On June 17, 2010, the European Court of Justice (“ECJ”) rendered its decision in the Commission v Portugal (C-105/08). The case concerns the question whether Portuguese withholding tax on interest paid to non-resident financial institutions is contrary to EU law because it is imposed on the gross amount of the interest paid, whereas resident financial institutions are taxed on their net income, i.e. after deduction of costs. Advocate General (“AG”) Kokott concluded in March 2010 that this would, in principle, constitute a restriction of the freedom to provide services, but considered that the ECJ should reject the European Commission’s claim on the grounds that it had not provided adequate factual or statistical evidence in support. The ECJ essentially followed the AG’s opinion and rejected the Commission’s case on these formal grounds.
Facts and legislative background
Under its domestic law Portugal imposes a 20% withholding tax on interest paid to non-resident recipients. This may be reduced under tax treaties to rates ranging from 5% to 15%. The tax is withheld from the gross amount, without any deduction for the costs of financing the underlying loans. Portuguese residents, on the other hand, are subject to corporate income tax at 25% (plus a municipal surcharge up to 1.5%), imposed on their net income, i.e. after deduction of business costs, including financing costs.
The European Commission considered that this different treatment resulted in non-resident financial institutions being more heavily taxed than resident financial institutions, in breach of the free movement of capital and the freedom to provide services under both the EC Treaty and the EEA Agreement.
The Portuguese government argued that the Commission had not demonstrated that the different tax treatment would actually result in non-resident financial institutions being more heavily taxed. As a secondary argument, they took the view that non-resident financial institutions were not in a comparable situation to resident financial institutions as regards financing costs, because the financing costs could not be directly allocated to specific loans.
The ECJ’s decision
Like the AG, the ECJ based its decision on the formal argument that the Commission had not put forward any concrete evidence to support the numerical calculations it had used as the basis for its arguments. In line with this, the Court pointed out that, according to settled ECJ case law, the Commission may not rely on any presumptions when alleging the failure by a Member State to fulfill its obligations under EU law. The Court accordingly rejected the Commission’s case without addressing the substantive issues.
KPMG Meijburg & Co comment
The ECJ’s decision is disappointing but not surprising. We will have to wait until the Commission brings another infringement procedure or until a national court refers the question in a concrete case to the ECJ for a resolution of the central issue of this case.
Although the AG and ECJ both have rejected the Commission’s claim, it is clear that the AG agrees with the basic principle that imposing withholding tax on non-residents on a gross basis is contrary to EU law where residents are taxed on a net basis. This accords with the position KPMG Meijburg & Co has been advocating and that has led to similar infringement claims being submitted in several Member States by KPMG.
If, in a new case, the ECJ follows the AG’s reasoning on the technical argument, this is likely to have significant and widespread practical implications for cross-border payments such as interest, dividends and royalties, given that most Member States, if they impose withholding tax on such income, distinguish between residents and non-residents in a similar way to Portugal. Concerning the Netherlands this is relevant for the levying of dividend withholding tax.