The Belgian Minister of Finance recently announced a proposal for a “first phase of a broader tax reform”. This blog discusses the proposed changes to the taxation of dividends and capital gains on shares in the hands of Belgian companies, some with significant impact on existing investment structures. The proposal, if adopted, could take effect as of 1 January 2024. Please refer to our briefing for further detail on these topics.
The dividend received “deduction” becomes a real “exemption”
Under current law, dividends and capital gains are fully exempt subject to the following conditions: (i) the shareholder must hold a stake in the distributing company of either at least 10% or with an acquisition value of at least EUR 2,500,000 (the minimum participation condition), (ii) the shares must have been held (or will be held) for at least one year (the holding period condition) and (iii) a number of conditions relating to the minimum level of taxation in the hands of the dividend distributing company and the absence of abuse (the taxation condition).
However for dividends this regime currently does not operate as a real exemption. Dividends are first included in the corporate tax base and are then, as part of the various steps in the tax return, deducted from the corporate tax base via the so-called dividend received deduction (DRD) regime. Any dividends that cannot be “deducted” due to insufficient taxable income, can be carried forward to subsequent years.
At various occasions, the Court of Justice of the EU has considered that this mechanism violates the EU parent-subsidiary directive (PSD). The Court clarified that member states which have implemented the PSD via the so-called “exemption method” (like Belgium), should provide for a “real exemption”. This requirement would not be fulfilled if the holding company is taxed more heavily in one way or another than would have been the case if it had not received the dividends (eg. by forfeiting another tax benefit).
Until today, the DRD regime is not fully compatible with the PSD. As discussed in a previous blog, one important remaining incompatibility relates to Belgium’s tax consolidation regime which allows a profit-making company to shift tax base (via a “group contribution”) to a group company to offset the latter’s current-year losses. However, the Belgian income tax code provides that no DRD can be deducted from a “group contribution”. This means that the group contribution regime cannot be effectively used to the extent the holding company receives dividends in the same year.
The Minister of Finance now proposes replacing the DRD by a “dividend received exemption” (DRE). The received dividend would thus no longer be first included in the tax base but will instead ab initio be excluded from the tax base via an increase of the initial state of the taxed reserves, just like the way capital gains on shares are currently already “exempt”. The “real” participation exemption would apply to any dividends fulfilling the minimum participation condition, the holding period condition and the taxation condition, and not only to dividends in scope of the PSD.
This is a welcome change that should put an end to EU incompatibility issues, including the one referred to above.
Companies holding less than 10%: participation must qualify as financial fixed assets
Companies holding a minimum participation of less than 10% but with an acquisition value of at least EUR 2,500,000 would in the future only benefit from DRE and capital gains tax exemption if the participation qualifies as “financial fixed assets”.
This requirement is (re)introduced to ensure that the DRE and capital gains tax exemption is only granted in cases where there is a durable and specific relationship between companies, and the participation is not held purely for investment purposes. As discussed further in our detailed briefing, the notion “financial fixed assets” is an accounting principle and should in principle be interpreted accordingly.
The question whether shares qualify as financial fixed assets should be determined by the management body of the shareholder in the first place. Companies are advised to duly document the reasons why shares are considered as financial fixed assets and obviously to record the shares accordingly in the accounts.
However, what will matter most is that shares are financial fixed assets in nature. While a recording of shares qualifying as financial fixed assets under one of the above subsections is the normal consequence for companies that are subject to Belgian GAAP, an (incorrect) recording as “investments” should not per se prevent companies from claiming DRE or capital gains tax exemption. For the same reason, the fact that the introduction of the financial fixed asset condition causes companies to revise and rectify the accounting treatment of shares should not be considered problematic or abusive if the accounting classification as financial fixed assets can be justified.
It is finally to be noted that qualifying non-resident shareholders that hold a participation in a Belgian company of less than 10% but with an acquisition value of at least EUR 2,500,000 benefit, subject to certain conditions and limitations, from an exemption from Belgian dividend withholding tax that can be claimed via a reimbursement procedure or even at source (Article 264/1 ITC). This exemption would now also become subject to the financial fixed asset condition, which may cause interpretation questions as non-resident shareholders may apply different accounting classifications. In any case, in order to benefit from this dividend withholding tax exemption, the classification as financial fixed asset will have to be confirmed by the shareholder in a written attestation. The dividend distributing company can normally rely on such attestation when applying the exemption at source and does not have an active investigation duty in this respect.
Minimum participation and holding period condition: exception for investment companies abolished
Under the current regime, the minimum participation and holding period conditions do not need to be fulfilled with respect to shares held in investment companies (and regulated real estate companies) and with respect to shares held by investment companies (and regulated real estate companies). Dividends and capital gains on such shares are fully exempt provided that the taxation condition is fulfilled, regardless of the size or holding period of the participation.
The Minister of Finance proposes abolishing such preferential treatment: in order to benefit from dividend and capital gains tax exemption, the minimum participation condition and holding condition would have to be fulfilled in all circumstances, in addition to the taxation condition.
One of the obvious and clearly intended “victims” of this proposal are the so-called “DBI-beveks/Sicavs-RDT”, i.e., tax-exempt regulated investment companies (UCITS) that meet the taxation condition (because they invest in normally taxed companies and distribute at least 90% of their net income). DBI-beveks have become a rather popular and commercialised investment product for Belgian companies as it offers a tax-free return on their excess cash regardless of the size of the investment.
However, the proposals are much further reaching as today many investment structures rely on the exception, including those involving the Belgian private equity fund “Private Privak/Pricaf Privée” (namely the Private Privak of the so-called “second category”, which does not have the full tax-exempt status). Belgian companies that invested less than EUR 2,500,000 in such funds would automatically lose the current tax exemption on their return and companies that invested less than 10% but with an acquisition value of at least EUR 2,500,000 would only keep the exemption if the new financial fixed asset condition would be fulfilled.
In addition, if the fund invests in shares with an acquisition value below EUR 2,500,000 (and representing less than 10%), the fund itself would also be taxed on its return.
As discussed further in our detailed briefing, requiring the participation condition in the context of a Private Privak structure would reverse a significant incentive intentionally created by previous governments and would fundamentally deny the specific position of privately held companies, and start-ups in particular. Requiring the minimum participation condition at the level of the Private Privak would furthermore mean that the investment structure even no longer achieves tax neutrality for investors which is inconsistent with established tax policy. There therefore seem compelling reasons to reconsider the proposal, at least as far as the Private Privak is concerned.