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In a recent judgment for Köln-Aktienfonds Deka v Nederlandse Orde van Belastingadviseurs, the Court of Justice of the European Union (“CJEU”) clarified the rules surrounding free movement of capital in the context of tax refunds granted to collective investment funds and, importantly, the extent to which Member States can legitimately set conditions on granting such refunds.

Why was clarification sought?

Under Legislation introduced into the Netherlands, a regime relating to fiscal investment enterprise (“FIEs”) was established to enable natural persons, particularly small investors, to make collective investments in certain types of assets. Those qualifying from the regime were subject to a zero corporation tax rate and benefitted from a refund of dividend tax withheld on dividends received in the Netherlands.

To qualify for the refund, a number of conditions first had to be met. One of these conditions (the “distribution condition”) was that part of the profit had to be paid to shareholders and holders of certificates of participation within 8 months of the end of the financial year. When doing so, the undertaking needed to withhold Netherlands tax on the recipient’s dividends.

KA Deka was an investment fund established in Germany with share prices listed on the German Stock Exchange which made investments on behalf of individuals. It received dividends distributed by companies in the Netherlands but those dividends were subject to a tax of 15% which was withheld at source. The Netherlands tax authorities rejected its application for a refund, quoting the failure to meet the distribution condition as one of the grounds for the rejection. KA Deka therefore sought to challenge some of these conditions on the ground that they were contrary to free movement of capital.

Could the Netherlands refuse the refund on the ground of failing to distribute profits in time?

Under German law, individuals were deemed to receive an annual amount of dividends. Tax was imposed on half of the dividends actually received and on all dividends which were deemed to have been received to meet the minimum threshold. In challenging this condition, KA Deka argued that whilst it did not distribute profits within the specified timeframe, its situation was objectively comparable to a resident FIE because its proceeds were either deemed to have been distributed or were taken into account in the tax which was levied on its shareholders and participants.

The distribution condition did not expressly distinguish between resident and non-resident investment funds. However, the CJEU emphasised that there could be a de facto disadvantage to non-resident funds even if there was no express discrimination in the domestic rules. Importantly, the court held that making the possibility of obtaining a refund subject to strict compliance with the conditions “irrespective of the legal conditions to which non-resident funds are subject to in their State of establishment” would amount to reserving advantageous treatment to resident funds. As such, the Netherlands tax authorities should not have denied the refund on grounds of failing to meet the distribution requirement if KA Deka’s situation was comparable to a FIE qualifying fund.

To establish if their situation is objectively comparable, the CJEU confirmed that one must look at the aim pursued by the national provisions as well as their purpose and content. Therefore, if the aim of the distribution requirement was to ensure profits reached investors speedily, the deemed distribution was irrelevant and therefore not comparable. In contrast, if the objective lied in the taxation of profits, the court stated that this must be regarded as being a comparable situation meaning the refusal of the refund would amount to a restriction. Determining the true objective of the national provisions was for the national court to decide.

Finally, the CJEU acknowledged that such a restriction may be permitted if justified by overriding reasons of public interest but did not elaborate further as such justification had not been proffered by the Netherlands.

Why is important?

KA Deka opens a useful route of challenge to any refusal of a tax advantage which is founded on a failure to comply with specific requirements set out in national provisions. As such, establishments and individuals alike would be wise to reflect on similarities between the rules of their resident State and those of other Member States to ascertain if any additional tax advantages can be gained.