Dear FS professional,
We are presenting our third FS Tax Newsletter for this year in which we have summarized the most recent tax-related developments of the last two months in the FS-sector for you.
This issue includes VAT related topics regarding amongst others the management of SIFs, the cross-border application of the cost sharing exemption and the VAT treatment of outsourced services relating to the operation of ATMs. Also, we have included a summary of two CJEU judgments regarding the application of the withholding tax exemption and the judgment of the Amsterdam Court of Appeals regarding a so-called fraus legis case.
For tax-related topics not included in this FS Tax Newsletter, please visit our website.
If you would like to know more about the matters addressed in this newsletter please contact us.
Niels Groothuizen, Partner, Financial Services Tax Group
Table of Contents
- 1. Preliminary questions regarding the cross-border application of the VAT cost sharing exemption
- 2. Preliminary questions regarding the VAT treatment of management services supplied by a third party for both SIFs as non-SIFs
- 3. European Court of Justice renders landmark cases on conduit companies
- 4. Opinion of the CJEU Advocate General on the VAT treatment of outsourced services relating to the operation of ATMs
- 5. Amsterdam Court of Appeals applies abuse of law doctrine in private equity investment case
- 6. Preliminary questions regarding the VAT treatment of insurance management services supplied by insurers and insurance management services supplied by investment managers
1. Preliminary questions regarding the cross-border application of the VAT cost sharing exemption
We start with an update of the VAT cost sharing exemption. As mentioned in the 35th issue of this newsletter, the Court of Justice of the European Union (‘CJEU’) rendered judgments in the DNB Banka (no. C-326/15) and Aviva (no. C-605/15) cases regarding the cost sharing exemption in the FS sector. The CJEU ruled that the VAT exemption for cost-sharing groups does not apply to the financial and insurance sector. However, the Dutch Ministry of Finance announced in mid-2018 that it will endeavor to keep the cost sharing exemption in place for financial institutions and insurers.
A court in the United Kingdom (‘UK’) has now requested a preliminary ruling on the application of the VAT cost sharing exemption in the Kaplan International Colleges UK case (no. C-77/19). Kaplan had procured services without VAT in Hong Kong and was providing these VAT-free to EU taxpayers under application of the VAT cost sharing exemption. The reference begins by asking whether the exemption extends to a cost sharing group in another Member State or outside of the EU. The case relates to the educational sector and not the FS sector. Now that some Member States (such as the Netherlands) allow the application of the cost sharing exemption in the financial and insurance services industry, this case might be an interesting one to follow.
2. Preliminary questions regarding the VAT treatment of management services supplied by a third party for both SIFs as non-SIFs
The UK court has also requested a preliminary ruling regarding the interpretation of the VAT exemption for the management of Special Investment Funds (‘SIFs’). This case concerns Blackrock Investment Management (UK) (no. C-231/19), whereby a third party supplies a management service to a fund manager and which is used by that fund manager for both the management of SIFs (VAT exempt) and the management of non-SIFs (subject to VAT). The questions are as follows:
- Is this a single supply to be subject to a single rate of tax; and if so, how is that single rate to be determined; or
- Is the consideration for that single supply to be apportioned, so as to treat part of the single supply as VAT exempt and part as VAT taxable?
These questions may have a wider impact. This case could for example be relevant for management services supplied to pension funds, whereby the pension fund has two pension schemes: one that qualifies as a SIF and one that does not. The question is whether the single supply of the management service that relates to both pension schemes is VAT taxed or VAT exempt. The current interpretation from the Dutch tax authorities appears to be that the full service is VAT taxed based on the CJEU case Stadion Amsterdam CV (no. C-463/16). The question is whether this will now change.
3. European Court of Justice renders landmark cases on conduit companies
On February 26, 2019 the CJEU issued two judgments on the application of the withholding tax exemptions provided for by the Interest and Royalties Directive (joined cases C 115/16, C 118/16, C 119/16 and C 299/16) and the Parent-Subsidiary Directive (joined cases C 116/16 and C 117/16). The cases involve (dividend and interest) payments made by Danish companies to affiliated companies resident in EU Member States. The Danish tax authorities declined to apply the withholding tax exemption since, in their view, the recipients of the payments are mere conduit companies and cannot be considered to be the beneficial owners of the payments. The main difference between the Interest and Royalties Directive case and the Parent-Subsidiary case is that the former Directive includes a beneficial ownership requirement, while the latter does not impose such requirement.
The CJEU found that there is a general principle in EU law such that EU law cannot be relied on for abusive or fraudulent ends and cannot be extended to cover transactions carried out for the purpose of fraudulently or wrongfully obtaining advantages provided for by EU law (such as the withholding tax exemptions in the Directives referenced above). According to the CJEU, Member States must refuse to grant the benefits of EU law where provisions are relied upon not with a view to achieving the objectives of those provisions but with the aim of benefiting from an advantage in EU law, although the conditions for benefiting from that advantage are fulfilled only formally. Finally, the CJEU rules that on the one hand, a taxpayer is in principle free to choose the most favorable tax regime and that in itself cannot set up a general presumption of fraud or abuse. On the other hand however – according to the CJEU – a taxpayer cannot enjoy ‘EU benefits’ where the transaction at issue is purely artificial economically and is designed to circumvent the application of the legislation of the Member State concerned. It is for the referring (Danish) courts to determine whether the arrangements in place in these cases are in fact abusive.
However, the CJEU did provide an indication of what it would view as abuse of law. The existence of a conduit company with no substance, which does not have the power to enjoy income but must pass it on to a third party, could be viewed as an indication of abuse. More specifically, the indicia developed by the Court include among others:
- On account of a conduit entity interposed in the structure of the group between the company that pays dividends and the company in the group which is their beneficial owner, payment of tax on the dividends is avoided.
- All or almost all of the dividends are, very soon after their receipt, passed on by the company that has received them to entities which do not fulfil the conditions for the application of the PSD.
- The fact that a company acts as a conduit company may be established where its sole activity is the receipt of dividends and their transmission to the beneficial owner or to other conduit companies.
- The absence of actual economic activity must, in the light of the specific features of the economic activity in question, be inferred from an analysis of all the relevant factors relating, in particular, to the management of the company, to its balance sheet, to the structure of its costs and to expenditure actually incurred, to the staff that it employs and to the premises and equipment that it possesses.
- Indications of an artificial arrangement may also be constituted by the various contracts existing between the companies involved in the financial transactions at issue, giving rise to intragroup flows of funds, by the way in which the transactions are financed, by the valuation of the intermediary companies’ equity and by the conduit companies’ inability to have economic use of the dividends received. In this connection, such indications are capable of being constituted not only by a contractual or legal obligation of the parent company receiving the dividends to pass them on to a third party but also by the fact that, ‘in substance’, that company, without being bound by such a contractual or legal obligation, does not have the right to use and enjoy those dividends.
- Moreover, such indications may be reinforced by the simultaneity or closeness in time of, on the one hand, the entry into force of major new tax legislation, and, on the other hand, the setting up of complex financial transactions and the granting of intragroup loans.
The case is a clear indication that the concept of abuse under EU law is continuing to evolve. While it provides a precedent for tax authorities and courts in EU jurisdictions to deny the benefits of an EU Directive where they believe an arrangement to be abusive, it could also extend to the provision of treaty benefits and in particular to the concept of “beneficial owner” under treaties between EU jurisdictions.
- An argument could be made that, under the EU principle of loyalty, Member States that do not grant the benefits of EU Directives by virtue of applying the EU anti-abuse concept, may not grant a similar benefit under an intra-EU tax treaty. In this line of thinking, granting treaty benefits in situations where a Directive’s benefits are denied, frustrates the combatting of (perceived) abuse of the Directives, since the CJEU seems to view (to a certain extent) treaty benefits (e.g. reduced withholding tax rates) as a benefit resulting from EU law.
- Whilst one can argue that treaty provisions should override domestic law, the CJEU seems to take the position that primary EU law outranks treaty provisions, i.e. from an EU perspective, granting treaty benefits is no different from including such benefits in domestic law.
Governments and tax authorities across Europe are analyzing these milestone judgments in detail. It is almost certain that this will not be the last that is heard from Luxembourg on this topic. It is clear that this is a very relevant topic for multinational enterprises, especially in the private equity sector where the prompt payment of dividends (as return on investors’ investments) is essential. Dated May 8, 2019, Members of Parliament raised questions on the impact of the judgments on Dutch (domestic) tax law. The Dutch Deputy Minister of Finance will (need to) answer these questions in the weeks to come, at which point we will know more on the Dutch government’s stance in the matter.
4. Opinion of the CJEU Advocate General on the VAT treatment of outsourced services relating to the operation of ATMs
On May 2, 2019, the Advocate General (“AG”) issued its Opinion in the Cardpoint case (C-42/18). This case concerns the VAT treatment of services relating to the operation of ATMs supplied to the banks that operate those ATMs. The activities outsourced to Cardpoint consist of the operating and maintaining the ATMs, replenishing them, installing computer hardware and software in them to enable them to read bank card data, sending a withdrawal authorization request to the bank card used, dispensing money and registering withdrawal transactions. The question was raised whether such services are covered by the VAT exemption for transactions concerning payments and transfers.
From the CJEU cases Bookit (C-607/14) and DPAS (C-5/17) it follows that in order for the VAT exemption to apply, the services supplied, taken individually or together, must be regarded as performing a specific and essential function of a payment or transfer transaction. A service only fulfils a specific and essential function of the transfer insofar as it has the effect of transferring funds and entails changes in the legal and financial situation resulting from such a transfer. Consequently, in order to be exempt, a supply of service must have the effect of making the legal and financial changes which are characteristic of the transfer of a sum of money.
On the basis of the abovementioned case law, the AG concluded that the service supplied by Cardpoint does not have the effect of actually or potentially transferring ownership of the funds in question or of fulfilling the specific and essential function of such a transfer. The fact that Cardpoint is responsible for the operability of the ATMs and is therefore liable for malfunctions, damages, and improper installation of the ATMs is also not convincing for the AG, since Cardpoint assumes no liability for the legal and financial changes involved in the payment transactions. According to the AG, the service must only be regarded as a technical and administrative service that cannot fall within the scope of the VAT exemption.
It could already be derived from the previous CJEU case law that the application of the VAT exemption for transactions concerning payments and transfers is very strict. Interestingly, no questions have been raised on the application of the exemption for transactions in bank notes, which exemption appears to be relevant for the case at hand. We look forward to the CJEU’s decision, but do not expect the CJEU to deviate from its strict line.
5. Amsterdam Court of Appeals applies abuse of law doctrine in private equity investment case
In a lengthy and detailed judgment published on May 8, 2019, the Amsterdam Court of Appeals (‘the Court’) ruled that the interest paid by a Dutch acquisition entity paid in respect of convertible instruments issued to the investors of a private equity firm is not deductible for Dutch tax purposes under the abuse of law doctrine.
In short, the case involves a private equity firm (and its investors) that set up various French partnerships to fund a Dutch company (‘SPV’) in order to acquire a target company. The French partnerships are so-called transparent (i.e. flow-through) entities for French tax purposes (and as such, not subject to tax in France) but are considered non-transparent for Dutch tax purposes (and thus regarded as the owners of the SPV). The investors contributed approximately EUR 78 million to the equity of the SPV, provided EUR 61.5 million of cash to the SPV under convertible instruments and EUR 5 million via non-interest bearing loans. Additionally, approximately EUR 150 million of funds was obtained from third party banks at the SPV level. The case revolves around the (non-)deductibility of the interest paid in respect of the convertible instruments.
The convertible instruments had a 40-year term, carried interest at a rate of 13% (the interest was not actually paid but added, interest bearing, to the principal), included a conversion right for the SPV, ranked senior only to the SPV’s equity, had no voting rights and were issued in proportion to the capital contributed. The convertible instruments could only be transferred by the holders upon receiving explicit approval from the SPV. The Dutch tax authorities challenged the deductibility of the interest in respect of the convertible instruments (EUR 27 million over a three-year period) based on a myriad of arguments. The Court decided as follows.
- For Dutch civil law purposes, the convertible instruments constitute a loan (i.e. debt) and are not be considered a so-called ‘sham loan’ (by virtue of which the instruments would be deemed to be equity).
- For Dutch tax purposes, the debt character of the instruments is not to be re-characterized into equity on the basis of the profit participating loan doctrine (under which debt is reclassified into equity if the amount or the indebtedness of the interest is profit contingent, the loan has a term of more than 50 years and is only repayable upon liquidation, bankruptcy or suspension of payment under a creditor’s arrangement and the loan is subordinated to all ordinary creditors).
- For Dutch tax purposes, the instruments are not to be considered ‘non-business motivated loans’, nor is the interest considered to be a non-business expense or not at arm’s length.
- The anti-base erosion rule (of Section 10a of the Dutch Corporate Income Tax Act (‘CITA’)) does not apply since that rule requires (a direct or indirect) affiliation between the creditor(s) and debtor of at least 1/3. Since this case involved four French partnerships, the 1/3 affiliation requirement was not met.
- The interest however, is non-deductible under the abuse of law concept (‘fraus legis’).
All of the Court’s deliberations are of importance to the current tax practice, especially to private equity acquisition structures. The most relevant part of the Court’s judgment however, is the application of the abuse of law doctrine. According to the Court, the investment structure is aimed at tax avoidance since equity (at the investor/group level) was presented as debt to the SPV which was ‘rerouted’ through hybrid instruments (the convertible instruments), using hybrid entities (the French partnerships), with the sole purpose of generating interest deductions at the SPV level. In addition, the Court ruled that the arrangement is incompatible with the meaning and purpose of Section 10a CITA. It appears as though the Court feels that the arrangement was set up to (artificially) prevent the application of Section 10a CITA – that requires a 1/3 affiliation – by using four French partnerships in order not to reach the referenced affiliation threshold.
The Court’s judgment could be considered groundbreaking, although we understand that the taxpayer in question (i.e. the SPV) will fight the Court’s decision in front of the Dutch Supreme Court.
6. Preliminary questions regarding the VAT treatment of insurance management services supplied by insurers and insurance management services supplied by investment managers
Lastly, a UK court has requested a preliminary ruling on whether insurance management services supplied by (a) insurers and/or (b) non-insurers to managers of pension funds can be qualified as an insurance or reinsurance transaction. The UK applied the exemption to all regulated insurance activities, including pension fund management supplied by an insurer. However this policy was changed by the UK tax authorities with effect of April 2019. As insurers could apply an exemption on all pension management services, and investment managers that supplied services to pension funds with a Defined Benefit (DB) scheme could not apply the VAT exemption on their services, questions were raised as to whether this is a breach of fiscal neutrality and a recipient of such services, United Biscuits, had raised an appeal. We will update you on the progress of this case.