Impact of EU Law on the taxes withheld at source when dividends are paid

Tax Administration Bulletin, 11/25/2015

The treatment of resident and non-resident taxpayers may be different under EU law when the circumstances are different.  However, the treatment should normally be the same in circum­stances that are similar. Nevertheless, sometimes resident and non-resident taxpayers are treated differently due to a justification of the difference in treatments. When a procedure is based on such a justification, it is required that the EU principle of proportionality is being adhered to.

The Treaty on the Functioning of the European Union lays down the principle of the free movement of capital and payments in a specific provision ( Article 63, TFEU ), which is further applied on countries outside the European Economic Area. The justifications of different treatment may vary outside of the EEA.

Paying dividends to a corporate entity residing outside EEA

Finland's Supreme Administrative Court (KHO) handed down a ruling on 13 January 2015 where it applied the free movement  of capital principle on a distribution of dividends to an investment entity from the United States (Ruling KHO:2015:9).  The recipient of the dividends was a trust.

Under U.S. tax rules, trusts are regarded as legal persons able to conduct business in their name;  and when they engage in investments they are seen as investment companies subjected to regulatory procedures. The trust in question was a closed investment fund, i.e. it had a fixed quantity of stock-exchange listed fund shares. For U.S. federal tax purposes, it was treated as a corporate entity and as the beneficial owner of the invested assets and any returns on them. It should additionally be noted that it is commonplace in the United States that trusts do not have to pay tax.

The Court held that as a type of legal entity, a trust must primarily be viewed as being similar to a Finnish public limited company (Oyj); although there was some resemblance to a Finnish investment fund as well. According to the Court ruling, having regard to the provisions of Article 63, TFEU and the ECJ case law that has emerged, no source tax must be withheld on the payments of dividends to the trust because any receipts of dividends are tax-exempt in Finland in the hands of a domestic public limited company (and in the hands of a domestic investment fund) if they are distributed by another domestic public limited company.

Under the ruling, the exemption from taxation required that there was enough comparability between the beneficiary and a similar Finnish entity and that there was a tax treaty in force that contains a provision on the exchange of tax-related information between the countries involved.

Finnish investment funds do not pay tax to Finland

Investment funds are not regarded as legal persons in Finland. They may be undertakings for the collective investment in transferable securities (UCITS) regulated at EU level by the "UCITS Directive" or they may be special investment funds. The assets to be invested are made up of the money that the investors have paid in to the fund. Investors may be individuals or corporate entities. The investment fund is regarded as being owned by them. There is a separate fund company that manages the assets. Shares in an investment fund are freely tradeable and may additionally be quoted within the trading system of a stock exchange (ETF), if the fund has become stock-exchange listed. The investment fund is able to utilize its assets in order to purchase its shares and to redeem its shares.

Investment funds are deemed to be corporate entities and consequently, each one is treated as a separate taxpayer. However, they are exempted from income taxation ( § 20, Income Tax Act ). When we consider the question of whether an overseas entity that engages in investments can be equated with a Finnish investment fund, the legal form of incorporation and other characteristics of the overseas entity must resemble a Finnish investment fund to a higher degree than they resemble e.g. a Finnish limited-liability company that makes investments.

Other tax-exempt corporate entities

Under Finnish law, not only investment funds but also some entities established under public law are exempted from taxation (§ 20, Income Tax Act). These public entities are listed in the provisions of the Act, and the exemption given to them is due to the nature of their business (the list includes the Bank of Finland, the Social Insurance Institution, the Local Government Pensions Institution Keva). Under Article 63 of the Treaty of the Functioning of the European Union, with the relevant case law, it is required that the exemption from taxation at source be extended to any similar foreign entities, which bear enough resemblance to the listed Finnish entities established under public law.  The minimum requirement for giving this exemption is that the investments made by the foreign entity serve the legally defined public-service purposes which the foreign entity is responsible for by definition of law.

Refunding the withheld taxes to the beneficiary

Subject to certain restrictions, the exemption that concerns dividends is only given to beneficiaries that are corporate entities domiciled in the European Economic Area (§ 3, Act on the Taxation of Nonresident's Income). The exemption that the Finnish Income Tax Act provides is not applicable to foreign investment funds directly; nor is it applicable to other tax-exempt persons directly (§ 20, Income Tax Act).  However, it may be that exemption is given to them in any case by virtue of EU law i.e. the free movement of capital.

It falls within the jurisdiction of the Tax Administration to make decisions on refunds of withheld source taxes to applicants that are corporate entities either inside or outside the EEA. Reference is made to the ruling of the Supreme Administrative Court discussed above and to other case law on the subject of free movement of capital.

To make a request for refund of withheld source taxes, complete Form 6163e — Application for refund of Finnish withholding tax on dividends.

Applicants submitting this form must enclose a sufficient explanation of their facts and circumstances making it clear that a comparison is feasible between a similar Finnish entity, which has the exemption from tax (such as a Finnish limited-liability company or a Finnish investment fund), and the applicant. In addition, the applicant must provide an account indicating that it cannot receive a full refund by virtue of a bilateral tax treaty (between its country of residence and Finland). Finally, it is required that there is an agreement in force on the exchange of tax-related information between the two countries. 

The processing times of such requests are the same as the usual statutory processing times of taxpayers' appeals against tax decisions.