On March 25, 2010, Advocate General (AG) Juliane Kokott issued her opinion in the case pending before the European Court of Justice (ECJ) 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. The AG concluded that this would, in principle, constitute a restriction of the freedom to provide services, but considered that the ECJ should reject the Commission's claim on the grounds that it had not provided adequate factual evidence in support.
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 subsidiary 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 AG's opinion
The AG referred to settled case law of the ECJ to support her conclusion that the freedom to provide services was the only freedom that needed to be considered in the present case.
The AG then addressed the question whether the different treatment of residents and non-residents was discriminatory: this would be the case if the different treatment resulted in less favorable tax treatment of interest for non-resident financial institutions than for resident institutions. The AG addressed the Commission's argument in this context by reference to a numerical example. She pointed out that whether or not there was a heavier burden for non-residents in a particular case depended on the applicable tax rate and on the relative level of costs in relation to the gross interest income. The AG then noted that the Commission had not put forward any concrete evidence to support the actual relationship between costs and income for Portuguese financial institutions. While they did not have to show that all non-residents would be taxed more heavily, they did have to show that it was effectively possible. Since the Commission had failed to do this, the AG concluded that they had not demonstrated that the Portuguese rules were discriminatory.
Given the above, the AG did not feel it necessary to address the subsidiary argument raised by the Portuguese government of whether resident and non-resident financial institutions were in comparable situations, in particular in the situation where costs could not be allocated to specific loans.
KPMG Meijburg & Co comment
Although the AG concludes that the ECJ should reject 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 two Member States by KPMG.
The question the AG leaves open is whether the discrimination would be limited to situations where costs can directly be allocated to specific loans or whether a pro rata allocation would be acceptable. This issue is obviously likely to be of most practical relevance for sectors such as financial services.
If 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.