CJEU finds Spanish withholding tax rules applicable to non-resident loss-making investors are contrary to EU right to free movement of capital

The Court of Justice of the European Union (CJEU) has recently issued a judgment (Case C-601/23) on the entitlement of a non-resident taxpayer in a loss-making position to recover withholding taxes borne at source (the Judgment). 

The CJEU has found that the Spanish withholding tax rules existing in Biscay (a province in the Basque Country which is part of Spain with autonomous tax legislation very similar to the Spanish common territory tax legislation) are not compatible with the EU right to the free movement of capital under Article 63 of the Treaty on the Functioning of the European Union (TFEU). The full CJEU decision is available here.

A team from Freshfields’ Madrid office led by counsel Maria Mera, senior associate Álvaro Fernández and associate Carmen Delgado advised the inhouse tax team of Credit Suisse Securities (Europe) Ltd (Credit Suisse), throughout these judicial proceedings. 

Background

The case relates to Credit Suisse, a UK-tax resident company which in 2017 (i.e., the financial year in question): (i) had no taxable permanent establishment in Spain; (ii) was in a tax loss position for UK corporation tax purposes; and (iii) received dividends from a company established in Biscay, in which Credit Suisse had a minority shareholding (less than 5%), which were subject to Spanish withholding tax (reduced from the headline 19% rate to a 10% rate under the Spain-UK double tax treaty (DTT)).

Under the Biscay tax legislation, a Spanish resident company with negative or zero taxable base for corporation tax purposes in a given year and thus, with no corporation tax liability in that year, is able to request a full refund of Spanish dividend withholding tax borne during that year. However, this right to claim a Spanish dividend withholding tax refund is not available to a non-resident company such as Credit Suisse in a tax loss position (i.e., with no taxable base and no corporation tax liability), meaning the Spanish withholding tax is borne as a final actual tax cost for the non-resident company. 

Credit Suisse argued that this difference in treatment for Spanish resident companies versus non-resident companies under the domestic tax legislation constituted a restriction on the free movement of capital, prohibited under Article 63 of TFEU, which was not justified under Article 65 of the TFEU. 

Credit Suisse escalated the matter to the High Court of Justice of the Basque Country which then referred the case to the CJEU to seek clarification on whether the domestic tax legislation is aligned with EU principles governing the free movement of capital.

The Judgment

The CJEU has concluded that the Biscay tax legislation constitutes a restriction on the free movement of capital that is prohibited under Article 63 of the TFEU as it grants the right to a refund of withholding taxes on dividends paid to resident companies in a tax loss position, but denies an equivalent tax treatment (that is the right to a withholding tax refund) to non-resident companies in an equivalent tax loss-making situation and this restriction is not justified by any of the arguments put forward by the Spanish tax authorities.

To reach this conclusion, the CJEU followed the reasoning established by the 2018 CJEU judgment in Sofina (C-575/17), on which Freshfields’ Paris office also provided advice, and confirmed the following:

• the Biscay tax legislation confers an advantage on resident companies in a tax loss position, which is denied to non-residents in a similar situation. Excluding this advantage in a cross-border situation while accepting it in a pure domestic context constitutes a restriction on the free movement of capital; 
   
• the existence of this advantage for resident companies and thus, the less favourable treatment of dividends paid to non-residents, must be assessed for each financial year, viewed on an individual basis. Since dividends paid to a non-resident company are taxed when distributed, the financial year in which the dividend distribution occurs must be taken into account in order to compare the withholding tax burden on those dividends and that on dividends paid to a resident company. On the facts here, that burden would be nil for the resident company where it is in a tax loss-making position at the end of the tax year in question and a 10% withholding tax charge for the non-resident company; and
   
• this difference in treatment creates, at a minimum, a cash-flow disadvantage for non-resident entities. This stems from the position that, for resident companies, the withholding tax is treated as a pre-payment of domestic corporation tax that is then refunded if the resident company records losses at the end of the tax year concerned. Whereas for a non-resident company, the withholding tax (at either the headline 19% rate or the applicable reduced treaty rate, 10% in this case) is treated as an immediate actual tax, as the Biscay tax legislation does not provide any mechanism for non-resident companies in a tax loss position to recover that withholding tax (whether via a tax credit or a refund). The CJEU highlighted that this difference in treatment could ultimately result not only in a cash-flow disadvantage for non-residents, but also in a total exemption for resident companies if these companies continue to incur losses in subsequent years (thereby resulting in a perpetual disadvantage for the non-resident).

The CJEU also rejected Spain's arguments comparing the 10% withholding rate under the Spain-UK DTT with the general 28% corporate tax rate for resident entities in Spain (more specifically, in the Basque Country). The CJEU cited its well-established case law confirming that a domestic measure that is contrary to a fundamental freedom cannot be regarded as compatible with EU law because of the potential existence of other advantages, such as the difference in tax rates applicable to resident and non-resident companies. 

Having established the Biscay tax rules in question constituted a restriction on the free movement of capital, the CJEU then considered if such discriminatory tax treatment can be justified on the basis that: (i) the situations in question (here the position of resident companies versus non-resident companies) are not objectively comparable; or (ii) it is necessary to uphold public policy interests under Article 65 TFEU. The CJEU found neither justification was applicable in these circumstances. In summary the CJEU: 

• confirmed that when a Member State elects to tax both residents and non-residents on dividends, these situations must be regarded as equivalent/comparable by operation of EU law; and
   
• rejected that the restriction on the free movement of capital imposed by the Biscay tax legislation can be justified by the need to ensure tax collection, on the basis that less restrictive means were available to the source Member State to achieve that objective. Specifically, the CJEU considers that granting non-resident companies in a tax loss position the withholding tax refund, as is available for resident companies in a tax loss position, would effectively eliminate any restriction on the free movement of capital and would be an adequate measure to ensure tax collection as: (i) the withholding tax refund would be limited to companies with losses, that would have previously proved their tax loss position; and (ii) the mutual assistance mechanisms between Member States would allow the Member State in which the dividends are paid (Spain in this case) to check the accuracy of the evidence put forward by the non-resident to evidence its tax loss position; and 
   
• finally, also rejected arguments raised by the Spanish and German Governments (the latter having submitted observations on the case) relying on the balanced allocation of taxing rights and the coherence of the tax system, on the basis that once a Member State has agreed not to tax resident companies on domestic dividends and grant them a withholding tax refund when they are in a tax loss position, it cannot rely on these principles in order to justify the taxation of non-resident companies.  

Key takeaways

This Judgment will have significant implications for cross-border investors in Spain and/or other EU Member States, particularly where domestic withholding tax rules differentiate between resident and non-resident investors and leave non-resident companies in a disadvantaged position. 

Non-resident investors in Spanish companies that have suffered dividend withholding taxes in the years where they were in a tax loss position, resulting in actual withholding tax costs, may now have grounds to claim withholding tax refunds as a result of this Judgment. It is relevant to note that although the Judgment analyses the specific case of the withholding tax rules in Biscay, the conclusions should be applicable to the Spanish tax regime more generally as the relevant regulations in the Biscay autonomous tax legislation and the Spanish common territory tax legislation are essentially equivalent. 

If you would like to discuss any of the points raised in this blog post in further detail, please contact the authors or your usual Freshfields contact.