Supreme Court rules on beneficial owner and tax treaty abuse cases
On 9 January 2023, the Danish Supreme Court released its highly anticipated decisions in two cases relating to the interpretation of the domestic withholding tax obligations on outbound dividend payments by a Danish company. The dividends were distributed to a company in another EU member state, which on-distributed the dividends in whole or in part to companies or a private equity fund resident outside the EU in another jurisdiction and then final payments were made to ultimate parent companies resident in countries that had concluded a tax treaty with Denmark. The two cases are part of a larger group of cases involving withholding tax obligations that relate to the meaning of the concept of “beneficial ownership” for double tax treaty (DTT) purposes and the conditions to qualify for benefits under EU parent-subsidiary directive (PSD). The cases are also referred to as the “beneficial ownership cases,” and include other cases involving withholding tax obligations on interest; these cases are currently pending at the Supreme Court.
During the time period at issue, Denmark levied a 28% withholding tax on dividends paid to nonresident shareholders (now reduced to 27%, dropping further to 22% under a “reclaim procedure”), which could be reduced to 0% under an applicable DTT or if the dividends qualify for the exemption under the PSD. Consequently, the critical issue is whether or not a DTT and/or the PSD apply to eliminate the withholding tax. It also should be noted that even if a relevant DTT or the PSD applies, the dividend withholding tax rate can still be challenged under Denmark’s general anti-avoidance rule (GAAR).
Whilst the Supreme Court decisions shed some light on the overall requirements and the interpretation of the concept of beneficial owner (BO), at least from a Danish tax perspective, the decision leaves room for further interpretation, and thus emphasises the challenges that arise when defining when a shareholder can be regarded as the BO under a relevant DTT and/or the PSD.
Background to the cases
The two cases—Ministry of Taxation vs. NetApp Denmark (NetApp case) and TDC A/S vs. the Ministry of Taxation (TDC case)—involve Danish operating companies owned by a company in another EU member state, which itself was owned by non-EU companies. The Danish companies claimed withholding tax exemptions based on a relevant DTT or the PSD. The Danish tax authorities, however, were of the opinion that the exemptions did not apply because the EU recipients of the dividends were not the BOs. While the fact patterns of the two cases were different (with one case involving a U.S. corporate group structure for a multinational company and the other a typical investment fund structure with a number of different investors), the shared issue was whether a company resident in another EU member state that had concluded a DTT with Denmark would be subject to Danish withholding tax on dividends received from a Danish company and whether the DTT and the PSD were applicable. The cases were brought to the High Court, which in 2016 referred them to the Court of Justice of the European Union (CJEU) for a preliminary ruling on the meaning of the BO concept, its interpretation of the PSD and certain provisions of the Treaty on the Functioning of the European Union (TFEU).
In its decision released on 26 February 2019, the CJEU agreed with the Danish tax authorities, concluding that EU member states should deny relief under the PSD where taxpayers use the directive to facilitate abuse or fraud. However, the CJEU held that the Danish courts must ascertain whether the arrangements at issue involve abuse or fraud (and if so to deny the tax exemptions for dividends) and the CJEU, therefore, remanded the cases to the Danish High Courts, which issued their decisions on 3 May 2021:
- In the NetApp case, the High Court ruled in favour of NetApp with respect to the first dividend distribution as the immediate recipient in Cyprus could be regarded as the BO. However, for the second dividend distribution, the High Court ruled in favour of the Ministry of Taxation, as it could not be directly proven that the dividends were further re-distributed to the ultimate U.S. parent company.
- In the TDC case, the High Court ruled in favour of the Ministry of Taxation because no direct financial or economic reasoning was provided, and thus it could not be demonstrated that the dividend distribution was not made simply to re-distribute the dividends to the investors.
An appeal was then filed with the Supreme Court.
NetApp Denmark ApS (NetApp DK) was established in 2000 as part of a larger multinational group, with the ultimate owner and parent company a listed U.S. company, Network Appliance Inc. (NetApp US). The relevant part of the group outside of the U.S. was held through a Bermuda company, Network Appliance Global Ltd. Inc. (NetApp Bermuda), which held all of the shares of a holding company in Cyprus, NetApp Holdings Ltd. (NetApp CY), which at the time of the relevant dividend distributions, was the direct parent company of NetApp DK. NetApp CY was established by NetApp Bermuda, which also transferred its shares in NetApp DK to the company shortly before the contemplated dividend distributions. The Danish company made two dividend distributions. The structure at the time of the distribution is depicted as follows:
NetApp US decided to repatriate overseas profits as a result of the favourable terms created by the American Jobs Creation Act of 2004. The overseas profits would be channelled through NetApp Bermuda, which would make a distribution to NetApp US. The timeline of the two dividend distributions made by NetApp DK is as follows:
With respect to the first distribution made by NetApp DK to NetApp CY, the Supreme Court held that NetApp CY should be regarded as a conduit company and, therefore, not entitled to an exemption from Danish withholding tax on the dividends based on the PSD, nor should it be considered the BO under the applicable DTT.
Since NetApp CY could not be regarded as the BO, the questions then became whether NetApp US could be regarded as the BO if the dividends were distributed directly from NetApp DK to NetApp US, and thus qualify for an exemption from withholding tax under the Denmark-U.S. DTT and whether the fact that the distribution was first received by NetApp Bermuda could impact the analysis of whether NetApp US could be considered the BO. To answer this question, the Supreme Court referred to the CJEU’s decision, in which that court stated:
- “Para 108: “In that regard, when examining the structure of the group it is immaterial that some of the beneficial owners of the dividends paid by the conduit company are resident for tax purposes in a third State which has concluded a double taxation convention with the source Member State. The existence of such a convention cannot in itself rule out an abuse of rights.”
- Para 110: “That said, it remains possible, in a situation where the dividends would have been exempt had they been paid directly to the company having its seat in a third State, that the aim of the group’s structure is unconnected with any abuse of rights. In such a case, the group cannot be reproached for having chosen such a structure rather than direct payment of the dividends to that company.”
Based on the facts in the case and the fact that NetApp DK was not able to further elaborate on the commercial reasons for the corporate restructuring undertaken immediately before the dividend distributions, i.e., the establishment of NetApp CY and the subsequent transfer of NetApp DK to NetApp CY and the timeline, the Supreme Court stated that it could not be ruled out that the purpose of the structure was an abuse of rights. Furthermore, as the dividends were distributed from NetApp DK through NetApp CY and ended in NetApp Bermuda, where they were temporarily placed (although invested in bonds) for five months before ultimately being distributed to NetApp US, the court concluded that NetApp US could not be regarded as the BO owner under the Denmark-U.S. DTT, and thus the Supreme Court overruled the decision of the High Court.
The second dividend distribution was a consequence of NetApp DK’s sale of the shares in its Dutch subsidiary (Sub NL (2)) to another Dutch company in the group (Sub NL (1)). Although the distribution was declared in 2006, it actually did not take place until 2010, where NetApp DK de facto received the proceeds from its sale of the shares. To ensure the liquidity needed to make the distribution of dividends, NetApp Bermuda had obtained a third-party loan. The Supreme Court concluded that whilst the distribution was first made in 2010, it was nevertheless part of the total distributions decided at the level of the U.S. parent and made from NetApp Bermuda to NetApp US in 2006, and this was supported by the fact that NetApp Bermuda had to obtain a third-party loan to have the liquidity needed to make the distribution. Consequently, in respect of the second distribution, the Supreme Court again overruled the decision of the High Court in that it concluded that NetApp US could be regarded as the BO under the U.S.-Denmark DTT, so the dividends were not subject to Danish withholding tax.
The second case involved five private equity funds, which established a consortium in 2005 consisting of a number of companies with the aim of purchasing TDC A/S (TDC), a large Danish telecom company. None of the funds were taxable entities resident in an EU member state or in a country that had concluded a DTT with Denmark. The private equity funds set up an acquisition company structure in Luxembourg. In 2010, one company, NTC Holding GP & CIE SCA (LuxCo 2), acquired a large holding in TDC, becoming a +50% holder of TDC’s shares during the relevant period. As TDC was a listed company at the time, its remaining shares were held by thousands of unrelated shareholders. The structure at the time was as follows:
In 2011, TDC requested a binding ruling from the Danish tax authorities to confirm that the dividends it was distributing to LuxCo 2 were exempt from Danish withholding tax under the legislation applicable at the time. TDC took the position that LuxCo 2 was not a conduit company, but rather an independent corporate entity with its own management and decision-making authority with respect to the dividends received from TDC. TDC also stated in its ruling request that a significant proportion of the ultimate investors in the five investment funds were resident in the U.S., which did have a tax treaty with Denmark. Finally, LuxCo 2 indicated that, for purposes of the binding ruling, it could be presumed that the dividends would be paid by TDC to LuxCo 2, which would on-distribute the dividends to its own parent company. A certificate of residence was obtained from the Luxembourg tax authorities to confirm the functions of LuxCo 2.
According to the information provided, it could be assumed that LuxCo 2 would distribute part of the amounts received (as dividends and/or interest and/or debt repayment) to companies controlled by the various private equity funds or by its creditors. TDC also outlined that the amounts paid by LuxCo’s parent company to companies controlled by the private equity funds would be transferred to the ultimate investors in the funds, but it was not known how those transfers would be made or be treated for tax purposes.
As no or limited information was submitted to the tax authorities (and subsequently the courts) about the actual distributions and related re-distributions, the Supreme Court concluded that LuxCo 2 should be regarded as a mere conduit company and thus not entitled to claim an exemption from Danish withholding taxes under the Denmark-Luxembourg treaty or the PSD. In this respect, the fact that the Luxembourg tax authorities had issued a certificate of residence could not lead to a different outcome. The Supreme Court also noted that no documentation had been provided for LuxCo’s specific financial and fiscal affairs, nor was there any information about the decision-making process relating to the re-distribution of dividends received by LuxCo 2, and thus did not change the High Court decision.
Although the Danish tax authorities have not issued any guidance following the Supreme Court decisions, and while all court cases are based on the merits of the case, some key takeaways may arguably be made when considering the risk that dividend payments made by Danish companies to foreign shareholders will be subject to Danish withholding tax obligations:
- If a corporate restructuring is undertaken immediately before a decision to distribute dividends which formally reinforces the Danish dividend withholding tax position of the (new) shareholder, the absence of specific demonstrable commercial reasons for the restructuring may create a presumption of an abuse of rights, which could result in the denial of treaty protection under either the PSD or the relevant DTT, as well as Denmark’s GAAR.
- The fact that a certificate of residence is obtained is insufficient to establish a company as the BO if this is not supported by documented proper functions and decision-making capabilities within the company.
- As the NetApp case further illustrates, the assessment of each dividend distribution is made on the basis of the transaction itself and thus may vary regardless of the legal structure.
Potentially affected companies should carefully consider the Danish withholding tax implications when a Danish company is to make a dividend distribution to confirm the Danish withholding tax position and any potential risk. Furthermore, as the NetApp case illustrates, the consideration should comprise each dividend distribution/transaction as the facts and circumstances underlying each distribution may vary regardless of whether the legal structure remains the same.