Parent-Subsidiary Directive: interpretation of anti-abuse measures

The European Court has given a wide interpretation to the reach of the anti-abuse provisions of the Parent-Subsidiary Directive in NEO Group UAB (Case C 203/25) concluding that they can apply even in circumstances where the parent company in receipt of the carries on genuine economic activities, is recognised as the beneficial owner of the dividends and is not a conduit company. Moreover, the Court has held that tax authorities may take into account transactions carried out in other jurisdictions, including transactions further up the chain that the dividend payment is part of and advantages obtained by other participants in the chain, including the ultimate beneficial owner, whether or not the dividend paying company is aware of the non-genuine nature of the arrangements.

Background

The case concerns a group of companies including Lithuanian and Cypriot entities. The Cypriot parent company (Retal) received dividends from a Lithuanian subsidiary, NEO and a further Lithuanian subsidiary. NEO treated distributions it made to Retal as exempt from dividend withholding tax on the basis of the operation of the Parent Subsidiary Directive (PSD). In 2017, a reorganisation took place under which the shares in Retal were sold by a Belize company to a further Cypriot holding company with the purchase price left outstanding. These loans were assigned to the ultimate beneficial owner of the entities (who did not change).

Following a tax audit, the Lithuanian tax authorities concluded that dividends paid by NEO did not qualify for exemption from withholding taxes based on the application of the PSD. They did not challenge the beneficial owner status of Retal nor did they challenge the fact that Retal actually carried on an economic activity. However, they argued that the transactions involving the dividends formed part of arrangements involving non-genuine elements designed to obtain a tax advantage, engaging the application of the anti-abuse rule under the PSD. In particular, the Lithuanian tax authorities concluded that economically, the dividends were ultimately paid to the individual owner, through a chain of artificial transactions.

Paragraph 2 of Article 1 of the PSD provides that, “Member States shall not grant the benefits of this Directive to an arrangement or a series of arrangements which, having been put into place for the main purpose or one of the main purposes of obtaining a tax advantage that defeats the object or purpose of this Directive, are not genuine having regard to all relevant facts and circumstances.” Paragraph 3 goes on to state that “For the purposes of paragraph 2, an arrangement or a series of arrangements shall be regarded as not genuine to the extent that they are not put into place for valid commercial reasons which reflect economic reality.”

The Lithuanian courts referred a number of questions to the European Court concerning the correct interpretation of the anti-abuse provisions of the PSD in the context of this case.

Decision of the Court

Can the anti-abuse provision in the PSD apply where dividends are paid to a parent company that carries on genuine economic activities and is not a conduit company, but forms part of a wider chain of transactions containing one or more allegedly non-genuine elements? In this context, the Court noted that two conditions must be met for benefits under the PSD to be denied: the arrangement must be non-genuine, meaning that it is not put in place for valid commercial reasons reflecting economic reality; and one of the principal purposes of the arrangement must be to obtain a tax advantage that defeats the object or purpose of the Directive.

As regards the first condition, namely the classification of a chain of transactions as a ‘non-genuine arrangement’, the Court noted that the wording of the provision does not indicate that it is applicable only to specific situations or types of arrangement. On the contrary, it adopts an overall perspective consisting in identifying the potential non-genuine nature of an arrangement having regard to all relevant facts and circumstances, that arrangement being characterised by the absence of valid commercial reasons which reflect economic reality. In particular, the Court emphasised that it cannot be inferred from the earlier Danish cases (Cases C 116/16 and C 117/16) that the anti-abuse provision of the PSD applies only to arrangements comprising conduit companies.

“Consequently, the fact that, in an arrangement involving more than one step, the first transaction consists of the distribution of dividends by a subsidiary to a parent company which carries on an actual economic activity does not, in itself, support the conclusion that there is no abusive practice. To analyse only the economic activity of that parent company, without taking into account the other relevant elements, would not be consistent with the necessity of carrying out an overall examination.”

The referring court had asked to what extent the following factors might be taken into account: first, that the amounts transferred in a chain of transactions – all or some of which are not genuine – are similar, or even identical, to the amounts of dividends distributed by a subsidiary resident in that Member State to its parent company resident in another Member State and, second, that such transfers took place not in a short period of time after the payment of those dividends, but on a continuous basis over a certain period.

The Court has confirmed that, in the assessment of the existence of abuse, it is possible to take account, as an indication of abuse, of the “correspondence between the amounts of dividends received by the parent company and the amounts from which, as a result of the creation of the chain of transactions concerned, the natural or legal person controlling the companies involved in such a chain benefits”. However, the Court stressed that such evidence cannot give rise to a general presumption of abuse. In addition, the Court noted that whilst although the fact that the parent company passes on, within a short period of time, the dividends that it has received from its subsidiary may constitute a relevant indication of the existence of abuse, it does not follow that such a short period is required for such abuse to be demonstrated. Indeed, the Court noted the fact that such movements take place at regular intervals might equally be a relevant factor. “In that regard, it should be specified that a non-genuine arrangement, the effects of which are repeated over a certain period, is no less contrary to that object or purpose than a one-off arrangement.”

The referring court also asked whether the anti-abuse provision of the PSD could be engaged where the transactions regarded as non-genuine were carried out, not in the Member State of the payer, but by persons not resident in that Member State, and irrespective of the stage in the chain of transactions at which the tax advantage is obtained. The Court has noted that the anti-abuse provision of the PSD does not require proof of the existence of a tax advantage for the subsidiary which initially distributed the dividends. “The tax advantage may be derived by the person who controls the group of companies within which the chain of transactions aimed at obtaining that advantage is carried out and who resides in a Member State other than that of the subsidiary which initially distributed those dividends.” It is therefore necessary for the Member State granting a resident subsidiary the benefit of the exemption from withholding tax to be able to take account of transactions carried out outside that Member State using the amounts received in respect of those dividend.

Finally, the referring court asked, in essence, whether the anti-abuse provision of the PSD must be interpreted as precluding a national practice whereby the tax authorities of a Member State levy a withholding tax on dividends that a subsidiary resident in that Member State distributes to its parent company resident in another Member State, without establishing that that subsidiary was or could have been aware that that distribution was part of a chain of transactions, all or some of which were not genuine. On this point, the Court has held that provided that it is demonstrated that at least one of the companies in the group participating in the chain of transactions or the person who, as a result of the creation of that chain of transactions, benefits from the advantage, was or could have been aware of the existence of that chain of transactions involving non-genuine elements, that is sufficient for the application of the anti-abuse provision. It is not necessary for the paying subsidiary itself to be aware of the non-genuine arrangements.