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EU Questions National Taxation Of Pension Fund Payments

by Ulrika Lomas,, Brussels

08 May 2007

The European Commission is questioning nine member states about their rules under which dividend and interest payments to foreign pension funds (outbound payments) may be taxed more heavily than dividend and interest payments to domestic pension funds.

In the first stage of infringement proceedings, the Commission has sent letters requesting further information on these tax regimes to the governments of the Czech Republic, Denmark, Spain, Lithuania, the Netherlands, Poland, Portugal, Slovenia and Sweden.

The Commission said that it doubts whether such higher taxation is compatible with the EC Treaty and with the EEA (European Economic Area) Agreement, as it may restrict the free movement of capital. The member states involved are asked to reply within two months.

"The European pension industry has complained about higher taxation of pension funds if they exercise their rights under the EC Treaty to invest across the border" said EU Taxation and Customs Commissioner László Kovács. "The Commission is taking these complaints seriously and has decided to start formal enquiries".

The higher taxation of foreign pension funds may result from the levying of withholding taxes on dividend and interest payments. Most member states exempt their domestic pension funds from any corporation and/or income tax. In addition, they usually provide for exemption at source of any withholding tax on dividend and interest paid to domestic pension funds. Where there is no such exemption at source they normally apply a refund procedure, by which the pension fund can claim back the withholding tax. However, foreign pension funds may not qualify for the relief at source or the refund procedure. The result may be that the source state levies a higher tax on interest or dividends paid to foreign funds than on those paid to domestic funds.

If a member state levies a higher tax from foreign pension funds this may dissuade these funds from investing in that member state. Equally, it is likely to make it more difficult for companies established in that member state to attract capital from these foreign pension funds. The higher taxation of foreign pension funds may thus be a restriction of the free movement of capital as protected by Article 56 EC and Article 40 EEA. The Commission says that it is not aware of any justification for such a restriction.

The Commission noted that the ruling by the European Court of Justice in the Denkavit case of 14 December 2006 on outbound dividends appears to confirm that higher taxation of outbound dividend and interest payments than of domestic dividend and interest payments is not in conformity with the Treaty freedoms. This case concerned Netherlands-based firm Denkavit Internationaal BV which between 1987 and 1989 received 14.5 million French Francs by way of dividends from its two French subsidiaries, Agro-Finances SARL and Denkavit France. In accordance with the Franco-Netherlands Convention and the French legislation, a withholding tax of 5% of the amount of those dividends was levied, corresponding to 725,000 French Francs.

Denkavit Internationaal and Denkavit France claimed repayment of that sum from the French government, which subsequently asked the ECJ to rule on the compatibility of the French withholding tax system with Community law.

Tax experts have observed that the ECJ's ruling in the Denkavit case could have ramifications across the EU for investment and pension funds.

“(This) ruling dramatically reduces the scope for imposing withholding tax in the EU," commented Jonathan Bridges of KPMG’s EU law group.

Following up to the complaints it received, the Commission is still examining the situation in other member states. This may result in the opening of further infringement procedures.

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