(CN) - Differing tax schemes for dividends of U.K. and non-British companies may lead to inequalities that violate EU law, the Court of Justice ruled.
Under current U.K. tax law, British investment firms receiving dividends from nationally based subsidiaries are exempt for corporation tax. But firms that receive dividends from their foreign subsidiaries owe the tax or must offset it against tax already paid in the country of origin. Even if the subsidiary is in another EU country, the British parent company allegedly faces less favorable tax treatment on dividends.
Though member states are theoretically allowed to apply the two different tax schemes to nationally and foreign-sourced dividends, the EU high court concluded Tuesday that different tax rates in different countries will inevitably lead to tax inequality.
"First, if the resident company which pays dividends is subject to a nominal rate of tax below the nominal rate of tax to which the resident company that receives the dividends is subject, the exemption of the nationally-sourced dividends from tax in the hands of the latter company will give rise to lower taxation of the distributed profits than that which results from application of the imputation method to foreign-sourced dividends received by the same resident company, but this time from a non-resident company also subject to low taxation of its profits, inter alia because of a lower nominal rate of tax," the decision states. "Application of the exemption method will give rise to taxation of the distributed nationally-sourced profits at the lower nominal rate of tax applicable to the company paying dividends, whilst application of the imputation method to foreign-sourced dividends will give rise to taxation of the distributed profits at the higher nominal rate of tax applicable to the company receiving dividends."
"Second, exemption from tax of dividends paid by a resident company and application to dividends paid by a non-resident company of an imputation method which, like that laid down in the rules at issue in the main proceedings, takes account of the effective level of taxation of the profits in the state of origin also cease to be equivalent if the profits of the resident company which pays dividends are subject in the member state of residence to an effective level of taxation lower than the nominal rate of tax which is applicable there," the Luxembourg court added. "The exemption of the nationally-sourced dividends from tax gives rise to no tax liability for the resident company which receives those dividends irrespective of the effective level of taxation to which the profits out of which the dividends have been paid were subject. By contrast, application of the imputation method to foreign-sourced dividends will lead to an additional tax liability so far as concerns the resident company receiving them if the effective level of taxation to which the profits of the company paying the dividends were subject falls short of the nominal rate of tax to which the profits of the resident company receiving the dividends are subject. Unlike the exemption method, the imputation method therefore does not enable the benefit of the corporation tax reductions granted at an earlier stage to the company paying dividends to be passed on to the corporate shareholder."
Originally designed to prevent double taxation on dividends, the court found that the tax scheme constitutes "a restriction on freedom of establishment and on capital movements that is in principle prohibited" by EU law.
Britain argued that its tax scheme ensures cohesion of its national tax system. Though the EU court agreed that the scheme satisfied the prevention of double dipping, it found that it is not vital to hold the tax system together.
"The tax exemption to which a resident company receiving nationally-sourced dividends is entitled is granted irrespective of the effective level of taxation to which the profits out of which the dividends have been paid were subject," the decision states. "That exemption, in so far as it is intended to avoid economic double taxation of distributed profits, is thus based on the assumption that those profits were taxed at the nominal rate of tax in the hands of the company paying dividends. It thus resembles grant of a tax credit calculated by reference to that nominal rate of tax. For the purpose of ensuring the cohesion of the tax system in question, national rules which took account in particular, also under the imputation method, of the nominal rate of tax to which the profits underlying the dividends paid have been subject would be appropriate for preventing the economic double taxation of the distributed profits and for ensuring the internal cohesion of the tax system while being less prejudicial to freedom of establishment and the free movement of capital."
Foreign Companies Cope With U.K. Taxes
Britain's tax policies toward multinational corporations also took center stage this week as the Public Accounts Committee grilled senior representatives of Google, Starbucks and Amazon on their corporate tax affairs in Britain.
Taxand, an international group of tax advisers to multinational businesses, says that the U.K. may be looking to tax international companies based on their global profits.
"This further grilling for multinational executives only serves to perpetuate the mixed messages being received by multinationals, as governments lower corporate tax rates on one hand whilst pointing the finger and creating instability with the other," Taxand chairman Frederic Donnedieu de Vabres said in a statement. "All of this unfolded alongside calls for moves to an additional sales based tax, away from the profit based system that is currently in place."
Donnedieu de Vabres pointed out that international corporations engage in legal tax planning to meet diverse tax laws across multiple jurisdictions around the world.
"To ask a multinational company either to choose which country within its global operations should benefit from the revenue raised through its tax obligations, therefore denying others, or to decide on an amount of tax beyond the legal requirement which should be taken from investor returns and given to one or more jurisdictions, are surely a moral and political judgment outside their scope of responsibility," Donnedieu said. "Politicians and supranational bodies must take responsibility for the tax systems that they have designed and not push this responsibility back to the companies that have to operate these systems."
Tinkering with the system would add "considerable instability to the international tax system" and onerous regulations within the EU mean rough sailing for multinational companies, Donnedieu de Vabres warned.
"The prospect of continual tax code changes does little to promote the stability needed for multinationals' growth and the potential for tax authorities to, for example, penalize certain structures retrospectively, is doing little to encourage investment in an ongoing environment of economic uncertainty," he said. "Equally, whilst commendable, the actions that tax authorities have taken to more effectively engender the exchange of information across borders is creating a burgeoning compliance burden for multinationals that must be managed."
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