On 3 April 2025, the European Court of Justice (“ECJ”) delivered a decision (C‑228/24) providing clarifications on the interpretation of the anti-abuse provision included in the parent-subsidiary directive. The decision recalls the broad character of the rule, not limited to identifying conduit companies, adds precision on the timeframe within which the presence of an abusive arrangement (entirely or in part) must be analysed, and finally sheds some light on the condition pertaining to the obtention of a tax advantage which was not defined in the directive.
Background leading to the request for preliminary ruling
A Lithuanian company (the “Shareholder”) operating in the development and distribution of video games was holding a UK subsidiary (the “Subsidiary”), which existed between 2009 and 2021 and was responsible for the marketing and distribution of the Shareholder’s products. The Subsidiary distributed dividends in 2018 and 2019, which were treated at the level of the Shareholder as tax exempt in application domestic rules transposing Council Directive 2011/96/EU of 30 November 2011 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States (“PSD”).
The Lithuanian tax authorities, following their audit and based on information provided by the British tax authorities, considered the UK subsidiary as a non-genuine arrangement and denied the benefit of the dividend exemption. This specific anti-abuse rule results from Council Directive (EU) 2015/121 of 27 January 2015 adding to the PSD the obligation for Member States to deny the benefits of the PSD to “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.” (PSD article 1, § 2).
Local tax authorities relied on the mismatch between the level of activity of the Subsidiary (number of distributed products, clients, distribution channels) and the low level of local resources (a single employee acting as director for the Subsidiary and seven other companies, the absence of own premises) to conclude that the activities were in fact pursued by the Shareholder and its employees during 2018 and 2019, when the dividend was distributed.
The Shareholder did not agree with such conclusion and demonstrated that the Subsidiary was implemented for valid commercial reasons, that it had an effective commercial activity until its progressive unwind, thus providing a rationale to the tax audit findings. The Shareholder also put forward that there was no tax advantage obtained as the Subsidiary’s profits were taxed at a rate higher than they would have been in Lithuania at the level of the Shareholder.
Lithuanian authorities faced several interpretative questions referred to the ECJ:
- The Subsidiary was not found to be a conduit company and distributed profits resulting from real economic activities pursued in its own name. How does this factual background fit in previous ECJ case law (T Danmark C‑116/16 and Y Denmark Aps C‑117/16) which concluded that a “group of companies may be regarded as being an artificial arrangement where it is not set up for reasons that reflect economic reality, its structure is purely one of form and its principal objective or one of its principal objectives is to obtain a tax advantage running counter to the aim or purpose of the applicable tax law. That is so inter alia where, on account of a conduit entity interposed in the structure of the group between the company that pays dividends and the company in the group, which is their beneficial owner, payment of tax on the dividends is avoided.”
In this context, can the domestic legislation still deny the benefits of the PSD on the ground that the subsidiary is a non-genuine arrangement even though it is not a conduit company? (question 1). - If the above is allowed, in which timeframe should the constitutive elements of the PSD anti-abuse rule be researched? Thus, is it compatible with the PSD anti-abuse rule to rely only on the factual situation at the time of the dividend’s distribution? (question 2).
- The third question pertains to the obtention of a “tax advantage that defeats the object or purpose” of the PSD. Is obtaining the dividend exemption under the PSD from a subsidiary considered as a non-genuine arrangement constitutive of a tax advantage that defeats the object and purpose of the PSD? In addition, are the taxes paid by the subsidiary on its profits relevant in assessing the presence of a tax advantage or an arrangement? (question 3).
ECJ decision
Answer to question 1: conduit companies are only examples of non-genuine arrangements, where all conditions are met, a non-genuine arrangement can be found even though the subsidiary is not a conduit company
According to the ECJ, the interpretation of the anti-abuse rule of article 1, §§ 2 and 3 of the PSD, should be done in light of:
- The text which is not limited to specific arrangements and requires to consider all relevant facts and circumstances to identify the non-genuine arrangement whose characteristic is the absence of valid commercial reasons reflecting the economic reality.
- The system and objectives of the PSD: the anti-abuse rule should be considered as having a transversal character based on (i) the objective stated in the recitals of directive 2015/121 (which added the anti-abuse rule) to avoid abusive use of the PSD despite the variety of EU national tax rules and (ii) its positioning in article 1 of the PSD. From these elements, the ECJ concludes that the valid interpretation is the one allowing an application of the rule despite specific sets of circumstances, thus discarding a narrow interpretation.
- Case laws in relation with Directive 90/435 (i.e., the initial PSD since replaced by Directive 2011/96) including the T and Y Denmark cases Cadbury Schweppes case C‑196/04 where conduit companies are only an application case of the anti-abuse rule.
From these interpretation sources, the Court concludes that the qualification of an abuse results from the analysis of all relevant facts and circumstances without being limited to the identification of a conduit company.
Answer to question 2: it is not compatible with the PSD to analyse the anti-abuse rule only in the light of the facts and circumstances at the time of one step of the arrangement (here a dividend distribution) and disregard the facts that a subsidiary was formed for valid commercial reasons and engaged in genuine economic activity until this date
From the text of the PSD and Directive 2015/121, the Court notes that:
- Article 1, §2 of the PSD targets non genuine arrangements that have “been put into place for the main purpose or one of the main purposes of obtaining a tax advantage…”
- The last sentence further adds that an “arrangement may comprise more than one step or part.”
- Recital 8 of Directive 2015/121 provides that it is possible to consider as non-genuine only a step or part of an arrangement.
The Courts provides the following interpretation: (i) an arrangement initially set up for valid economic reasons reflecting economic reality can, at a certain point, become non genuine where the arrangement is maintained but the circumstances have changed, (ii) the possibility of applying the anti-abuse provision to non-genuine steps of an arrangement imply that circumstances subsequent to the arrangement set up must be considered to assess whether a step of an arrangement is genuine, (iii) the assessment of the abuse of right can neither be limited to the circumstance at the time of the arrangement set up nor, when assessing the step or part of an arrangement, exclude these initial circumstances as well as those existing before the step under review.
All interpretative sources (text of the PSD, recital 7 of Directive 2015/121, the T Danmark and Y Denmark cases) pointing at the necessity to take into consideration all relevant facts and circumstances to assess the existence of an abusive situation, the same must apply when assessing whether one or more steps of an arrangement are genuine. Therefore, these facts and circumstances cannot be limited to those existing at the date of the step reviewed.
Question 3: reaching the qualification that the subsidiary forms a non-genuine arrangement is not sufficient to establish that by obtaining a dividend exemption under the PSD the parent company obtained a tax advantage that defeats the object or purpose of the PSD
The Court starts by recalling that to deny the benefits of the PSD under the anti-abuse provision of article 1, §§ 2 and 3 PSD, two distinct and cumulative conditions are needed (i) the arrangement was not put into place for valid commercial reasons reflecting economic reality and (ii) the arrangement needs to have been put into place with the main purpose of obtaining a tax advantage that defeats the object or purpose of the PSD. In line with T Danmark and Y Denmark cases, the Court recalls that the proof of abuse requires (a) an objective component, i.e. that despite meeting the forms to benefit from the PSD its purpose is not met and (b) a subjective element, the intention to benefit from EU rules by artificially meeting their requirements.
The judges concluded that establishing the non-genuine character of an arrangement (here the subsidiary without substance and activity) only fulfills the first condition and is insufficient to establish the second condition, i.e. the proof of the subjective component being met.
On the tax advantage, the Court starts by observing that it is an undefined concept, thus requiring clarification on whether it should be strictly interpreted as obtaining an exemption under the PSD or it should be interpreted more broadly to consider the overall tax effects of an arrangement (in this case whether the difference in the corporate tax rate between the subsidiary and its shareholder provided for a “tax saving”).
To reach its conclusion the Court considered (i) the text of the PSD anti-abuse rule which does not suggest an interpretation of the tax advantage in isolation and the requirement to consider all facts and circumstances supports the view that the overall tax effects of the arrangement must be considered and (ii) the fact that without considering the overall tax effects, the subjective component of the abuse of rights would be difficult to identify as in practice taxpayer can seek an overall reduction of their tax burden and not only obtain the benefits of the PSD.
In the case under review, the fact that the corporate tax rate of the Subsidiary was higher than the rate applicable to the Shareholder must be considered to assess whether the main purpose or one of the main purposes of Subsidiary’s existence on dividend distribution dates was to benefit from a tax advantage.
Conclusion
The PSD together with its anti-abuse provision are part of the Luxembourg income tax law and through the principle of consistent interpretation, the ECJ’s decision is immediately relevant for Luxembourg companies as shareholder or subsidiary of other EU companies.
The decision recalls the broad character of the anti-abuse provision of the PSD, ensuring that when an entity is not a conduit company it does not automatically put such entity outside of the anti-abuse provision.
The Court brings two significant clarifications for taxpayers: the existence of facts and circumstances that could be viewed as abusive at one point in time are not sufficient to establish abuse under the PSD if contradicted by the overall facts and circumstances. Conversely, the existence of valid economic reasons upon implement does not mean that the arrangement is genuine during its whole existence, requiring taxpayers to ensure a commercial rationale continuously exists. Finally, the Court sheds some light on the condition pertaining to the obtention of a tax advantage, first it is not automatically met because a non-genuine arrangement benefited from the PSD and second it must be analysed in light of the overall tax effect produced by the arrangement. For example, as in the case reviewed (which is not an uncommon pattern) the fact that the subsidiary is subject to a higher tax rate than its parent is relevant for this analysis.
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