Judgment summary
This is a preliminary ruling given by the Court of Justice of the European Union (First Chamber) on a request from the Tribunal Supremo (Spain), concerning the interpretation of Article 63 TFEU on the free movement of capital (paragraph 1).
The reference arose from proceedings between the Spanish tax authority (Agencia Estatal de la Administración Tributaria) and Ishares Europe ETF, a US-established collective investment undertaking, over the tax rate applied to dividends Ishares received from Spanish companies for tax years 2007 to 2010 (paragraph 2).
The Court held that a restriction on the free movement of capital arising from a Member State applying a higher tax rate to dividends paid to non-resident investment funds than to resident investment funds may be considered neutralised by a bilateral double taxation convention, but only where the fund's unit-holders can actually deduct in full, in their state of residence, the amount corresponding to the difference between the two tax rates (paragraph 65).
Background
Ishares is a collective investment undertaking established in the United States, meeting the definition of a 'regulated investment company' under the US Investment Company Act of 1940 (paragraph 10).
During tax years 2007 to 2010, Ishares received dividends on shares it held in Spanish companies. Spain levied withholding tax on those dividends at a rate of 15%, in accordance with Article 10(2)(b) of the Convention between the United States of America and the Kingdom of Spain for the avoidance of double taxation (paragraph 11).
Under Spanish law, resident open-ended investment companies and financial investment funds meeting certain conditions are taxed on dividends at a rate of 1% under Article 28(5) of the Law on Corporation Tax (paragraphs 9, 12).
Ishares sought a refund of the difference between the 15% withheld and the 1% rate applicable to comparable Spanish funds. Its applications were rejected, and its complaint was dismissed by the Tribunal Económico-Administrativo Central on 5 October 2017, on the grounds that Ishares' situation was not objectively comparable to Spanish undertakings and that any restriction had in any event been neutralised (paragraphs 12-13).
The Audiencia Nacional, by judgment of 12 September 2022, upheld Ishares' action, finding the entities comparable and finding that the tax authority had not established that the additional tax burden had been neutralised (paragraphs 14-16). The tax authority appealed to the Tribunal Supremo, which made this reference (paragraph 17).
Under US law, a regulated investment company may elect a special transparent tax regime under which income received is not taxed at the level of the entity but attributed to, and taxed in the hands of, its shareholders or unit-holders, to whom the entity may also transfer a 'foreign tax credit' corresponding to tax withheld abroad. It is established that Ishares transferred such a credit to its unit-holders, though it was not established that the unit-holders succeeded in neutralising the Spanish tax burden (paragraphs 18-20).
Core dispute
The referring court asked, in essence, whether Article 63 TFEU permits a restriction on the free movement of capital, arising from Spain applying a higher tax rate to dividends paid to a non-resident collective investment undertaking than to a resident one, to be regarded as neutralised where the non-resident undertaking, under the applicable double taxation convention and its state of residence's domestic law, could have elected to be taxed itself (allowing it in principle to deduct the excess Spanish tax in full), but instead chose to transfer the corresponding tax credit to its unit-holders (paragraph 22).
The Spanish, Belgian and Italian Governments and the European Commission also disputed, before the Court, whether there was a restriction at all and whether a non-resident, tax-transparent collective investment undertaking is in a comparable situation to a resident one (paragraph 24).
Court findings
The Court first found that Spanish legislation taxing dividends paid to a US-established collective investment undertaking at 15%, while taxing dividends paid to a resident collective investment undertaking at 1%, constitutes a restriction on the free movement of capital prohibited in principle by Article 63(1) TFEU (paragraphs 30-36). The fact that Ishares was not itself taxed in the United States and instead passed the tax burden to its unit-holders under a transparency regime did not alter this finding, since Spain had exercised its own tax jurisdiction (paragraph 33).
The Court noted that this case was distinguishable from Finanzamt für Großbetriebe (C-602/23), because in that earlier case the dividends paid to the non-resident entity were not subject to a heavier tax burden than dividends paid to a resident fund, whereas here they were (paragraphs 34-36).
On comparability, the Court noted it is for the referring court to assess whether resident funds taxed at 1% are comparable to non-resident funds, but observed that the referring court itself considered US regulated investment companies and Spanish collective investment undertakings to be in objectively comparable situations (paragraph 44).
On neutralisation, the Court held that a bilateral tax convention can, in principle, achieve equivalent treatment, but only if its application allows the tax rate difference to be compensated in full, in all cases, by deduction against the tax due in the other state (paragraphs 46-50). The Court stated it is not for it to interpret the Spain-US convention itself; that is for the referring court (paragraphs 52-53).
The Court found that, even assuming the Spain-US convention allowed full deduction, Ishares itself could not benefit from this because it transferred the dividends and tax credit to its unit-holders under the transparency regime, meaning any deduction possibility was only theoretical for Ishares (paragraphs 54-57). It cannot be said that a Member State has discharged its obligations by relying on a convention where the non-resident fund, having lawfully and non-abusively elected a transparency regime, cannot itself benefit from the convention's protection (paragraph 56).
However, the Court noted that Article 24(2)(a) of the Spain-US convention allows US residents or citizens to credit against US tax not only tax paid by them but tax paid on their behalf, so it could not be ruled out that the convention allows Ishares' unit-holders themselves to benefit from the credit corresponding to the Spanish withholding tax (paragraphs 60-61). This was distinguished from ACC Silicones (C-572/20), which concerned a different scenario of shifting the burden of proof onto shareholders (paragraphs 62-63).
Outcome
The Court ruled that Article 63 TFEU must be interpreted as meaning that a restriction on the free movement of capital may be considered neutralised by the application of a bilateral double taxation convention between the state of residence of a collective investment undertaking and the Member State paying the dividends, where that undertaking benefits, in its state of residence, from a tax transparency regime under which it is not itself taxed on dividends received but transfers to its unit-holders those dividends and the corresponding tax credit.
This is subject to the condition that the unit-holders can actually benefit from that application, in that it allows them to deduct in full, from the tax payable by them in their state of residence, the amount corresponding to the difference between the tax rate applied to dividends paid to non-resident collective investment undertakings and the rate applied to dividends paid to resident ones (paragraph 65 and operative part).
It is for the referring court, the Tribunal Supremo, to determine whether the Spain-US convention in fact permits such full deduction for Ishares' unit-holders.
Major issues / areas of contention
- Whether Spanish legislation taxing dividends paid to non-resident collective investment undertakings at 15% while taxing dividends paid to comparable resident undertakings at 1% constitutes a restriction on the free movement of capital under Article 63 TFEU.
- Whether a non-resident, tax-transparent collective investment undertaking (a US regulated investment company) is in an objectively comparable situation to a resident Spanish collective investment undertaking.
- Whether a restriction on free movement of capital can be regarded as neutralised by a bilateral double taxation convention where the non-resident fund itself elects not to be taxed but instead transfers dividends and the associated tax credit to its unit-holders under a tax transparency regime.
- Whether neutralisation can be established by reference to the position of the fund's unit-holders rather than the fund itself, and what conditions must be met for such neutralisation to be effective.
- The distinction between this case and the Court's earlier judgments in Finanzamt für Großbetriebe (C-602/23) and ACC Silicones (C-572/20).