1 – Introduction
European Union Law intervenes in the tax field in different ways. From establishing national solutions through Directives, to the direct application of Regulations, and to the need to respect primary law rules (Treaties), all variants are relevant in determining the meaning and viability of national rules. Thus, there are different concrete situations that I intend to analyse.
In first place, the judgment of the Court of Justice of the European Union of March 17th, 2022, in case C-545/19. This had as object a request for a preliminary ruling submitted by a Tax Arbitration Court (from the Centro de Arbitragem Administrativa) regarding the adequacy, or not, of the free movement of capital and freedom to provide services with the Portuguese tax regime regarding the taxation of income from shareholdings by Collective Investment Undertakings that are not resident in national territory and do not have a permanent establishment therein: Under Portuguese law the above-mentioned entities will be subject to withholding tax and taxation at a rate of 25% (articles 4(2) and 87(4)(c) of the CIT Code), whereas resident entities are not subject to the same obligation (Article 22(1), (3) and (10) of the Tax Benefits Statute), although they are subject to the autonomous tax rates established in Corporate Income Tax (more specifically Article 88(11) of the CIT Code) and Stamp Duty (Part 29 of the General Annex to the Stamp Duty Code). The Court considered that this regime jeopardized the free movement of capital as provided for in Article 63 of the Treaty of the Functioning of the European Union.
On the other hand, the Council of the European Union adopted, on April 5th, a directive allowing a revision of the VAT rates system, allowing a wider use of reduced rates. This even includes the possibility of zero rates for food and pharmaceutical products. In this way, and according to what is foreseen, States will be able to have four rate systems: the normal rate, the two reduced rates and a zero rate. This system and its application will depend, once the Directive has been transposed, on the way in which the States apply the new system of rates. Its application may generate an enormous complexity in the management of the tax and is generating some doctrinal perplexity.
2 – The Judgement: steady wind
The contested issue arose from an administrative claim, and consequent appeal to the Arbitration Tax Court, by a Collective Investment Undertaking incorporated in Germany and headquartered in the same country. This Collective Investment Undertaking held shares in Portuguese resident companies and was therefore taxed by withholding tax at a rate of 25%. The opposite happened with the dividends paid to Collective Investment Undertakings based in Portugal and operating in accordance with Portuguese law, which are exempt from such taxation.
The Court started by considering that the compatibility with the free movement of capital and it should be examined in three main groups of questions.
The first related to the existence, or not, of a restriction on the free movement of capital. The Court first considers that restrictions on that freedom include those which may dissuade a non-resident from investing in a Member State or dissuade residents from investing in other States. It then holds that there is unfavourable tax treatment of dividends paid to non-resident Collective Investment Undertakings and that such treatment may deter investment and therefore constitutes a restriction on the free movement of capital. Despite this assumption, as a result of the combined reading of Article 65 (1) and (3) of the Treaty of the Functioning of the European Union, it should be analysed whether the difference in treatment refers to situations which are not comparable or whether that difference should be admitted for an overriding reason in the public interest. Those are the two questions which the Court then addressed, in particular because a distinction must be drawn between situations involving permissible differences in legal treatment and those involving prohibited discrimination.
One should note that a difference in treatment which concerns situations which are not objectively comparable is compatible with European rules on the free movement of capital. That is precisely what the Portuguese Government claimed as being applicable to the situation at stake. More specifically, it was claimed that the situations are not comparable because of the existence of autonomous tax rates on CIT Code (Article 88(11)) and stamp duty in relation to resident taxpayers; that there is a difference in the taxation of dividends depending on whether the distribution is made to residents or non-residents without a permanent establishment (the former being generally exempt); that there is an integrated nature of this taxation; that withholding tax can always be subject to repercussion; and that the option to operate in Portugal, besides being unrestricted, excludes it from comparison with resident entities, as the comparison should be made with other non-residents. In this regard the Court concluded that the difference in tax treatment between resident and non-resident Collective Investment Undertakings involves comparable situations, which means that there is no compatibility in this way with the free movement of capital. It should be noted, in line with previous decisions, that the Court considered that both situations may be subject to economic double taxation or chain taxation.
Finally, as to whether there is an overriding reason in the public interest capable of restricting the free movement of capital, the Court essentially considered two possible grounds for justifying the measure: the need to preserve the coherence of the national tax system, and the need to ensure the balanced allocation of the power to impose taxes between Member States. According to the Court’s judgment, neither of them is valid. As regards the need to preserve the coherence of the national tax system, the Court recalls that for this to be acceptable, the existence of a direct link between the tax benefit in question and its offsetting by a specific tax burden must be demonstrated. Such a link does not, in the Court’s view, exist. On the other hand, the preservation of the balanced allocation of the power to impose taxes between the Member States may be admissible where the aim is to prevent the possibility of jeopardising the right of a State to exercise its tax powers. However, the taxation of non-resident Collective Investment Undertakings did not have that objective.
For all these reasons, the Court considered that there was a violation of the principle of free movement of capital, as there were no exceptional situations that could justify it. This decision is relevant in itself and for all its future consequences as it corresponds to a corrective intervention of the Court of Justice of the European Union regarding discrimination between residents and non-residents in relation to taxation of income in Portugal. As is well known, the field of intervention par excellence of the European rules is in the field of indirect taxation. In this situation the Court corrects a dysfunction in the direct taxation regime, and it is important to analyse objectively other different regimes in which the taxation of residents and non-residents without permanent establishment is differentiated and assess their compatibility with European rules on freedom of movement.
3 – VAT: wind to be observed
In the VAT field, an indirect tax in which the European institutions take a central position, the Council of the European Union has released a proposal to amend the VAT Directive, as well as the General Orientation on the same. According to the Press Release, and on the matter of VAT rates according to the position taken, the updates envisaged ensure that Member States are treated equally and give them more flexibility to apply reduced and zero VAT rates. Thus:
- On the one hand, the proposal allows Member States to apply (i) up to two reduced rates of up to a minimum of 5% in up to 24 cases from the list of goods and services set out in Annex III of the VAT Directive, and (ii) the application of a reduced rate below 5% and an exemption with the right of deduction of the VAT paid at the preceding stage, but only to a maximum of seven items from the list in Annex III, selected from the goods and services considered to meet basic needs, namely those related to the supply of food products, water, medicines, pharmaceutical products, sanitary and hygiene products, transport of persons and certain cultural goods (books, newspapers and periodicals).
- On the other hand, the Council agreed to progressively eliminate reduced VAT rates or exemptions for fossil fuels and other goods with similar impact on greenhouse gas emissions, notably natural gas and wood, by January 1st, 2030.
Within the aforementioned seven points eligible for a reduced rate below 5% and one exemption, solar panels are included (see Recital 4a of the Proposal), which should be adopted for clearly defined social reasons of benefit to the final consumer or in the public interest (see Recital 4b of the Proposal). Accordingly, point 10c is inserted in Annex III, which states “Supply and installation of solar panels on and adjacent to private dwellings, housing and public and other buildings used for activities in the public interest”.
According to the Proposal (Article 3), Member States have until December 31st, 2024, to transpose the VAT Directive amendments.
These changes have caused several observations. On the one hand, there are those who are very concerned with the complexity that this modification may bring to the tax system, and on the other hand, there are those who highlight the relevance that the State will assume in the admissibility or not of these rates. The truth is that the pressure for the application of lower rates will be naturally assumed. All this leads us to conclude that more than sporadic changes to the different rates, we should move on to a rethink of the general VAT rates system: for the sake of its greater uniformity and application. We shall see where the winds take us.
Diogo Feio
21/04/2022