Spanish Supreme Court Rules in Favor of Spanish Dividend Withholding Tax Refund to U.S. Fund

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The decision, of November 13, 2019, confirmed the discriminatory tax treatment established in Spain for nonresident investment funds in comparison to EU qualifying investment funds (Undertakings for Collective Investment in Transferable Securities—UCITS). In the authors’ view, the same rationale should also be applicable to U.S. pension funds investing in Spain (and in general to any qualifying non-EU investment or pension fund).

Background

A U.S. regulated invesment company (RIC) (mutual fund) filed a claim for refund of Spanish dividend withholding tax, on the grounds that Spanish law was contrary to EU law, due to it providing a discriminatory tax treatment for nonresidents investment funds in comparison with Spanish UCITS (instituciones de inversión colectiva—IIC). In particular, the amount claimed to be refunded was the difference between the Spanish dividend withholding tax (15%) imposed and the reduced (1%) Corporate Income Tax (CIT) rate applicable to Spanish UCITS.

It should be taken into account that the Spanish Non-Resident Income Tax (NRIT) Law was amended in 2011 to comply with EU law, in order for the EU UCITS to be entitled to a 1% Spanish dividend withholding tax, instead of the relevant domestic/tax treaty rate. However, according to the legal provision, this reduced withholding tax rate is not applicable to non-EU funds and, therefore, to a U.S. RIC.

Before the relevant judgment was issued, in March 2019, the Spanish Supreme Court (Supreme Court) had already confirmed in two different rulings the breach of the EU free movement of capital (Article 63 of the Treaty on the Functioning of the EU (TFEU) of the Spanish NRIT Law (prior to the 2011 amendment explained above), as the NRIT Law did not provide—before its amendment in 2011—a reduced tax rate for EU UCITS while the Spanish UCITS benefited from a specific reduced CIT rate of 1%.

These judgments extend the same conclusion for non-EU funds that meet the conditions established for UCITS, clearly stating that the non-EU funds should comply with these conditions and not with the specific ones applicable for Spanish UCITS to apply the 1% reduced rate.

Spanish Supreme Court Judgments

The Supreme Court based its decision mainly on the Emerging Markets Series of DFA Investment Trust Company case (C-190/12) (Emerging Markets case), April 2014. According to the ECJ decision, Article 63 of the TFEU on the free movement of capital applies to dividends paid by companies established in an EU member state to investment funds established in a non-member state. Therefore, if the investment fund based in a non-EU country is able to prove that it is comparable to an EU qualifying investment fund, and there is a regulatory framework of exchange of information between both countries, any kind of tax discrimination is prohibited.

The Supreme Court decision confirms that EU Law (Articles 63–65 of the TFEU) under legislation of a member state which, as the Spanish imposes withholding taxes at source on dividends paid by a resident company, while establishing a credit or reimbursement procedure which is only available to resident taxpayers or EU funds. Such unrecoverable withholding tax constitutes a definitive tax for non-EU taxpayers, thus resulting in a higher tax burden compared to the limited tax to be paid by residents on the same dividends.

The Supreme Court believes that a tax distortion exists whereby Spanish UCITS, taxable at 1%, is favored in respect of comparable nonresident funds, which will generally pay Spain withholding taxes at levels between 15% and 19% depending on the specific tax treaty, where applicable. All of it constitutes a differentiated tax treatment under Article 63 of the TFEU since it involves a restriction to the EU free movement of capital, with the exception of Article 65 of the TFEU not being applicable.

The fact that the fund is a resident of a third country which is not a EU member state should not, in the opinion of the Supreme Court, be an obstacle for due application of the EU free movement of capital, given that, since the Maastricht Treaty, restrictions to the movements of capital and to payments between member states, and in respect of third countries, have been eliminated, with further restrictions of any kind being prohibited, except those of an exceptional nature as legally foreseen.

For due application of its doctrine, the Supreme Court decided that it is appropriate to dispose of the relevant comparability elements to see whether or not a different treatment exists (not sufficient for these purposes but to merely consider the fund’s denomination).

Thus, for proper analysis, a verification that, in effect, the nonresident fund is of a comparable nature to that of a qualifying Spanish or EU UCITS is required. In this regard, according to the Supreme Court, claiming that the nonresident fund should be subject to an identical regulation to that applicable to a qualifying Spanish UCITS would steal all effectiveness to the free movement of capital principle, i.e. absolute identity between nonresident and resident institutions, as regulated by Spanish legislation, may not be required, because both types of funds are similar or equivalent in accordance with the defining features contained in Directive 2009/65/CE.

The Supreme Court further ruled that the Exchange of Information (EOI) clause contained within the U.S.–Spain treaty (treaty) was sufficient to obtain any verification the Spanish tax authorities or courts would require in order to ensure that the funds operate within a legislative framework equivalent to that of the EU.

Furthermore, the EOI requires that all means have been exhausted internally prior to applying the EOI. In the case at hand, the Spanish tax authorities had received information requested from the fund and the fund had provided the information it deemed appropriate to respond to the queries raised by the Spanish tax authorities.

The Supreme Court stated that due to the claimant having provided extensive evidence in order to establish its comparability, as well as the Spanish tax authorities not exhausting their means of verification via the treaty, the Supreme Court confirmed the right to obtain the refund by the appellant.

Practical Considerations

The impact of this decision of the Supreme Court is very relevant, since it concludes that the ECJ’s doctrine in the Emerging Markets case is applicable to Spanish-sourced dividends obtained by non-EU funds.

The criterion of the Supreme Court has binding effects to all lower courts and tax administrations. Therefore, investment funds resident in non-EU countries may invoke the content of this judgment in their claims in order to request the same tax treatment or file new claims on these grounds in order to recover the unlawful Spanish dividend withholding tax—within the statute of limitation period: previous four years .

The specific means to prove the tax residence of the investment fund in a third country and its comparable qualifying nature will vary depending on the country of residence´s certification practice and whether a tax treaty with Spain is in place.

In the specific case of the present Supreme Court´s decision, the following was deemed sufficient to comply with the comparability test:

a certificate issued by the U.S. Treasury reporting on the U.S. tax domicile of the investment fund;
a certificate attesting to its condition of registered variable capital investment fund subject to due supervision by the SEC; and
a reference to the treaty.

In any case, considering that the comparability analysis should be performed, according to the Supreme Court, to EU UCITS, and not to Spanish UCITS, we expect that the burden of proof should be eased for the relevant claimants.

In conclusion, non-EU investment funds having paid such excess Spanish dividend withholding taxes should focus on duly claiming any reimbursable amount, provided they can support, through the appropriate documentation, their status as comparable entities to UCITS.

Pension Funds

In the authors’ opinion, this judgment from the Supreme Court should also be extended to non-EU pension funds with investments in Spain. As with investment funds, since 2011, Spanish NRIT Law provides an exemption of Spanish dividend withholding tax obtained by qualifying EU pension funds. However, under the EU free movement of capital, such exemption should also apply to dividends obtained by non-EU qualifying pension funds, provided the comparability test is met.

There are favorable judgments from lower courts allowing the refund of unduly Spanish dividend withholding tax to non-EU pension funds, and we expect that the Supreme Court will issue a favorable decision as well, in light of the criteria established for non-EU investments funds.

In this regard, it should be taken into account that on November 13, 2019, the ECJ has also ruled that pension funds from non-EU states (in that case, a Canadian pension plan) must not be treated less favorably for corporate income tax purposes than pension funds in Germany (C-641/17—College Pension Plan of British Columbia v. Finanzamt München III).

In any case, affected non-EU pension funds should approach the Spanish tax administration and formally (and timely) claim the reimbursement of excess Spanish dividend withholding taxes paid, plus late interest. Filing the related claim is essential to avoid the application of the statute of limitation to the right of obtaining the refund (previous four years).

Eduardo Martínez-Matosas is a Tax Partner and Luis Cuesta Cuesta is a Tax Senior Associate at Gómez-Acebo & Pombo, Barcelona.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.