European Union: Brisal Decision: The CJEU Rules That Withholding Taxes May Be Contrary To EU Law

Overview

The Court of Justice of the European Union (CJEU) delivered its judgment in the Brisal¹ case in July which could result in a fundamental change to the manner in which withholding taxes are applied on payments between EU member states and reduce the effective tax which may be suffered on certain cross-border payments.

The ruling may result in a lower withholding tax (WHT) burden for certain EU resident financial institutions, as well as the potential for reclaims by EU resident financial institutions which have suffered interest WHT on payments from other EU member states. The ruling may also apply to non-bank commercial lenders as well as to other payments which may be subject to WHT such as royalties.

The Case

On 13 July 2016, the CJEU handed down its decision in the Brisal case which held that national tax rules which only allow a deduction for financing costs and other expenses to resident financial institutions, and deny that right to non-resident financial institutions in other EU member states, are contrary to EU law.

Brisal, a Portuguese resident entity, had a loan with a syndicate of banks, which included Portuguese financial institutions and an Irish bank. Interest received by Portuguese resident financial institutions was subject to corporation tax in Portugal on a net basis (i.e. after deduction of expenses) at the rate of 25%. In contrast, interest received by non-resident financial institutions was subject to Portuguese withholding tax at source on the gross amount of the interest at the rate of 20% (or lower if treaty relief applied, e.g. 15% under the Portugal/Ireland double tax treaty). The CJEU held that by imposing WHT on interest payments made by Brisal to an Irish resident bank without permitting the right to deduct financing costs and business expenses, Portugal was discriminating against non-Portuguese resident financial institutions.

Applying WHT per se to non-resident financial institutions in other EU member states was not an infringement. However, domestic rules which only permitted resident financial institutions, and not non-resident financial institutions, to deduct financing costs and related business expenses against their taxable interest income constituted a restriction on the freedom to provide services and was prohibited under EU law. This was the case notwithstanding the fact that non-resident financial institutions may be taxed at a lower rate.The CJEU held that nonresidents must in principle be treated the same way as residents and must be able to deduct the same expenses as those which residents are allowed to deduct. The CJEU elaborated upon those expenses which it would envisage would necessarily arise in the granting of a loan, such as in the case at hand, travel and accommodation expenses, and legal or tax advice, as well as financing costs. While acknowledging that financial institutions may find it more difficult to directly link financing costs with a given loan, the CJEU rejected the use of average interest rates charged on interbank financing which did not correspond with the financing costs actually incurred unless domestic rules permitted resident financial institutions a deduction on the same basis.

What are the implications of the judgment generally?

The direct implications of the judgment are that national rules which apply WHT on interest paid to EU resident financial institutions may need to be amended to permit those financial institutions to deduct financing costs and related business expenses. This could be achieved by applying WHT on net rather than gross interest income, or perhaps more practically by permitting a reclaim of excess tax withheld from the local tax authorities or by election to pay tax by direct assessment in the paying jurisdiction.

While the case only dealt with WHT on interest payments to financial institutions, it is arguable that the decision should equally apply to interest payments to non-bank commercial lenders. As such the decision may be relevant not only for the banking industry but for all companies involved in EU cross-border financing.

It may also be argued that the ruling should also extend to withholding taxes on payments other than interest, such as royalty payments.

What are the implications for Ireland?

As is the case with many EU member states, Ireland does not generally apply WHT on interest paid to financial institutions in other EU member states. As such, the decision may give rise to few, if any, reclaims of Irish WHT on interest. However, Irish WHT rules (or treaty provisions) may need to be reviewed in the context of intra-EU interest payments by Irish resident individuals or to non-corporate lenders where WHT tax on gross interest can, in certain cases, apply.

Irish residents that are currently withholding tax on interest or royalties paid within the EU may wish to seek legal advice as to whether they should continue to withhold tax.

What are the implications for Irish financial institutions and other non-bank lenders?

The ruling may result in a lower withholding tax burden for Irish resident financial institutions that engage in EU cross-border lending and enable them to contest the application of WHT (if applicable) on future interest payments. It also opens up the possibility for Irish resident financial institutions (and possibly other Irish resident non-bank commercial lenders) which have suffered WHT on interest payments from borrowers resident in other EU member states to seek to reclaim some of the tax withheld.

Irish residents which have suffered material WHT on interest or royalties paid within the EU may also wish to seek legal advice as to whether a refund is available and whether protective claims should be filed in relevant EU member states.

Footnotes

1 Brisal and KBC vs Fazenda Pública case (C-18/15) August 2016

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