Digest of recent important foreign decisions on cross border taxation

In a decision (No. 370650) given on 5th November 2014, the Administrative Supreme Court (Conseil d’Etat) ruled that the 5% participation threshold provided for by the French participation exemption regime does not relate to both capital and voting rights of a subsidiary, but only to capital. A parent company which holds at least 5% of the capital, but less than 5% of the voting rights of its subsidiary may therefore benefit from the participation exemption on dividends derived from shares carrying a voting right.

a) Facts: In 2008 and 2009, Sofina, a company resident in Belgium, received dividends from the French company Eurazeo, which were subject to a 15% withholding tax. Sofina held shares representing 5% of the capital of Eurazeo, all of which carried a voting right. However, the shares held by Sofina represented only 3.63% of the voting rights of Eurazeo in 2008 and 4.29% of the voting rights of Eurazeo in 2009. Sofina claimed the repayment of the withholding tax on the basis of the French tax authorities’ guidelines which, following the European Court of Justice decision in Denkavit II (Case C-170/05), provide that where a EU non-resident parent company which fulfils the domestic 5% participation requirement finds it impossible to set off the French withholding tax on dividends derived from its French subsidiary, such dividends shall not be subject to a withholding tax.

b) Issue: Under article 145(1)(b) of the General Tax Code, a company must hold at least 5% of the capital of its subsidiary at the date of payment of the dividends to benefit from the participation exemption. Article 145(6) (b)(ter) provides that the participation exemption shall not apply to dividends derived from shares which do not carry a voting right, unless the parent company holds shares representing at least 5% of both capital and voting rights of its subsidiary. The tax authorities took the view that these provisions imply that, in order to benefit from the participation exemption, a parent company shall hold shares representing at least 5% of the capital and at least 5% of the voting rights of its subsidiary. The firstinstance tribunal (tribunal administratif) dismissed the claim of Sofina, but the Administrative Court of Appeals (cour administrative d’appel) later ruled in favour of the Belgian company. The Conseil d’Etat confirmed the decision of the Administrative Court of Appeals.

c) Decision. The Conseil d’Etat ruled that:

– article 145 of the General Tax Code does not require, for the 5% participation in capital condition to be met, that a voting right be attached to every share held by the parent company, nor that voting rights attached to the shares, if any, be strictly proportionate to the portion of capital such shares represent;

– the fact that, under article 145(6)(b)(ter) of the General Tax Code, dividends derived from shares which do not carry a voting right may not be exempted, unless the parent company holds shares representing at least 5% of both capital and voting rights of its subsidiary, does neither mean nor imply that the application of the participation exemption is limited to parent companies which hold shares representing at least 5% of the capital and 5% of the voting rights of a subsidiary.

Dividends derived from shares carrying a voting right received by a parent company which holds at least 5% of the capital of its subsidiary may therefore be exempted under the French participation exemption, notwithstanding the fact that the shares held by the parent company do not represent 5% of the voting rights of the subsidiary.

2) Canada
Tax Court of Canada holds foreign exchange gains not realised on conversions of convertible debentures

The Tax Court of Canada gave its decision, on 4th November 2014, in the case of Agnico-Eagle Mines Limited vs. The Queen (2014 TCC 324). The taxpayer, Agnico-Eagle Mines Limited (Agnico), a taxable Canadian corporation, issued US-denominated convertible debentures in 2002 at an aggregate price of $ 143,750,000. The issue in the appeal was whether or not Agnico realised foreign exchange gains when the convertible debentures were converted and redeemed for Agnico’s common shares. The tax authorities argued that foreign exchange gains were realised because the conversions and redemption resulted in a repayment of the debt equal to its US dollar principal amount, which had decreased when translated to Canadian dollars. Agnico argued instead that the principal amount of the debt became irrelevant once holders exercised their rights of conversion, as most of them did. It submits that a gain could not have been realised because it borrowed far less than it paid out in Canadian dollar terms (i.e., CAD 228,289,375 borrowed and CAD 280,987,312 paid out, measured by the value of common shares issued to holders).

a) Background: Agnico produces gold. Its shares (Common Shares) were listed on the New York Stock Exchange (NYSE) and the Toronto Stock Exchange (TSX). In 2002, it issued convertible subordinated debentures (Convertible Debentures) at a price of $ 1,000 each, which traded on the TSX. Under the terms of an indenture, interest was payable at 4.5%, the principal amount was $ 1,000 and they were redeemable on or after 15th February 2006 for a redemption price (Redemption Price) equal to the principal amount plus accrued and unpaid interest. Agnico had the option of delivering Common Shares on redemption instead of cash. The holder had the option to convert the debentures for 71.429 Common Shares at any time prior to redemption or maturity. Most of the debentures were converted into Common Shares during 2005 and 2006. Most of the conversions took place after Agnico issued a notice of redemption late in 2005. Most investors availed themselves of the option to convert rather than being subject to the redemption because this yielded a higher number of Common Shares.

The tax authorities determined that Agnico realised deemed capital gains on the conversions and the redemption pursuant to section 39(2) of the Incometax Act. The amounts assessed are the same as if the principal amount had been repaid in cash. This resulted in assessments of deemed capital gains in the amounts of CAD 4,499,360 and CAD 57,676,430 for the 2005 and 2006 taxation years, respectively.

b) Court’s decision: The Court concluded that the consideration received for the issuance of the Common Shares was $ 14 per Common Share or US CAD 1,000 per Convertible Debenture. The Court then determined that the relevant amounts should be translated into Canadian dollars at the spot rates when the amounts “arose”. The date of translation relating to the issuance of the debentures was not in dispute, but the translation date for the amount paid out by Agnico on the conversions. The Court determined that the appropriate date was the date the debentures were issued, in which case there could be no gain. With respect to the redemption, however, the Court held that the terms of the indenture made it clear that the Common Shares issued on redemption are in satisfaction of the redemption price, which became due and payable on the date of redemption. As such, there was a foreign exchange gain on the date of redemption. In conclusion, no foreign exchange gains were realized on the conversions and the tax authorities’ determination of foreign exchange gain on the redemption was upheld.

3) European Union; United Kingdom

ECJ Advocate General’s opinion: Commission vs. United Kingdom (Case C-172/13) – Cross-border loss relief – details

Advocate General Kokott of the Court of Justice of the European Union (ECJ) gave her opinion in the case

Commission vs. United Kingdom of Great Britain and Northern Ireland (Case C-172/13). Details of the opinion are summarized below.

    Facts: Following the ECJ judgment in Marks & Spencer (Case C-446/03) on cross-border loss relief, the United Kingdom had introduced group relief in regard to foreign group members by amending the Corporate Tax Act with effect from 1st April 2006. In 2007, the Commission raised concern that the United Kingdom breaches freedom of establishment by imposing conditions on cross-border group relief that make it virtually impossible in practice to obtain such relief. After the United Kingdom had failed to comply with the Commission’s request to amend its legislation, the Commission brought an action before the Court.

    Advocate General’s Opinion: The AG opened her assessment by stating that it is necessary to examine whether legislation at hand breaches the freedom of establishment (article 49 of the Treaty on the Functioning of the EU (TFEU) and article 31 of the EEA Agreement). The AG continued by stating that contested legislation restrict the freedom of establishment because it imposes stricter requirements on claiming the advantages of group relief if a parent company establishes a subsidiary abroad than if it does so in its state of residence. According to the settled ECJ case law, such restriction is justified only if it relates to situations which are not objectively comparable or where there is an overriding reason in the public interest.

Regarding the objective comparability, the AG notes that although the objective comparability test should not be rejected, there is a significant and, to some extent, crucial difference in the situation of a parent company with a resident or a non-resident subsidiary. The AG concluded that difference must therefore be examined as a possible justification for unequal treatment, including a test of the proportionality of the national rules.

Going further, on overriding reason in the public interest, the AG refers to the ECJ decision in the Marks & Spencer case (C-446/03) by stating that this decision created the so-called “Marks & Spencer exception”. Based on that exemption, losses incurred by a non-resident subsidiary can be transferred to the parent company if those losses cannot be taken into account elsewhere, either for present, past or future accounting periods, in which connection the burden of proof lies with the taxpayer and the Member States are entitled to prevent abuse of that exception. The AG continued by noting that the regime created under this exception has proved to be impracticable and as such does not protect the interest of the internal market. According to the AG, its application also constitutes source of legal disputes because of four reasons:

– the possibility of loss relief elsewhere is in terms of fact really precluded only if the subsidiary has ceased to exist in law;

– the case in which the loss cannot by law be taken into account in the state in which the subsidiary is established, the “Marks & Spencer exception” comes into conflict with another line of case law;

the impossibility of loss relief elsewhere can be created arbitrarily by the taxpayer; and

– the parent company’s Member State is obliged, on the basis of the freedom of establishment, only to accord equal treatment which means that it is possible that a notional tax situation over a period of decades has to be investigated retrospectively.

In conclusion of the analysis of the “Marks & Spencer exception”, the AG stated that this exception should be abandoned because of numerous reasons. By abandoning the exception, the contradictions in the ECJ case law would be resolved and clear borders of the fiscal powers of the Member States would be established. As a second argument, the AG stated that this solution is in line with the requirement of legal certainty which provides for law to be clear and its application foreseeable. Finally, the AG concluded that the abandonment of the “Marks & Spencer exception” does not infringe the ability-to-pay principle as the Commission has claimed.

The AG finalised her assessment by stating that even the complete refusal of loss relief for a non-resident subsidiary satisfies the principle of proportionality. Any restriction on cross-border relief in respect of a subsidiary is thus justified by ensuring the cohesion of a tax system or the allocation of the power to impose taxes between Member States.

In the light of the above, the AG proposed that the ECJ should:

–  dismiss the action;

–  order the European Commission to pay the costs; and

– order the Federal Republic of Germany, the Kingdom of Spain, the Kingdom of the Netherlands and the Republic of Finland to bear their own respective costs.

4) France; United States

Treaty between France and United States – French Administrative Supreme Court rules that participation exemption does not apply to dividends received through a US partnership

In a decision given on 24th November 2014 (No. 363556), the French Administrative Supreme Court (Conseil d’Etat) ruled that dividends received by a French corporation from a US corporation held through a general partnership registered in Delaware may not benefit from the participation exemption, even though such a partnership is transparent for tax purposes under Delaware law. Details of the decision are summarised below.

    Facts: The French corporation Artémis SA held 98.82% of the capital of the general partnership Artemis America, registered in the state of Delaware. This partnership, which did not elect to be treated as a corporation, held more than 10% of the capital of the US corporation Roland. The French corporation Artémis SA received from the partnership Artemis America a EUR 4.7 million share of the dividends distributed by the US corporation Roland to the partnership. Considering that such dividends could benefit from the participation exemption, the French corporation Artémis SA deducted them from its taxable result for year 2002. The French tax authorities, however, contested the deduction of the dividends.

    Issue: Does domestic law, combined with the provision of the France – United States Income and Capital Tax Treaty (1994) (the Treaty) and in particular of article 7(4) of the Treaty, allow the application of the participation exemption on dividends received by a parent company where such dividends are derived from shares held through a transparent US partnership?

Article 7(4) of the Treaty provides that “a partner shall be considered to have realised income or incurred deductions to the extent of his share of the profits or losses of a partnership, as provided in the partnership agreement (…). For this purpose, the character (including source and attribution to a permanent establishment) of any item of income or deduction accruing to a partner shall be determined as if it were realised or incurred by the partner in the same manner as realised or incurred by the partnership.”

    Decision: In accordance with the well-established principle of subsidiarity of tax treaties, the French

Administrative Supreme Court first applied domestic law and then considered whether the Treaty provisions might have an impact on domestic rules.

Domestic law

The Court explained that where the tax treatment of a transaction involves a foreign legal person, one should first determine the type of French legal person to which such foreign legal person is the closest in regard of all the characteristics and of the law ruling the formation and functioning of the foreign legal person. The tax regime which is to be applied to the transaction shall then be determined according to French law.
 

The Court noted that the partnership Artemis America was not treated as a corporation in the US and that, under the law of Delaware, it had a legal personality which was distinct from the one of its partners. Therefore, such a partnership should be viewed as a French partnership (société de personnes) ruled by article 8 of the General Tax Code, even though the partnership Artemis America is transparent for tax purposes under the law of Delaware (while French partnerships are semi-transparent).

Article 145 of the General Tax Code provides that the participation exemption may only apply to companies subject to corporate income tax which hold shares fulfilling certain conditions. The Court ruled that these provisions mean that a French partnership (société de personnes) may not benefit from the participation exemption insofar as it is not subject to corporate income tax, even in the case where its partners are subject to corporate income tax. In addition, the Court ruled that a parent company must have a direct participation in the capital of its subsidiary to benefit from the participation exemption. Therefore, a parent company may not benefit from the participation exemption on dividends derived from shares held through a French partnership.

Insofar as the US partnership Artemis America, which is comparable to a French partnership, stands between the French corporation Artémis SA and the US corporation Roland, the parent corporation Artémis SA is not allowed under domestic law to benefit from the participation exemption on the dividends distributed by the US corporation Roland.

The Treaty

The Court ruled that the purpose of article 7 of the Treaty is to allocate the taxing rights over profits realised by enterprises resident in one of the two contracting states. The only purpose of article 7(4) is to allocate such taxing rights when profits are realised by a US partnership. Pursuant to articles 7 and 10 of the Treaty, dividends distributed by a US corporation to a US partnership, a partner of which is a French corporation, must therefore be seen as dividends distributed to the French partner, thus being taxable in France. However, it does not result from article 7 of the Treaty that such dividends should be seen as dividends directly distributed to the partner for the application of French tax law.

Hence, the Court concluded that the Treaty does not include any provision allowing the French corporation Artémis SA to deduct from its taxable result its share of the dividends distributed by the US corporation Roland to the US partnership Artemis America, and dismissed the taxpayer’s appeal.

5) Finland; Hungary

Supreme Administrative Court: Private pension based on work exercised abroad not income from Finnish sources The Supreme Administrative Court (Korkein hallinto-oikeus, KHO) gave its decision on 6th October 2014 in the case of KHO:2014:146. Details of the decision are summarised below.

    Facts: The taxpayer, A, has moved permanently to Hungary on 23 October 2005 and has been treated as a non-resident of Finland since 1st January 2009. In 2009, A received pension payments from a Finnish pension fund. The pension was based on work done for eight private employers between the years 1972 and 2002.

The first four employments were mainly exercised in Finland, whereas the four latter ones between 1988 and 2002 were exercised abroad.

The tax authorities taxed the pension payments fully whereas the Tax Appeal Board investigated the tax treatment based on each employment and ruled that the part which related to employment exercised abroad was not taxable in Finland. The tax authorities appealed against the ruling which was also upheld by the District Administrative Court of Helsinki.

    Legal background: Section 10 of the Income-tax Law (Tuloverolaki) includes a non-exhaustive list of items of income which are treated as derived from Finland. The list includes pension which is received from a pension insurance taken from Finland.

    Issue: The issue was whether or not the pension paid to the non-resident taxpayer is regarded as income from Finnish sources.

    Decision: The Court upheld the decisions of the Tax Appeal Board and the District Administrative Court and held that the pension income was not income from Finnish sources and not taxable in Finland as it related to work exercised abroad.

The Court acknowledged that it would be in accordance with the wording of the law to treat pension from a Finnish pension fund as income from Finnish sources. The Court, however, looked into the law proposal (HE 62/1991) (the Proposal) which added the pension insurance taken from Finland to the list of items of income which are treated as derived from Finland. The Proposal was explicitly referring only to pensions based on private pension insurances, whereas the tax practice about pensions based on obligatory pension insurances was that such pensions are taxable in Finland only if they were based on work exercised in Finland. This was also established in the unpublished decision of the Supreme Administrative Court (decision No. 3922 from 1990).

The Court emphasised that if the legislator wanted to change the existing practice, the Proposal should have explicitly stated this. Considering the Proposal and the tax practice, there were no grounds to change the interpretation so that pension insurance from Finland would cover obligatory pension insurance. The Court acknowledged that such interpretation may lead to double non-taxation of such pension due to the functioning of a tax treaty, which is likely not the intended effect of tax treaties. Despite this, there were no grounds to change the previous interpretation.

6) Finland; Switzerland

Treaty between Finland and Switzerland – Administrative Court of Helsinki: Licence fee for using group name and logo paid to a Swiss related party not deductible for Finnish company

The Administrative Court of Helsinki (Helsingin hallinto-oikeus) (the Court) gave its decision on 10th October 2014 in the case of 14/1103/4. Details of the decision are summarised below.

    Facts: A Finnish company (FI Co) has belonged to an international group since 1981. FI Co has been using the group’s logo since 1989 and the group’s name has been included in its name since 1995. In 2004, FI Co concluded a contract with a Swiss company (CH Co), which belongs to the same group and holds the rights to the group’s name and logo. Under the contract terms FI Co received the right to use the group’s name and logo in Finland and in return was charged a licence fee for the those rights. During the court proceedings, FI Co emphasised that the licence fee covered also other features of the brand, such as the mission and values of the group.

    Issue: The issue was whether or not the licence fee (royalty) FI Co paid to CH Co was a tax deductible business expense for FI Co.

    Decision: The Court held that the licence fee was not tax deductible for FI Co. The Court referred to section 31 of the Law on Tax Procedure which stipulates on transfer pricing adjustments between related parties and section 7 of the Business Income Tax Law under which all costs and expenses incurred for the purpose of earning, securing, or maintaining the taxpayer’s income are deductible for tax purposes. The Court emphasised that it is crucial whether an independent entity in similar circumstances would be willing to pay for such rights or were they simply benefits which FI Co accrued by belonging to a group.

As a starting point, the Court pointed out that the name and logo as well as the mission and values of the group are common for all entities belonging to the same group and indicate that the entity in question is part of a bigger entity. As such, those are benefits which accrue based on the group relationship without a fee. A fee can, however, be charged provided that the entity paying the fee can show that it has obtained commercial benefits from the contract.

The Court pointed out that FI Co has belonged to the group since 1981, used its logo since 1989 and attached the group name to its own name since 1995, whereas the licence fee was introduced only in 2004. Although these facts on their own are not decisive to deem the licence fee non-deductible, such facts have specific significance when no significant changes in the market position and circumstances have taken place. FI Co has not indicated that there has been a significant change in its market circumstances since 2000.

The Court held that FI Co had failed to show that the increase in its profits resulted from the contract. The benefits FI Co had accrued are benefits obtained based on the group relationship. As such, there were no grounds for CH Co to charge for such benefits and no business reasons for FI Co to pay for them.

Article 9 (associated enterprises) of the 1991 Finland-Switzerland tax treaty was mentioned as an additional legal basis for the decision although the Court did not elaborate more on the treaty aspects.

7) France; Germany

Treaty between France and Germany – French Administrative Supreme Court qualifies income derived from “jouissance” rights as dividend

In a decision (No. 356878) given on 10th October 2014, the French Administrative Supreme Court (Conseil d’Etat) ruled that the income derived from German “jouissance” rights (Genussscheine) within the meaning of German law is to be treated as dividend pursuant to paragraphs 6 and 9 of article 9 of the France – Germany Income and Capital Tax Treaty (1959) (as amended through 2001) (the Treaty).

    Facts: From 2004 to 2006, the French bank Caisse régionale du crédit agricole mutuel du Finistère received an income from securities issued by the German entity Landesbank Sachsen. These securities were denominated as “Genussscheine” in the issuance contract.

Under the contract, the annual income to be received by the French bank amounted to 6.6% of the nominal value of the securities, except:

– where and insofar as the payment of this amount would create or worsen a loss in the debtor’s accounts; or
– where, after a capital reduction resulting from debtor’s losses, the capital has not been built up to its former total nominal value.

The contract also provided that the amounts paid in relation to the “jouissance” rights (Genussscheine) were deductible from the profits of the securities’ issuer.

The income received by the French bank was subject to a 26.375% withholding tax corresponding to the corporate income tax and the solidarity tax due under the German tax legislation.

    Legal background: Article 9 (6) of the Treaty provides that the term “dividends” as used in this article means income from shares, “jouissance” shares or “jouissance” rights, mining shares, founders’ shares or other rights, not being debt claims, participating in profits.

In turn, article 9(9) of the Treaty provides that income referred to in paragraph 6 arising from rights or shares participating in profits (including “jouissance” rights or “jouissance” shares) and, in the case of Germany, income from a sleeping partner (stiller Gesellschafter) from his participation as such, and income from loans participating in profits (partiarisches Darlehen), and income from profit-sharing loans (Gewinnobligationen)) that is deductible in determining the profits of the debtor may be taxed in the contracting state in which it arises, according to the laws of that state.

    Issue: The French bank considered that it was entitled to a French tax credit amounting to the German withholding tax, pursuant to article 20(2)(a)(bb) of the treaty referring to    income    arising    from    rights    participating    in    profits,    that is     deductible     in     determining     the     profits     of     the     debtor    (article 9(9) of the treaty).

However, the french tax authorities took the view that the income derived from “jouissance” rights constituted interest, which is taxable only in the state of which the recipient is a resident (article 10 of the treaty), and refused to grant the tax credit.  The french bank made a claim against this decision. On 5th december 2011, the french administrative Court of appeals (Cour administrative d’appel),    confirming the judgment given by the administrative tribunal (tribunal administratif) on 28th  january 2010, ruled that, in regard to the terms of the issuance contract and especially of its provision    which    defines    “jouissance” rights as debt claims, the income derived from these “jouissance” rights cannot be     qualified     as     dividend     under     article     9(6)     of     the     Treaty.    Consequently, the German withholding tax cannot give rise to a tax credit in france.

In the course of the subsequent proceedings, however, the Conseil d’Etat ruled in favour of the french bank.

d)  Decision: The Conseil d’Etat noted that the following facts were not disputed:
–   the income received by the french bank was derived from “Genussscheine” within the meaning of the German legislation;    and

–   the income derived from “Genussscheine” is expressly mentioned as a dividend in paragraphs 6 and 9 of article 9 of the treaty in its German-language version, which is equally authentic pursuant to the treaty.

The Conseil d’Etat, therefore, concluded that the income received    by    the    French    bank    qualified    as    a    dividend    under    article 9(6) of the treaty.

Note. The case has been referred back to the administrative Court of appeals.