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Beneficial ownership: freedom of management is key
CAA Versailles 17 octobre 2023, n°21VE03404, SAS P.S.T Industries
In 2013, a Luxembourg holding company purchased the shares of a French company from an unrelated Swiss company. The shares were purchased by means of a vendor loan payable over 5 years, with an interest rate of 2.83%. From 2014 onwards, the vendor loan was repaid thanks to the dividends received by the Luxembourg company from its French subsidiary (paid in full to the Swiss company) and the “management fees” invoiced each year to the same subsidiary.
The French distributing company exempted the dividends paid to its Luxembourg parent from withholding tax based on art. 119 ter of the French Tax Code, as it was applicable at the relevant time.
Following an audit of the French company's accounts, the tax authorities questioned the exemption from withholding tax on the following grounds:
The dividends received from the French company were paid in full to the Swiss company, which is resident in a third country;
The Swiss company must be regarded as the beneficial owner of the distributions, as the Luxembourg company is merely an intermediary;
Consequently, the conditions for exemption from withholding tax set out in art. 119 ter are not met.
The Administrative Court ruled in favor of the tax authorities.
According to the Administrative Court of Appeal:
The Luxembourg company received the dividends and used them to repay its vendor loan, thereby reducing its debt and increasing its assets;
As a result of its own management decisions, the Luxembourg company used these sums to pay down its debt;
Under these conditions, the Luxembourg company has effectively benefited from the dividends received from its subsidiary.
In this regard, the Court judged that:
- The following circumstances are irrelevant:
- the Swiss company was created shortly before the acquisition of the French company's shares;
- during the period in which the Swiss company held its shares (from 2008 to 2013), no dividends were distributed by the French company;
- the Swiss company realized a capital gain of €2 million on the sale;
- the Luxembourg company did not have the necessary equity for this acquisition, and was granted a vendor loan for the full price;
- it was stipulated that the pledged securities would revert to the seller in the event of default;
These circumstances did not pertain to establish that the Luxembourg company was merely an intermediary between the French company and the Swiss company, which were, in any case, not related.
Our experts’ view
The issue in this case was the exemption from dividend withholding tax for European parent companies based on article 119 ter, 1 of the French Tax Code. Under the terms of this article, the legal entity receiving the payment must be able to prove that it is the beneficial owner of the payment, to qualify for the exemption.
It should be noted that although this condition is not expressly set out in the Parent/Subsidiary Directive (Directive 2011/96 EU), which is transposed into domestic law by Article 119 ter, case law has confirmed that it is implicit (see CE 5 June 2020 no. 423809 to 423812, a solution that already emerged from the CJEU rulings of 26 February 2019 aff. 116/16 and 117/16).
Similarly, for the application of most bilateral tax treaties, the status of beneficial owner is a condition for the withholding tax exemption or reduced rate on interest, dividends, and royalties (OECD, Model Tax Convention on Income and Capital, Comm. art. 10, 11 and 12).
Although the tax authorities regularly use the notion of beneficial owner to deny a foreign taxpayer the benefit of a treaty advantage, or, as in this case, to deny a European taxpayer the benefit of the withholding tax exemption provided for in article 119 ter of the French Tax Code, it is not precisely defined in the texts. It is, however, clarified by the OECD commentaries on articles 10, 11 and 12 of the Model Convention on Income Tax and Capital.
As early as 1977, the commentaries on article 10 of the Model Convention stipulated that a treaty benefit should be denied to a person who is not the beneficial owner of the income. This concept was clarified to refer, in particular, to a recipient who is an intermediary, such as an agent or other representative interposing himself between the creditor and the debtor of the income (OECD Comm. 1977, art. 10 § 12), or who acts as a conduit on behalf of another person (OECD Comm. 2003 art. 10 § 12.1).
In 2014, the OECD's commentary was supplemented to stipulate that the direct recipient might not be the beneficial owner because his or her right to use and enjoy the dividend is limited by a contractual or legal obligation to assign the payment received to another person (OECD Comm. 2014 art. 10 §12.4). The OECD further clarifies that this obligation usually derives from relevant legal documents, but it may also exist because of facts and circumstances that fundamentally show that the recipient clearly does not have the right to use and enjoy the dividend without being limited by a contractual or legal obligation to pass the payment received to another person (OECD Comm. 2017 art. 10.§12.4).
These comments reveal a primarily legal approach to the concept of beneficial ownership which includes the roles of agent and representative, as well as the obligation to assign payments received. This is sometimes complemented by a more factual or economic perspective, involving the notion of an intermediary company and an approach based on facts and circumstances.
Judges naturally take these elements into consideration when ruling on the qualification of a beneficial owner, as they appear to be relevant to the interpretation of the directive (see ECJ rulings cited above. Recent case law reflects a relatively strict interpretation of the concept, as illustrated by the decisions summarized below.
For instance, a Swiss company was determined not to be the beneficial owner of dividends paid by its French subsidiary, despite having retained them without distribution to its sole shareholder, a Portuguese tax resident. According to the judges, it was not established in this case that the company had the practical power to dispose of the income, and that it was not merely acting on behalf of its sole shareholder. In this case, the amount of current account advances granted to the sole shareholder had increased, and the tax authorities contended that these circumstances demonstrated that, even without redistribution, the sole shareholder had access to the company's funds (CAA Versailles May 27, 2021, n°19VE00090, SAS Alphatrad).
It has also been ruled that a Dutch company which received sub-licensing royalties from France and transferred at least 88% of their amount to its parent company, owning 99.6% of the Dutch company and initially established in the British Virgin Islands, later relocating to Panama, was not the actual beneficiary of these royalties. This was because its authority to use and allocate the funds was notably limited in this scenario. Indeed, a "master license agreement" executed with its parent company reflected the sub-licensing contract from which it received the revenues and mandated it to remit a substantial proportion of those funds (CAA Bordeaux October 5, 2021, n° 20BX03606, SAS Meltex).
Lastly, it has been ruled that a Luxembourg company, which received an interim dividend from its French subsidiary, which was paid out in full the following day to its member, a second Luxembourg company, was not the beneficial owner of the French dividends. This conclusion was drawn because the three companies were in a 100% chain of ownership, the two Luxembourg companies shared the same directors, and the cash generated by the interim dividend was used for the redistribution. The fact that the first Luxembourg company had incurred local expenses amounting to €25,000 for rent, office space, fees and remuneration did not, according to the Court, prove that its activity was distinct from that of a mere conduit company. In support of its reasoning, the court expressly referred to the ECJ decisions of February 26, 2019, cited above (CAA Paris December 7, 2022, n° 21PA05986).
This decision by the Paris Administrative Court of Appeal on December 7, 2022, could legitimately cause concern for companies, as it seemed to create legal uncertainty. This concern is heightened by a decision from the French Supreme Court in 2021, concerning the repayment of royalties from France by the Performing Rights Society, a British company akin to Sacem, to the artists it represented. In that case, it was ruled that the concept of beneficial owner could be applied in a non-abusive context, where sums received by a company are, in practice, intended to be paid to another entity by virtue of a legal or contractual obligation, as already foreshadowed by the case law of the ECJ (CE February 5, 2021, n°430594 and n°432845).
In this decision, the judges presumably relying on the OECD's 2014 comments, seem to have set out to examine the existence of a connection between the dividend payment received by the Luxembourg company and the allocation of these sums (as well as the management fees it invoiced to its subsidiary) to the repayment of the vendor loan, which was granted by an unrelated company. In this case, the Luxembourg company, having received dividends from a French source, autonomously decided to allocate the received funds to the repayment of its acquisition debt. The judges thus inferred from the Luxembourg company's freedom of management regarding the allocation of its cash flows, as evidenced by its decision to use the dividends received to repay its acquisition debt, that the Luxembourg company could not be regarded as a mere conduit between its French subsidiary and its Swiss creditor. Both legally and economically, the Luxembourg company was therefore the effective beneficiary of the dividends received and qualified for the withholding tax exemption provided for in article 119 ter of the French Tax Code.
In line with previous case-law, the concept of freedom of management, that is, the capacity of the recipient of income French-source income to freely utilize the sums received, serves as a critical demarcation when tax authorities challenge the designation of the beneficial owner. Once confirmed, this principle facilitates the differentiation between voluntarily dispositions of income by the beneficial owner and compelled reimbursements, executed in the role of a mere intermediary or conduit entity, by the person who is merely the nominal recipient of the said income. No appeal has been lodged against this decision.
It should be noted that in this particular case, the tax authorities also challenged the tax residency of the Luxembourg company, arguing that it was in France. The court rejected this claim without examining it, ruling that even if the Luxembourg company were deemed to have its tax residence in France rather than Luxembourg, the distributions at issue would not be subject to the withholding tax provided for in article 119 bis 2 of the French Tax Code. On this latter point, it should be recalled that the French Supreme Court has recently overturned, due to excess of power (CE December 8, 2023, n°472587, Fédération bancaire française), the revision of the French Administrative guidelines BOI-RPPM-RCM-30-30-10-10 published February 15, 2023. Specifically, the annulment pertains to the final sentence of paragraph 1 of this guidelines declaring that the withholding tax provided for in article 119 bis, 2 of the French Tax Code "is applicable even when the recipient is domiciled for tax purposes or has their registered office in France, provided that the beneficial owner of the income, that is the person who has the right to dispose of it at their discretion, is domiciled for tax purposes or has their registered office outside of France".
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