The case concerns a Lithuanian company distributing dividends to its Cypriot parent company. This entity forms part of a chain of entities ultimately leading to a private individual shareholder, who is not a resident in Lithuania (UBO).

Neo Group UAB, the Lithuanian company, was wholly owned by Retal Industries Ltd, the Cypriot company. In 2016 and 2017, Neo Group UAB inter alia distributed substantial dividends to its parent company. These distributions were treated as exempt under Lithuanian law, and no withholding tax was applied.

According to the Lithuanian tax authorities, however, these dividend distributions did not end at the level of the Cypriot parent. Instead, these were allegedly part of a chain of transactions through which the funds were ultimately passed on to the UBO. The Lithuanian tax authorities observed that the amounts received by the parent company closely matched the amounts subsequently paid further up the chain to another Cypriot entity, which had no employees and derived almost all its income from dividends.

At the top of the structure, the UBO had sold the shares of the other Cypriot entity with the purchase price remaining indebted. Payments made within the structure were offset against those obligations.  

On this basis, the tax authorities considered that the transactions had been carried out artificially. In their view, the structure created the impression that dividend payments were used to cover debt, while serving to channel profits to the ultimate shareholder without triggering taxation. They therefore concluded that the arrangement was designed to avoid withholding tax and that the exemption should not apply.

Neo Group UAB disputes this assessment. It argues that the companies involved were not artificial and that the transactions reflected economic reality.  

Against this background, the referring body (i.e. Tax Disputes Commission) questioned whether the interpretation of the Lithuanian national anti-abuse rule by the Lithuanian tax authority is compatible with the objectives of the Parent-Subsidiary Directive (PSD).

In her opinion, Advocate General Kokott (AG) provides important guidance on the application of the concept of abuse under the PSD. The emphasis is clearly less on formal criteria and more on economic reality and the actual taxation within the structure.

The two-part abuse test remains the starting point. The AG reiterates that there are two conditions under which exemption is refused: (i) the arrangement must not be genuine and (ii) its purpose must be to obtain a tax advantage that defeats the object of the directive. An arrangement is not genuine to the extent that it was not put in place for ‘valid commercial reasons’ which reflect economic reality.

At the same time, the Advocate General explicitly places this within the context of the PSD’s framework, under which corporation tax on the profits of a group of companies is, in principle, only levied at the point where they are generated at the level of the subsidiary, and income tax is levied only on the ‘final’ distribution by the group’s parent company to its shareholder. 

There is abuse of the PSD whenever its constituent elements are fulfilled only formally in order to obtain the tax advantage granted by the PSD.  

Consequently, in the case of a distribution of profits by a subsidiary to its parent company which is the beneficial owner of the dividends, there is not, as a rule,a non-genuine arrangement. In particular, it is not possible to infer any such non-genuine arrangement solely from the fact that the parent company which is the beneficial owner distributes its profits (which include the dividends received) onward. It is specifically the purpose of a corporation to generate profits and to distribute them to its shareholders.

There may be abuse if the distribution is made in order to obtain a tax advantage contrary to the PSD, so where the distribution by the subsidiary to the parent company – which, in isolation, reflects economic reality – is part of an abusive overall plan.

That is the case, for example, where the PSD is exploited to generate income for the final beneficiary, which, in contravention of the law, cannot be taxed in respect of him or her.

The Advocate General also rejects a formalistic approach: elements such as the timing of dividend flows, similarities in amounts, or the mere passing through of dividends do not in themselves constitute an indication of abuse. Nor does a possible abuse of national law in another Member State automatically lead to a denial of the benefits of the PSD.

However, a clear line is drawn where structures are deliberately set up to avoid taxation of the ultimate shareholder. In that context, the subjective test also shifts to the level of the ultimate decision-maker: the decisive factor is the extent to which the ultimately controlling shareholder is aware of the intended tax advantage.

This conclusion thus confirms a clear trend in European abuse doctrine: less emphasis on formal qualifications and more focus on the overall picture, the economic reality, and the position of the ultimate shareholder.
 

Regarding tax advice or questions about this blog, please contact Peter van Dijk (vandijk@dayonelegal.nl)