The EC Parent-Subsidiary Directive 90/435/EEC applies to profit distributions among companies in the European Union. The provisions were amended by Directive 2003/ 123/EC dated December 22, 2003; they are enforceable on all Member States as from January 2005 (“2003 amendment”).
The Directive ensures elimination of both economic and juridical double taxation on cross-border profit distributions among companies of Member States.
It provides either exemption or ordinary underlying credit for the tax due on profit distributions received in the State of the parent company or its overseas permanent establishment. In addition, an exemption from withholding tax is granted on such distributions in the State where the subsidiary is resident.
The Directive applies to distributions received by either:
i. The parent company or its permanent establishment located in a Member State from a subsidiary in another Member State; or
ii. A PE located in a Member State from a subsidiary based in the same State as the parent company in another Member State; or
iii. A PE of a Member State in a non-Member State from a subsidiary in another Member State.
It excludes domestic profit distributions where the permanent establishment and the subsidiary are situated in the same Member State (Article 1(1)). The permanent establishment is defined as a fixed place of business subject to source taxation under either a tax treaty or domestic law (Article 2(2)).
To qualify as a “company of a Member State”, both the parent and subsidiary companies must fulfill the following three conditions of the Directive (Article 2), relating to their form, residence and the liability to tax:
(i) The company must be a legal entity listed in the Directive. The list includes public companies and limited liability companies in Member States.
The list was expanded in the 2003 amendment, which added entities, including the new European company (Societas Europaea – SE), co-operatives, mutual companies, certain non-capital based companies, savings banks, provident funds and associations with commercial activity.
(ii) The company must be tax resident in a Member State under its domestic tax law and must not be resident outside the European Union under a tax treaty with a third State.
(iii) The company must be subject to one of the taxes listed in the Directive or a tax similar to them, without being subject to a special tax regime or an option not to pay the tax. (As this is a subjective, rather than an objective, requirement, the company and not the income received must be subject to tax without the option of being exempt. The Directive does not specify a minimum rate)
The terms “parent” and “subsidiary” are defined in Article 3 of the Directive. To be a parent company, a qualifying company in a Member State must hold 20% or more of the share capital (or voting rights) of a subsidiary company resident in the same or another Member State for a continuous period of two years.
The Member States have an option of replacing the holding of capital by voting rights. Moreover, they have an option not to apply the Directive to companies of a Member State which do not meet the two-year qualifying period (Article 4(2)). The Member States may elect a lower equity ownership or shorter holding period, if they wish under Article 7(2).
Thus, the Member States can have different (and lower) ownership and holding period requirements for inbound and outbound dividends, provided they do not exceed the limits prescribed under the Directive. Under the 2003 amendment, the upper holding limit is reduced to 15% in 2007 and will reduce to 10% in 2009.
Article 4 provides for either non-taxation of qualifying distributions or ordinary credit in the parent State for the underlying taxes paid by the subsidiary and lower-tier subsidiaries resident in Member States. For credit relief in the parent State, lower-tier subsidiaries must also be a “company of a Member State” under Article 2 and qualify under Article 3.
The Directive allows each Member State the right to deny the deduction of distribution or holding expenses incurred by the parent company. However, if such “management costs” are allowed at a fixed flat rate, the amount may not exceed 5% of the amount of the profits received from the subsidiary company (Article 4(2)). Thus, at least 95% of the dividends must be tax-free.
Under the 2003 amendment, the Directive does not prevent the parent State from taxing the parent company on its share of the subsidiary’s profits currently if under its laws it is deemed to be fiscally transparent, but exemption or credit must be granted to the parent company (Article 4(1 a)).
Article 5 grants withholding tax exemption on qualifying distributions of the subsidiary company in the subsidiary State. The Directive requires the qualifying dividends to be exempt from withholding tax; it does not permit tax payment with subsequent tax refund.
Based on ECJ decisions, withholding tax includes, besides dividend withholding tax, all other taxes withheld from distributed profits. Article 6 also denies the parent State the right to levy a withholding tax. However Article 7 permits certain dividend imputation credits (e.g. ACT in the United Kingdom), which is not regarded as a withholding tax for the purposes of the Directive.
The Directive does not apply to purely domestic profit distributions. It also excludes liquidation proceeds of a foreign subsidiary, if subject to withholding tax as dividends (Article 4(1)). The Member States are permitted to include anti-avoidance provisions in the domestic law or treaties (Article 1 (2)) to curb any fraudulent or abusive use of the Directive.
The Directive does not affect other provisions under domestic law or treaties that eliminate or reduce economic double taxation of dividends (Article 7(2)).
According to the European Commission, the Directive is an important element of its strategy to remove all forms of double taxation and other tax obstacles currently encountered by companies exercising their freedom to operate across borders within the Internal Market.
The Directive specifies the minimum requirements. Several EU Member States provide a more favourable tax treatment under their domestic law and tax treaties than required under the EU Directive.
In many cases, they have extended their domestic or international participation exemption rules with appropriate modifications to cover the dividend income of EU parent companies and their permanent establishments.
Following the Denkavit decision, many EU countries have amended their legislation to allow the minimum holding period to be applied on a prospective basis (e.g. commitment to hold). Therefore, distributions before the minimum holding period is satisfied are either tax exempt or fully creditable under a guarantee or deposit.
Moreover, this condition has to be met only for the qualifying shareholding (Examples: France, Luxembourg, and Slovenia).
(a) Dividends Received:
Wide variations exist in the rules. Some countries that do not tax domestic dividends also exempt foreign dividends (Examples: Cyprus, Estonia, Germany, Hungary, and Slovak Republic). Finland, Italy and Slovenia exempt wholly or partly all qualifying dividends from EU countries without holding period or ownership requirements.
All Member States have reduced their equity holding requirements to 15% or less in 2007 to comply with the 2003 amendment. However, many of them apply lower percentages.
The minimum capital ownership requirement varies from nil in Germany, Italy and Slovenia, to 5% in France, Ireland, Netherlands and Spain, to 10% in Austria, Belgium (or EUR 1.2 million), Czech Republic, Luxembourg (or EUR 6 million), Portugal (or EUR 20 million), Sweden, United Kingdom and Lithuania, and 15% in Denmark, Greece, Latvia and Poland.
The United Kingdom requires a minimum 10% voting right (not equity ownership) in a general shareholders’ meeting or 10% direct or indirect equity holding to qualify under the Directive.
Although the Directive permits a holding period up to two years, few countries insist on it (Examples: France, Greece and Poland). The most common period is one year. Finland, Germany, Ireland, Italy, Latvia, Lithuania, Netherlands, Slovenia and United Kingdom have no such requirement.
Certain EU countries grant foreign tax credit for the direct and underlying taxes under their domestic law (Greece, Ireland, Malta, Poland, and United Kingdom). Most of the other Member States provide full-exemption relief to qualifying dividends, or combine credit and exemption methods (Example: Spain). Belgium, France, Germany and Italy give 95% exemption or dividend deduction.
(b) Dividends Paid:
Similarly, both the ownership and holding period requirements for exemption from the withholding tax on dividends (or a claim for refund if already paid) vary in the Member States. Several countries do not levy a withholding tax on foreign dividends under their domestic law (Examples: Cyprus, Greece, Hungary, Malta, Slovak Republic, and United Kingdom).
Most Member States currently require 15% equity ownership. Austria (vote and value), Czech Republic, Luxembourg (or EUR 1.2 million) and Lithuania have lower percentage of 10%; only 5% holding is required in the Netherlands.
Ireland has no ownership requirement; it exempts companies resident in a Member State from dividend withholding tax, subject to anti-avoidance provisions. Germany reduces the required holding to 10% under certain reciprocal arrangements.
The holding period also varies. Most countries insist on a one-year holding period (Austria, Belgium, Czech Republic, Denmark, Finland, Germany, Italy, Lithuania, Luxembourg and Spain). Only France, Latvia, Poland, Portugal and Slovenia require a two-year period. Estonia, Ireland, Netherlands and Sweden have no holding period requirement.
Under the Savings Agreement between the European Union and Switzerland, the provisions similar to the EC P-S Directive are applicable to distributions between EU Member States and Switzerland, as from July 2005.
There is no withholding tax on eligible dividends received from EU Member States by Swiss parent companies (or vice versa,) provided at least 25% shareholding is held directly for two years.
Currently, the Agreement does not provide for voting rights, as under the Directive. Most EU Member States have more favourable tax exemptions under their domestic law or treaty with Switzerland than under the Directive.
Austria, Belgium, France, Germany, Ireland, Italy, and Spain have specific anti-avoidance provisions to prevent the set-up of an EU holding company for the ultimate benefit of non-EU shareholders. The anti-abuse provisions may not apply if the nonresident ownership is held for bona fide commercial reasons.
The EC Directive requires that a company must be subject to corporate income tax without the possibility of an option of not paying the tax or being exempt. It does not specify a minimum rate.
Companies with temporary tax-exemption or exemption limited to a geographical area or given type of income may qualify under the Directive. In Italy, the term “subject to tax” means subject to the relevant tax requirement.
Some countries (Examples: Austria, Belgium, Sweden) require that the subsidiary companies must be liable to tax under similar corporate tax systems, and have an acceptable tax rate (at least 15%).
Others insist on the compliance with the condition imposed under the EC P-S Directive that the companies are “subject to tax” (Examples: Belgium, France, Italy, Netherlands, and Portugal). Some of them require that the parent company is not based in a low-tax jurisdiction (Examples: Estonia, Slovenia).