Thorbjørn Henriksen Tax adviser at Copenhagen
Denmark's National Tax Tribunal on April 16 published its decision (SKM2010.268.LSR) in the first of a series of cases dealing with the beneficial ownership of dividends, interest, and royalties paid by Danish companies to nonresident holding companies.
Although this case was decided in favor of the taxpayer, the tribunal's reasoning suggests that the tax authorities could prevail in other cases with more typical fact patterns when a nonresident holding company has, as a practical matter, very narrow powers regarding the disposition of income received from a Danish company.
Under Danish domestic tax law, nonresident companies are subject to withholding tax on dividends, interest, and royalties unless certain conditions are satisfied. The rate of withholding tax is 28 percent on dividends and 25 percent on interest and royalties. If the taxpayer is entitled to invoke the benefits of a tax treaty or the EU parent-subsidiary or interest and royalties directives, the withholding tax may be reduced or eliminated. To qualify for tax treaty protection, the taxpayer normally must be the beneficial owner of the relevant income.
The acquisition of many Danish companies by corporate investors and private equity funds in recent years has prompted the Danish tax authorities to examine the structuring and income flows resulting from such acquisitions and to significantly increase their focus on the issue of beneficial ownership. This has given rise to a number of cases involving substantial amounts in which the tax authorities have asserted that nonresident holding companies located within the EU or in treaty countries are not the beneficial owners of dividends, interest, and royalties paid to them by Danish companies. The tax authorities have taken the position that the payments were subject to withholding tax and required the Danish companies to pay the withholding tax.
The case involved a consortium of private equity funds and other investors that had acquired a Danish company through a Luxembourg holding company. The legal structure may be summarized as follows:
The following transaction steps were scrutinized by the tax authorities:
• (1) HoldCo 1 distributed a dividend to LuxCo 2;
• (2) LuxCo 2 granted two loans to HoldCo 1;
• (3) HoldCo 1 subscribed for share capital in HoldCo 2; and
• (4) HoldCo 2 acquired shares in Target from third parties.
Steps 1 to 3 were executed on the same day and involved the same amount of money. Step 4, however, involved a higher amount because the purchase price for the shares was financed in part by third-party debt.
The tax authorities asserted that the dividends paid in Step 1 were subject to Danish withholding tax because LuxCo 2 was not the beneficial owner of the dividends under article 10 of the 1980 Denmark-Luxembourg tax treaty. The tax authorities relied on paragraphs 12, 12.1, and 12.2 of the commentary on article 10 of the 2003 OECD model treaty. According to the tax authorities, LuxCo 2 was not the beneficial owner because it did not carry out an active business and had no real power to act regarding the disposition of the dividends in question. On this basis, the tax authorities further argued that neither EU law nor the parent-subsidiary directive prevented Denmark from levying withholding tax on the dividends.
The taxpayer claimed that LuxCo 2 was the beneficial owner of the dividends. The taxpayer argued that a static interpretation should be made regarding the beneficial ownership concept; the applicable treaty was signed in 1980, and between 1977 and 2003 the OECD commentary significantly broadened the scope of circumstances in which a recipient of income can be regarded as not being the beneficial owner. However, the taxpayer claimed that LuxCo 2 should be considered the beneficial owner even under the 2003 commentary. The taxpayer's principal argument was that the dividends had not been redistributed but were used to finance the loans granted to HoldCo 1. Thus, it was immaterial whether LuxCo 2 had real power to act regarding the disposition of the dividends.
The taxpayer also referred to the prevailing opinion in Denmark that the Danish Supreme Court is expected to interpret the concept of beneficial owner in accordance with domestic law rather than to apply an autonomous tax treaty interpretation. The concept of beneficial owner is not used in domestic Danish tax law, so it was argued that a domestic law interpretation would mean that the "formal" owner of income normally should be recognized for tax purposes. That LuxCo 2 did not carry out an active business should be irrelevant because this was attributable to the nature of the company.
Article 1(2) of the EU parent-subsidiary directive, which authorizes member states to apply antiavoidance measures, requires that such measures be set forth in domestic tax law. Denmark does not have any specific antiavoidance rules on beneficial ownership, so Denmark would have to rely on the substance-over-form or assignment of income doctrines under Danish tax law. The taxpayer argued that the requirements for invoking these doctrines were not met in the case.
The majority of the National Tax Tribunal began by referring to paragraphs 12, 12.1, and 22 of the 2003 commentary on article 10. In particular, the tribunal emphasized that a conduit company could only be disregarded as the beneficial owner of dividends if the company had very narrow powers to act regarding the disposition of the dividends. However, narrow powers to act were not in themselves sufficient for a conduit company to be disregarded as a beneficial owner.
Since LuxCo 2 had not redistributed the dividends to its parent company, it could not be characterized as a conduit company regarding the dividends. Thus, LuxCo 2 was held to be the beneficial owner of the dividends under the Denmark-Luxembourg treaty. Moreover, the tax authorities were not entitled to deny the taxpayer access to the EU parent-subsidiary directive because the conditions for applying the substance-over-form and the assignment of income doctrines under Danish law were not met. The majority thus concluded that the taxpayer had not infringed on its withholding tax obligation. The minority of the tribunal, however, found in favor of the tax authorities on the grounds that it was immaterial whether the dividends were channeled to the parent company.
It should be emphasized that this case is not typical of the majority of cases, in which the income paid by a Danish company to a nonresident holding company is channeled to the ultimate shareholders. Based on the reasoning of the tribunal, it is not certain how such other cases will be decided. However, the emphasis placed on the 2003 OECD commentary suggests that new cases will be decided in the spirit of that commentary. Hence, a crucial issue will likely be the evaluation of the practical powers entrusted to a holding company in relation to income received from the Danish company. However, the decision does not give any indication of the National Tax Tribunal's position on the level of such powers that will be required to satisfy the beneficial ownership test.