Executive summary

On 19 December 2024, the Court of Justice of the European Union (CJEU) issued their ruling in case involving a withholding tax refund request filed by a United Kingdom (UK)-resident entity before the Provincial Council of Bizkaia.

The High Court of Justice of the Basque Country referred the case to the CJEU, which ruled that the difference in treatment applied for Spanish-resident entities — which can obtain a refund of withholding taxes paid throughout the year in case of negative result in their annual corporate tax return — and nonresident entities — which are subject to a final non-recoverable tax — is contrary to the free movement of capital.

Along with other previous rulings, this new CJEU pronouncement sets forth helpful grounds that taxpayers can assert to file refund claims, support their withholding-tax position in a tax audit setting or pursue additional opportunities in Spain or other European Union (EU) Member States.

Facts

The taxpayer, a UK-resident entity, requested the refund of the 10% withholding tax borne on dividends distributed during 2017 by a Bizkaia resident entity, arguing that, based on the double taxation agreement signed between Spain and the UK and given its tax loss position in the UK, such withholdings were not recoverable in its country of residence.

The taxpayer argued that, in a comparable situation, an investor resident in Bizkaia that was subject to a similar dividend withholding tax and was likewise in a tax-loss position could obtain a refund of such withholding tax through their corporate tax self-assessment. However, there was no comparable mechanism for the nonresident investor to obtain a refund, thus making the withholding an immediate and final tax.

According to the taxpayer, this difference in treatment constitutes a restriction on the free movement of capital, prohibited by Article 63 of the Treaty on the Functioning of the European Union (TFEU) and is not justifiable based on the criteria of Article 65 of the TFEU, invoking precedents such as the judgments of the same Court in cases C-575/17 and C-572/20.

Grounds of the CJEU decision

In the analysis of the comparability of the situations applicable to resident and nonresident investors regarding the nature of the withholding tax, the CJEU reasons that the Bizkaia regional rules allow resident companies to recover withholding through the corporate tax self-assessment in case of losses, because the domestic withholding tax is configured as a mere advance payment of the corporate tax, which is therefore refundable in case of a negative tax result. However, nonresident companies in the same loss situation do not have this mechanism available to them. The lack of a refund mechanism for such withholding implies that it becomes an immediate and final tax for the nonresident investor. This difference in treatment can therefore constitute an advantage for a resident company.

It is not disputed that the inclusion of dividends in the resident taxpayers' taxable income has the effect of reducing the loss amount that a resident taxpayer carries forward to subsequent years to use when they have a positive result, effectively deferring the taxation of the dividends. Despite this, the CJEU considers that the assessment of unfavorable treatment must be made for each individual fiscal year. In any case, the mere cash flow advantage for the resident also constitutes a difference in treatment, which can lead to a definitive exemption of the dividends if the company is liquidated without having recorded profits to offset the potential lower negative taxable base.

The CJEU does not consider relevant the tax difference between the 10% withholding rate applicable to a UK-resident entity — if the withholding becomes a final tax — and the 28% Corporate Income Tax rate to which a resident shareholder is subject in Bizkaia. The court relies on its numerous precedents under which the CJEU has established that the existence of other advantages, such as the difference in tax rates, is not a factor to consider when analyzing whether unfavorable tax treatment is contrary to an EU fundamental freedom such as the free movement of capital.

All of the above leads the CJEU to conclude that there is indeed a difference in treatment that can deter nonresident companies from investing in companies established in Bizkaia.

The CJEU thoroughly analyzes whether the observed difference in treatment between residents and nonresidents can be justified under Article 65 of the TFEU, which allows Member States to establish a distinction between taxpayers based on their residence or the place where their capital is invested. However, such a distinction must not constitute a means of arbitrary discrimination or a disguised restriction on the free movement of capital. For this, it is necessary that the resulting difference in treatment affects situations that are not objectively comparable or is justified by overriding reasons of general interest.

The CJEU rejects the justifications presented by the Provincial Council of Bizkaia, which argued the need to ensure effective tax collection, the balanced allocation of taxing rights among Member States, and the prevention of the risk of double taxation of income. The regional administration maintained that the tax obligation imposed on a nonresident company receiving dividends is proportionate to the objective of preserving a balanced allocation of taxing rights among Member States, given that the risk of nonpayment of the tax by that company, which also does not have a permanent establishment, increases over time.

The CJEU determines that extending to nonresident companies the advantages enjoyed by resident companies would eliminate any restriction on the free movement of capital without compromising the effective collection of the tax.

Decision

The CJEU judgment confirms that the Bizkaia withholding tax rules are contrary to the free movement of capital, as they give unfavorable treatment to nonresident investors compared to resident investors in the same loss situation. While the withholding becomes an immediate and final tax for the nonresident investor, for a resident investor it can constitute either a cash-flow advantage or a definitive exemption from taxation of such dividends if the company is liquidated without leaving its loss situation.

Implications

The impact of this judgment, along with its referred precursors, is significant and goes beyond the case analyzed by the CJEU.

Nonresident taxpayers that have paid Spanish withholding taxes while in a loss position will want to assess whether to file reclaims to request the refund of withholding taxes paid.

Although the judgment refers to dividend income, its conclusions may be also extended to withholding taxes applied to other types of income (such as interest and royalties). The decision refers to the Bizkaia regional rules on withholding tax, but because these are identical to the national rules applicable in the rest of Spain, the same conclusions should also apply to the latter.

Non-Spanish investors (EU and non-EU) should seek specialized tax advice to identify withholding tax reclaim opportunities and to consider the impact on their current structures. This may include reviewing gross-up agreements and assessing potential tax leakages.