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May 8, 2023
Danish Supreme Court issues rulings on beneficial ownership of interest and abuse of EU law
The Danish Supreme Court has decided two interest cases on remand from the Court of Justice of the European Union (CJEU). In February 2019, the CJEU ruled on several cases regarding the Danish withholding tax regime with respect to dividends and interest that Danish companies paid to companies in other European Union (EU) Member States.1 The Danish high courts had submitted these cases to the CJEU for preliminary rulings.
The underlying issue in the cases was whether dividend and interest payments were exempt from withholding tax when a Danish company made the payments to a company resident within the EU, which then fully or partially made payments to an ultimate parent company residing in a third country.
Since the CJEU's decisions and remand to the Danish national courts, the six original cases regarding beneficial ownership of dividends and interest have been pending before the Danish courts.
This Alert summarizes two of the interest cases, which the Danish Supreme Court decided on 4 May 2023. (The Supreme Court also decided the two dividend cases on 9 January 2022.2)
C-118/16, X Denmark A/S
Case C-118/16, X Denmark A/S, concerned a Danish company that, prior to a 2006 reorganization, was owned directly by private equity funds. In October 2006, a reorganization caused holding companies in Luxembourg and Sweden to be inserted between the private equity funds and the Danish company. The introduction of Danish withholding tax on interest from 1 May 2006 had spurred the company to reorganize.
In connection with the reorganization, the Danish company obtained a loan from its new parent company in Sweden (Holding 2). Holding 2 financed the loan through equity injection from its Swedish parent company (Holding 1). Holding 1 financed the equity contribution through a loan from its Luxembourg parent company (Lux SCA, SICAR). Lux SCA SICAR was owned by the private equity funds, and it was treated as a separate entity for Luxembourg tax purposes and as a transparent entity for Danish tax purposes.
Lux SCA SICAR was not subject to tax on the interest income under Luxembourg law. Interest was accrued on the loan from Holding 2 to the Danish company and Holding 2 made annual group contributions to Holding 1 almost matching its interest income. The interest accrued on the loan from Lux SCA CICAR to Holding 1 almost matched the group contributions received by Holding 1. Holding 2 also owned a Swedish sales company and performed research and development activities. Holding 1 and Lux SCA SICAR were pure holding companies.
During trial, the taxpayer stated that the purpose of the arrangement was to create an interest deduction in Denmark that was not matched by taxable income elsewhere. The tax authorities determined that X Denmark A/S was obliged to pay withholding tax of DKK 369 million on interest accrued to Holding 2 during the years 2007—2009.
The Danish Eastern High Court confirmed a position it had expressed in previous cases that the beneficial-ownership concept of tax treaties must be given a dynamic and autonomous interpretation based on the latest OECD Commentary. The financing transactions were considered as a coherent and predetermined arrangement. The sole purpose of the arrangement was held to be to obtain tax benefits, and the Swedish holding companies were considered not to have power to dispose of the income received, which was rechanneled to Lux SCA SICAR.
Against this backdrop, the Swedish holding companies were held not to be beneficial owners of the interest income. In this regard, it made no difference that the rechanneling of the income did not occur until 2011, because the tax effects materialized in 2007—2009. Based on the facts of the case, Lux SCA SICAR was held to be the beneficial owner, because the taxpayer had not substantiated a direct connection between the accrual of interest in 2007—2009 and a subsequent capital reduction of Lux SCA SICAR that caused the income to be paid to the private equity funds' investors. According to the 2019 decision of the CJEU, Lux SCA SICAR was out of scope of the EU Interest and Royalty Directive and, therefore, Danish withholding tax could not be eliminated under this instrument given that Lux SCA SICAR was treated as the beneficial owner.
Further, Danish taxation could not be eliminated under the Danish/Luxembourg tax treaty, because a special treaty provision excluding Luxembourg 1929 holding companies and similar entities meant Lux SCA SICAR was not protected by the treaty.
The Eastern High Court rejected the taxpayers' arguments that the tax authorities' decision instituted a new administrative practice to the detriment of the taxpayer that could not be implemented retroactively and that the Danish company had not acted negligently by not withholding tax. Based on the above, the court upheld the tax authorities' decision.
The Supreme Court found that the purpose of the financing arrangement was to create a tax deduction in Denmark that was not matched by taxable income elsewhere and that the financing transactions should be treated as a coherent and predetermined arrangement. The Supreme Court agreed with the Eastern High Court that the Swedish holding companies did not qualify as beneficial owners under the directive and the tax treaty. The fact that the interest was not paid, but only accrued, and that the interest subsequently was converted into equity did not make a difference. Further, the Court found that the taxpayer had, among other things, not proven that Lux SCA SICAR was the beneficial owner of the interest, because the taxpayer had refused to present written contracts between the company, the private equity funds and the ultimate investors that could have shed light on the company's power to dispose of the interest received from Holding 1. Finally, Holding 2 was not treated as beneficial owner of the interest margin subject to taxation in Sweden, because the margin formed part of the administration of the arrangement that was deemed to be abusive. The Supreme Court thus upheld the decisions of the high court and the tax authorities.
Case C-115/16, N Luxembourg 1
Case C-116/16, T Danmark, concerned a Danish company that, prior to a reorganization in 2006, was directly owned by five private equity funds that had granted loans to the Danish company. In 2006, Luxembourg Sarl companies (Luxcos) were inserted between the private equity funds and the Danish company, and the loans were transferred to one Luxcos before the interest withholding tax was introduced. In this way, there were back-to-back loans from the Danish company to the private equity funds through the Luxcos. The Luxcos were pure holding companies. The tax authorities determined that the Danish company was obliged to pay withholding tax of DKK 817 million on interest accrued to Luxcos during the years 2006—2008.
Referring to the CJEU's opinion in Case C-118/16, the Danish Eastern High Court held that the Luxcos were not beneficial owners of the interest under the Danish/Luxembourg tax treaty and the Interest and Royalty Directive, and that the arrangement constituted an abuse of the directive. Further, the high court rejected that the ultimate investors should be treated as beneficial owners due to lack of evidence of cash flow, etc. linking the interest payments to the investors. On this basis, the decision of the tax authorities was confirmed.
The Supreme Court upheld the decision of the high court based on the same reasoning applied in the other interest case.
The meaning of the beneficial-ownership clause in Danish tax treaties and the EU Interest and Royalty Directive, as well as the EU concept of abuse of law, have now been settled — first by the decision of the CJEU and now by the Supreme Court. The cases are important not just in a Danish context, as other EU Member States are obliged to administer EU directives in accordance with the interpretation laid down by the CJEU. The decisions are expected to soon be complemented by an EU directive introducing rules to prevent misuse of shell companies.
For additional information with respect to this Alert, please contact the following:
EY P/S, Copenhagen
EY P/S, Aarhus
Published by NTD’s Tax Technical Knowledge Services group; Carolyn Wright, legal editor
1 See Joint Cases C-115/16, C-118/16, C-119/16 and 299/16 of the CJEU. For background on the CJEU rulings, see EY Global Tax Alert, CJEU rules on application of Danish withholding tax on dividends and interest payments, dated 26 February 2019.
2 For details on the Supreme Court's decision regarding the dividend cases, Danish Supreme Court issues rulings on beneficial ownership, dated 9 January 2023.