Refunds of illegally levied withholding tax and UCITS

For the first time, the Spanish Supreme Court has upheld the position of a non-Spanish UCITS on a Fokus Bank claim. The Supreme Court rejected the appeal filed by the Spanish tax authorities against the fund’s entitlement to statutory interest for late repayment in addition to the principal amount of dividend withholding tax (WHT) refunded.

The judgment requires the Spanish tax authorities to pay to the Luxembourg UCITS statutory interest for late repayment of WHT for the whole period between the initial date when the dividend WHT was deducted and paid to the Spanish treasury by the local withholding agent and the final date of the effective refund of the WHT, rather than merely for the six months from the refund application.

Background

A Luxembourg resident UCITS received dividend payments from Spanish listed issuers in the years 2005, 2006 and 2007, when dividend WHT of 15% or 18% was applicable to payments to non-Spanish UCITS under domestic tax law (15% under the Luxembourg-Spain treaty provisions). Whilst at that time Spanish Corporate Tax Law allowed Spanish UCITS to recover the difference between the initial WHT borne and their final tax rate (1%), non-resident UCITS did not have an equivalent right to recover such WHT.

The fund therefore claimed, firstly from the Spanish tax authorities and subsequently before the administrative tax courts and jurisdictional courts, the refund of the aforementioned difference, so as to be treated equally with a Spanish resident UCITS, on the basis that such difference in the tax treatment constituted discrimination which was contrary to the right to the free movement of capital in the EU treaty. The fund also claimed statutory interest for late repayments for the full period between the initial date when the WHT was deducted and the effective date of refund of the WHT.

The fund was partially successful at the level of the tax courts and obtained the refund of the WHT withheld, though such refund was approved by the tax courts on the basis of formal errors made by the Spanish tax authorities and not as a result of any acknowledgement of discrimination.

As a result, the competent tax court held that statutory interest for late payment should only begin to accrue six months following the refund application date. This period is the one applicable to standard refund procedures under Spanish law. However, the longer period claimed by the fund was the period applicable to tax payments not due (ie tax payments levied in breach of the relevant tax laws). The application of the latter period claimed by the fund gave rise to a claim for large amounts of additional statutory interest due to the fact that for cost-efficiency reasons most asset managers have usually consolidated WHT reclaims every couple of years (up to the 4-year statute of limitations under Spanish tax law to claim the refund).

The fund appealed to a jurisdictional court - the Audiencia Nacional - the ruling in relation to the statutory interest entitlement element. The Audiencia Nacional ruled in favour of the claimant, declaring that the lack of opportunity for a non-Spanish UCITS to recover WHT in years prior to 2010 (when the Spanish non-residents tax law was amended with a view to ending the discrimination caused by the former legislation) constituted a breach of EU law and thus the levy of the WHT gave rise to illegal tax payments eligible for the much longer period of computation of statutory interest, as indemnification for the delay by the Spanish tax authorities in refunding the principal amount of WHT borne by the fund.

The Spanish tax authorities appealed this ruling to the Supreme Court.

The Supreme Court judgment

On 05 December 2018, the Supreme Court ruled on this case, finding in favour of the fund. The Supreme Court followed a previous Supreme Court ruling of 05 June 2018 issued in a very similar case, which, although it involved a UK unit linked insurer rather than a UCITS, contained equivalent underlying reasoning.

The Supreme Court has confirmed that, although the WHT was originally deducted by the relevant Spanish listed issuers paying the dividends in accordance with domestic law, the fact that the income tax law applicable to non-residents did not provide any method for recovering the difference between the initial WHT borne and the 1% effective income taxation which a comparable domestic fund (a Spanish UCITS) would finally bear, constituted illegal discrimination under EU law.

In accordance with the earlier case law of the Supreme Court, any breach of EU law gives rise to an undue tax payment suitable for indemnification via statutory interest running from the initial date of payment of the WHT.
Therefore, the approach claimed by the fund from the outset has been endorsed by the Supreme Court.

Comment

Though mostly expected since the recent ruling of the Supreme Court of 05 June 2018 in a similar case concerning a unit-linked insurer, this final judgment is a major milestone for Fokus Bank claims in Spain, particularly for UCITS. Firstly, because this is the first Supreme Court judgment in a UCITS case, and secondly, because it consolidates the Supreme Court’s position on this issue, which was determined for the first time in the 05 June 2018 ruling.

The fact that there are now two Supreme Court rulings on this issue means that there is very little likelihood of the Supreme Court’s current position changing in the future.

The financial impact of these two rulings has been estimated by the Spanish tax authorities as exceeding €1bn in additional refunds to UCITS, unit linked insurers and other asset managers with investments in Spanish equities prior to 2010.

Other asset managers, such as, for example, AIF managers or US fund managers, should also regard this ruling as a promising development for any existing or contemplated dividend WHT recovery claims, particularly bearing in mind the existence of several outstanding cases relating to US funds at Supreme Court level. Despite the fact that those claims by non-UCITS and US funds will require separate consideration by the court, the confirmation that the court is generally not taking a restrictive approach to the subject of discrimination under EU law is good news for asset managers generally.

Any AIF or US fund managers which have not already done so should now begin to evaluate their options for obtaining WHT refunds in Spain.