Dividend-tax gap needs full credit at holder level, Court holds

Spain taxes dividends paid to a United States regulated investment company at 15%Europa while dividends paid to a resident collective investment undertaking bear corporation tax at 1%Europa. The Court of Justice holds that this heavier burden is a restriction on the free movement of capitalEuropa, prohibited in principle by Article 63 TFEUEuropa, and that a bilateral double-taxation convention neutralises it only where the full rate difference is actually deductible from tax due in the state of residenceEuropa.

The dispute concerns Ishares Europe ETFEuropa, a United States regulated investment company under the Investment Company Act of 1940Europa. On dividends from shares in Spanish companies received in the tax years 2007 to 2010, Spain levied tax on the income of non-residents by withholding at 15%Europa, under Article 10(2)(b) of the Convention between the United States of America and the Kingdom of Spain for the avoidance of double taxation, signed in Madrid on 22 February 1990. Ishares sought a refund of the difference between the 15% withheld and the 1% rate applied to dividends received by resident entities under Article 28(5) of the Law on Corporation Tax, calculated on the gross dividend amount. The Audiencia Nacional granted the refund with interest; the tax authority appealed to the Tribunal Supremo, which referred the neutralisation question to Luxembourg.

The heavier Spanish tax burden exists merely because Spain has exercised its tax jurisdiction, so it is a less favourable treatment of income paid to a non-resident fundEuropa that is liable to deter cross-border investmentEuropa. That conclusion stands even though Ishares itself pays no United States corporation tax on the dividendsEuropa and passes the tax burden on to its unit-holders under the tax transparency regimeEuropa. The Spanish Government's reliance on Finanzamt für Großbetriebe failsEuropa for the same reason: that interpretation was conditional on dividends paid to the non-resident entity bearing no heavier burden in the distributing state than dividends paid to a resident fund.

Once Spain subjects both resident and non-resident collective investment undertakings to tax on income from a resident company, their situations become comparableEuropa, a point the referring court — which already treats the two fund types as objectively comparable — must confirmEuropa.

Neutralisation through a double-taxation convention requires that, in all cases, the amount corresponding to the full difference between the two rates be deducted from tax payable in the state of residenceEuropa. For Ishares itself that possibility is only theoreticalEuropa: under the United States special regime the income is not taxed in its name but attributed to its shareholders or unit-holdersEuropa, to whom it transferred the dividends and the foreign tax credit. Spain cannot claim compliance through a convention its counterparty cannot use, where the fund elected a lawful non-abusive transparency regimeEuropa — even though an election to be taxed at entity level would, in principle, have allowed a full deduction but would have bound all of its income, not only the Spanish-source dividends.

Neutralisation may still operate at the level of the unit-holdersEuropa. Article 24(2)(a) of the convention lets the United States credit against United States income tax tax paid in Spain on a resident's behalf, so the convention may allow the unit-holders to use the credit for the Spanish withholdingEuropa. The referring court must verify that they can actually do soEuropa, and that the deduction covers in full the difference between the 15% rate and the 1% rateEuropa. Only then is the restriction neutralisedEuropa.

Legal basis: Article 63 TFEUEuropa, as applied to the Spanish withholding at 15% under Article 10(2)(b) of the Spain–United States double-taxation convention and the credit mechanism in Article 24(2)(a) of that convention.