EC Questions Spain's And Portugal's 'Discriminatory' Pension Legislation

By Ulrika Lomas, Tax-News.com, Brussels

28 November 2008

The European Commission has referred Portugal and Spain to the European Court of Justice (ECJ) over ‘discriminatory’ taxation of foreign pension funds.

The European Commission has decided to refer Spain and Portugal to the ECJ for their rules under which dividend and/or interest payments to foreign pension funds (outbound payments) may be taxed more heavily than dividend and/or interest payments to domestic pension funds (domestic payments). The Commission considers these rules to be contrary to the EC Treaty and the European Economic Area (EEA) Agreement, as they restrict the free movement of capital.

According to the Spanish rules, pension funds established in Spain are exempted from tax on their income, and they can claim back any Spanish withholding tax on the dividends that they receive. Any domestic dividends that they receive are thus effectively tax-free. By contrast, Spain levies a withholding tax of 18% on dividends paid to pension funds established elsewhere in the EU or in the EEA and European Free Trade Area (EFTA) countries.

Similarly, Portugal exempts dividends received by domestic pension funds and levies a withholding tax of 25% on dividends paid to pension funds established elsewhere in the EU or in the EEA/EFTA countries.

This results in higher taxation of dividends paid to foreign pension funds, although bilateral tax treaties may provide for a reduced withholding tax rate.

The higher taxation on dividends paid to foreign pension funds dissuades these funds from investing in Spain and Portugal. At the same time, companies established in Spain and Portugal may face difficulties in attracting capital from foreign pension funds as a result of this difference in treatment. The higher taxation of foreign pension funds thus results in a restriction of the free movement of capital as established by the European Treaty. In the case of controlling participations held by the foreign pension funds, it may also result in a restriction of the freedom of establishment under the Treaty.

Given that the Spanish and Portuguese tax rules were not amended to comply with the 'reasoned opinions' sent by Brussels to Spain and Portugal on March 8, 2007, the Commission has decided to refer these cases to the Court of Justice.

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