Belgian Participation Exemption Not in Compliance with EU Parent/Subsidiary Directive

April 2009 / Special Alert

A legal update from Dechert’s International and Domestic Tax Group

Belgian Participation Exemption Not in Compliance With EU Parent/Subsidiary Directive

In case C-138/07 Belgische Staat v NV Cobelfret, the European Court of Justice (“ECJ”) held on 12 February 2009 that the Belgian participation exemption regime, as currently in effect, is not in compliance with the EU Parent/Subsidiary Directive, given that the exemption only applies when the parent company has a taxable profit balance after deduction of other exempted profits. Belgian companies which have been adversely affected by this limitation on the participation exemption as implemented in Belgium will be able to claim lost carry-forward tax losses that would have been available had Belgium correctly applied the provisions of the EU Parent/Subsidiary Directive.

EU Parent/Subsidiary Directive Belgian Participation Exemption Regime The EU Parent/Subsidiary Directive (Council Directive 90/435/EEC of 23 July 1990 on the Pursuant to the Directive, Belgium has opted to common system of taxation in the case of parent implement an exemption method with the companies and subsidiaries of different Member following particularities, as provided in Article States, O.J. 1990 L 225, p. 6, hereinafter “the 202 of the Belgian Income Tax Code: If the Directive”) has as its purpose to eliminate double parent company holds a participation of at least taxation of corporate profits when profits earned 10% of the subsidiary’s share capital, or by a subsidiary located in one EU Member State alternatively if the participation has an are distributed to a parent company located in acquisition cost of at least EUR 1.2 million, the another EU Member State. Pursuant to Article dividends related to this participation can be 4(1) of the Directive, the EU Member State of the eligible for the Belgian participation exemption. parent company receiving distributed profits Furthermore, the relevant participation must from its subsidiary must exempt these profits, qualify as a financial fixed asset, which is i.e. dividends, from taxation. In order to apply normally mentioned in the financial accounts such a tax exemption, the EU Member State can under the heading “participations and other use one of the following methods: (i) an shares”. exemption method, whereby the EU Member State refrains from taxing the profits; or (ii) a Regarding the manner in which the participation credit method, whereby the parent company may exemption is calculated, the dividends received credit against its taxes due a part of the (foreign) are first incorporated in the parent company’s tax already paid by the subsidiary on the taxable profits. Thereafter, 95% of the amount of distributed profits. Furthermore, the Directive the dividends so included is deducted from the provides that the EU Member State in which the parent company’s taxable profits. The latter subsidiary is located must exempt the deduction is commonly referred to in Belgium as distributed profits from withholding tax. the “Dividends Received Deduction” (DRD). Apart d d from the limitation to 95% of the dividend amount, Tax Authorities are obliged to adapt the DRD system the DRD is also limited to the net amount of profit to comply with the requirements of the Directive, and related to the taxable period concerned. This means retrospectively, to permit deduction of the excess that the DRD cannot be availed of in any year in DRD which has been lost pursuant to the operation in which the parent company is not making any profits. the past of the limitations which have been held Moreover, if the DRD exceeds the profits made by the incompatible by the Court. Although the Court’s parent company, the unused portion of the DRD decision is only binding insofar as dividends received cannot be carried forward. from subsidiaries in other EU countries are concerned, since the Belgian legislation and the ECJ In case C-138/07 brought before the ECJ, the Belgian ruling make no distinction between cross-border and company Cobelfret challenged the compatibility of domestic situations insofar the DRD is concerned, it the Belgian exemption system with the requirements is expected that the new rule to be adapted in of the Directive. Due to the aforementioned implementation of the Court decision will also apply limitations in the Belgian regime, Cobelfret had been in both domestic and cross-border situations. unable to use the DRD for several years, since the company had not generated any taxable profits for Should Belgian corporate taxpayers, whether they are these years. In addition, the DRD on dividends members of a European or domestic corporate group, received from Cobelfret’s subsidiaries had been only find themselves in the situation where the DRD was partially availed of in one year, since the profit for not applied due to lack of sufficient or no taxable that year was insufficient for Cobelfret to claim the profits, administrative claims can be filed with the full DRD. The Antwerp Court of First Instance Belgian Tax Authorities in order to recuperate the accepted Cobelfret’s arguments, holding that unapplied DRD. Pursuant to the applicable tax Belgium had implemented the Directive incorrectly. procedures currently in effect and depending on However, upon appeal by the Belgian Income Tax whether tax assessments were already made for the Administration, the Antwerp Court of Appeal referred year(s) where the DRD was applied incorrectly, the case to the ECJ for a preliminary ruling upon the administrative claims could be filed not only for the question of EU law. current tax assessment year but also for the two previous assessment years, and in some cases even for the four previous assessment years. In case no tax ECJ Ruling in Case C-138/07 Belgische assessment has yet been made for the year where the Staat v NV Cobelfret DRD was applied incorrectly, a correction can in principle be made via the first income tax declaration In its decision, the ECJ ruled that the Belgian system that must be filed. of limiting deductibility of the DRD to situations where the parent company’s operations are profitable Given that international corporate groups frequently was incompatible with the requirements of Article use Belgian holding companies for the accumulation 4(1) of the Directive. Indeed, the Belgian system and the distribution of their worldwide profits, it is results, in cases where the parent company’s anticipated that there will be fairly numerous tax operations are not profitable, in the effective taxation adjustments sought in the wake of the ECJ ruling. In of the dividend income by virtue of reduction of the addition, going forward, the changes to the Belgian parent company’s available loss carryforward. participation exemption mandated by the ruling should make Belgium an even more attractive The Court held that by limiting the application of the jurisdiction for the operation of holding companies, DRD to situations where taxable profits are achieved, joint venture investment companies and other Belgium has added a condition that is not envisaged vehicles which take advantage of Belgium’s nor permitted by the Directive. The Belgian Tax participation exemption, negligible domestic tax Administration’s argument that the DRD system charges on investment income and gains and liberal treats domestic and cross-border situations in the exemptions from withholding tax on outgoing same way, thereby implementing the Directive distributions. correctly, was rejected by the Court. ■ ■ ■ Practical Implications of the ECJ ruling on Belgian Cross-Border and Domestic Situations This client alert was authored by Geert Dierickx (+32 2 535 5416; [email protected]). Given the ECJ decision that the Belgian DRD regime is not in compliance with the Directive, the Belgian

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April 2009 / Special Alert 3