systems in place for domestic dividends paid to domestic shareholders, the Fokus Bank decision requires such member states to also provide effectively the same level of double tax relief for residents of other EEA member states, regardless of the double tax relief available to those non-residents in their respective states of residence.
Two interesting questions arise, but are not covered in this article, since each may require a lengthy analysis. They are:
A more extensive interpretation of the Fokus Bank case could be that wherever an EEA member state provides relief from economic double taxation on profit distributions, for example, through a participation exemption system combined with a refund of national dividend withholding tax or an exemption from national dividend withholding tax, such relief should be provided to residents in other EEA member states as well. Here again, the question will arise as to what a different treatment of resident corporate and resident individual shareholders means to individual shareholders resident in other EEA member states. As can be deduced from my comments above, I doubt whether such discrimination is allowed.
Both the ECJ and the EFTA Court take an economic approach in determining when there is discrimination or a restriction that is unjustifiable (see Section II. i.). I therefore believe the Fokus Bank case means, at the very least, that to the extent that any EEA member provides relief from economic double taxation on profit distributions to resident shareholders, it is obliged to provide relief from taxation at source on profit distributions to individuals or corporations resident in other EEA member states which fulfil the same conditions as the resident beneficiaries. However, those conditions may not include being subject to tax as a resident or being a corporation rather than an individual.
Let us assume that ACo resident in state A borrows money from a bank at 5 percent and then lends that money to BCo at 5.25 percent. Clearly, if BCo were also resident in state A, a normal tax system would allow BCo and ACo deductions of 5.25 percent and 5 percent respectively, and would tax ACo on the 0.25 percent spread it made. However, if BCo was resident in state B, which levies a 10 percent source tax on gross outgoing interest payments, then BCo and ACo would presumably still get deductions of 5.25 percent and 5 percent respectively, but ACo would pay a total tax of at least 0.525 percent (10 percent of the amount of the interest paid) which, considering the fact that its profit spread is only 0.25 percent, constitutes tax at a rate of 210 percent.
Could there be any reason why the EFTA Court (or for that matter the ECJ) should tolerate the above results while it does not tolerate the economic double taxation stemming from the Norwegian system in the Fokus Bank Case? I do not think so. Again, using the same system as has been used in the Fokus Bank Case, one would have to argue that:
The Court should reject any plea for justification on the basis of cohesion, arguing - inter alia - that permitting derogations from the EEA fundamental on the grounds of safeguarding the cohesion of the international tax system (source tax is always gross with relief granted by the resident state), would amount to giving bilateral tax agreements preference over EEA law.
While many (but still too few) tax practitioners in the European Union follow the developments of E.U. law and in particular the tax decisions of the ECJ, it is my impression that hardly any of them do the same with EEA developments and the decisions of the EFTA Court. This is a dangerous path to follow, since both are in many respects of equal importance and relevance.
During the proceedings before the EFTA Court, it was pointed out the Norwegian Government recently proposed legislation to abolish the imputation tax credit with regard to dividends paid to natural persons (i.e., to go to a classical system), and that dividends be exempt from the imposition of tax with regard to legal persons, irrespective of whether they reside in Norway or abroad.
It remains to be seen if other EEA member states will follow suit. It also remains to be seen whether member states will draw any of the conclusions I have drawn hereabove. Until now there seems to have been nothing but silence.
1 The national court's questions on the Norwegian authorities disregarding non-resident shareholders as parties to the discussion in this and similar matters and the EFTA Court's decision it is not consistent with the EEA Agreement that a member state deals solely with the distributing company when assessing and re-assessing the withholding tax without notifying the non-resident shareholders, is not dealt with in this article.
2 EEA Agreement, Articles 1 & 2
3 EEA Agreement, Article 40
4 "Within the framework of the provisions set out in this chapter, all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited."
5 EEA Agreement, Art. 40, first sentence: "Within the framework of the provisions of this Agreement, there shall be no restrictions between the member states on the movement of capital belonging to persons resident in EC member states or EFTA States and no discrimination based on the nationality or on the place of residence of the parties or on the place where such capital is invested". vs EEC, art. 56: "Within the framework of the provisions set out in this chapter, all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited".
6 EEA Agreement, Article 105
7 Before the Anneliese Lenz case the Walter Schmid (Case C-516/99) case was brought before the ECJ.
8 One does not read anywhere in the EC Treaty or the EEAA that it is acceptable to treat corporations better than individuals when it comes to general discrimination or the application of the fundamental freedoms. Furthermore, the EFTA Court's consideration "that permitting derogations from Article 40 EEAA on the grounds of safeguarding the cohesion of the international tax system, would amount to giving bilateral tax agreements preference over EEA law" seems to leave little room for the argument that it is accepted - by governments - under international tax law that individuals may suffer economic double taxation under a classical tax system, but corporations not. Finally, I point out that any argument based on the Parent Subsidiary Directive , such as that it too only applies to corporations, is futile unless it has first been established that the Directive itself is not in contravention of primary EC law.
9 I am not saying that this is the way the Norwegian system works, I am saying imagine that it (or any other EEA member with an imputation system) did work this way.
10 Mr. Gerritse was a Dutch drummer who performed in Germany and had to pay a flat tax of 25 percent on his income received in Germany. Mr. Gerritse argued that this restricted him in his freedom to provide services in Germany since he paid more tax than German residents would. Although the ECJ in principle agreed with Mr. Gerritse, it did not rule in favour of Mr. Gerritse due to the fact that the Commission calculated that Mr. Gerritse would in fact have had to pay 26 percent tax in Germany, had he been treated as a resident taxpayer
11 Mr. Wallentin was a German student with a holiday job in Sweden (less than 90 percent of his total income). Since he only received non-taxable income in Germany (support from his parents and a housing grant), he could not benefit from a tax-free amount in Germany, and did not qualify for a tax free amount in Sweden since he was not a resident. He argued - and the ECJ agreed - that under those circumstances, Sweden should allow him the same tax-free amount it allows for residents, when taxing his Swedish holiday income.
Last reviewed 25 June 2005
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