Tax Connect Flash | Tax treatment of UCITs referred to the European Court of Justice
The Conseil d’Etat, the supreme administrative jurisdiction in France, has delivered its opinion in respect of the questions raised by the Administrative Court of Montreuil regarding the tax treatment of foreign UCITs receiving dividends from French sources. As a result, some of the questions concerning more difficult aspects of community law will be referred to the European Court of Justice. Simultaneously, the Commission brought an action against France before the European Court of Justice concerning its discriminatory treatment of foreign pension and investment funds.
Undertakings for Collective Investment in Transferable Securities (“UCITs”) allow holding a participation in a jointly owned securities portfolio managed by professionals. Such entities exist in several Member States of the European Union and also outside the EU. Within the EU, Directive No. 85/611/CEE aims to harmonise the legislative background relating to UCITs.
In France, UCITs operate in the form of SICAVs being companies limited by shares and having a legal personality as well as in the form of FCPs, being investment funds without a legal personality. According to the applicable fiscal regime, French UCITs are not subject to corporate income tax in France on income they receive from their investments, including French sourced dividends. On the other hand, foreign UCITs are subject to 25% withholding tax on their French sourced dividends, the rate often being reduced by the applicable double tax treaties when UCITs are eligible to benefit from these treaties.
Many actions to get the reimbursement of such withholding tax were brought by foreign UCITs before the Administrative Court of Montreuil. Claims are principally based on the ground that imposing a tax on foreign UCITs from which French UCITs are exempted is discriminatory and contravenes the principle of free movement of capital set out in Article 63 of the Treaty on the Functioning of the European Union. Given the complexity of the issues involved, the Administrative Court of Montreuil requested a preliminary ruling from the Conseil d’Etat to clarify some of the legal issues at stake.
2. Questions examined by the French administrative courts
The questions referred to the Conseil d’Etat include - inter alia - the following:
- In order to establish whether there is an obstacle to the free movement of capital, do we have to compare the situation on the level of the UCITs only, on the level of their unit holders or globally?
- In case the comparison has to be made at the level of the UCITs, can a foreign UCIT, subject to a very low tax rate in its country of residence, deemed to be in an objectively comparable situation?
- Depending on the level of comparison, does the application of a withholding tax on dividends distributed by French companies to foreign UCITs constitute an obstacle to the free movement of capital considering that similar distributions made to French established UCITs are not subject to any taxation? If it does constitute an obstacle, is it justified by overriding reasons of general interest?
- Under what conditions can an investment fund established in a third country claim the non-conformity of such withholding tax with the free movement of capital taking into account the standstill clause allowing the maintenance of restrictions relating to direct investments which existed on 31 December 1993.
3. The position taken by the Conseil d’Etat
Level of comparison, existence of an obstacle to free movement of capital and justifiable reason
The Conseil d’Etat considers that the different treatment of French sourced dividends distributed to French UCITs on the one hand and to foreign UCITs on the other hand indeed constitutes an obstacle to the free movement of capital. Therefore it is essential to establish whether the restriction can be justified by overriding reasons of general interest.
In case the comparison has to be made at the level of the UCITs, French and foreign UCITs are in objectively comparable situation, and the difference in treatment cannot be justified by overriding reasons of general interest.
On the other hand if the special purpose of UCITs as well as the situation of unit holders is also taken into account, the question of the comparability of situation is much more difficult and the difference in treatment, if any, may be consistent with the principle of free movement of capital. The Conseil d’Etat considers that the questions consisting of (i) deciding whether the unit holders’ position has to be taken into account and (ii) if so, under what conditions a withholding tax can be compliant with the principle of free movement of capital present such difficulty that these issues should be referred to the European Court of Justice in the framework of a preliminary ruling.
Situation of UCITs established in third countries
The Conseil d’Etat takes the view that investments through UCITs can hardly be characterized as direct investments, therefore the standstill cause cannot be successfully invoked. There may be cases where in relation to UCITs established in a third country, authorities can validly claim that the withholding tax is necessary to ensure effective fiscal control. However, such argument shall not be valid concerning third countries which entered into a treaty with France providing for mutual administrative assistance in order to combat tax avoidance and fiscal fraud, eg. the United States.
4. Infringement procedure initiated against France
Following a reasoned opinion sent to France on 18 March 2010, on 19 May 2011 the Commission decided to refer France to the European Court of Justice over its discriminatory treatment of foreign pension and investment funds.
The Commission considers that the fact that dividends paid to foreign pension and investment funds are subject to 25% withholding tax whereas dividends distributed to similar domestic entities are exempt, limits the free movement of capital. As a result of this discrimination, pension and investment funds based in other EU countries are placed at a disadvantage compared to their French-based counterparts and French customers are therefore liable to enjoy less choice of pension and investment funds. Although with respect to pension funds France introduced a new legislation subjecting both domestic and foreign funds to a flat rate tax of 15%, it seems that in practice these new rules are scarcely applied.