New developments in case law on withholding tax treatment of dividends under Spain-Netherlands tax treaty
The Spanish Supreme Court recently shed light on the Spain-Netherlands tax treaty and the withholding tax treatment of distributions of dividends originating in Spain. This is an important judgment for those entities resident in the Netherlands. Spain clarifies the revised interpretations and why previous understandings of the treaty caused conflict in the past.
Article 10 of the tax treaty establishes that dividends paid by an entity resident in a contracting State to a company resident in another contracting State may be taxable in the country of origin up to a maximum limit of 15 percent of the gross amount of the dividends.
However, this same Article 10 of the tax treaty establishes the possibility of reducing this maximum limit to 10 percent where the entity distributing the dividends is resident in Spain and the payee of the dividends is resident in the Netherlands. This possibility requires the fulfilment of one of the following requirements:
- The entity receiving the dividend must own at least 50 percent of the capital of the Spanish entity; or
- The entity receiving the dividend must own at least 25 percent of the capital of the Spanish entity, provided that there is another entity in the Netherlands that also owns 25 percent.
Lastly, section VII of the Protocol to the tax treaty establishes that notwithstanding the provisions of Article 10, the Spanish tax that is levied on the dividends may not exceed 5 percent if the company receiving them is not required to pay Dutch corporate income tax on them. As is known, the “participation exemption” regime is provided in the Netherlands for entities that receive dividends from foreign companies in which they have a participation of at least 5%, among other requisites.
The interpretation of this provision of the Protocol had been contentious in Spain. Both the Spanish Directorate-General of Taxes and the Economic-Administrative Tribunals had held that to be able to apply the reduced rate of 5 percent to the dividends distributed, the participation requirements established by Article 10 (a participation of 50% or one of 25% with another shareholder with another 25%) had to be met and that, moreover, the entity receiving them had to be entitled to apply the participation exemption. In other words, they took the view that to qualify for the 5% tax rate, it was necessary to meet not only the requirements of the Protocol, but also those of Article 10.
However, taxpayers took a different position: the expression “notwithstanding” meant that the special rule included in the Protocol applied even in cases where the entity in question did not have the participation percentage necessary to apply the 10% limit, given that the special rule of the Protocol had a clear intent, which was none other than that (given that in the State of residence of the payees of the dividends, such income was not taxable) the tax levied on this income at source should be the minimum amount, regardless of the percentage of participation in the capital.
This point has been addressed by a recently published Spanish Supreme Court judgment, dated 16 December 2009, in which the Court upheld the taxpayers’ position, concluding that to apply the 5% withholding tax rate in Spain to dividends paid to shareholders resident in the Netherlands, the only requirement was that the entity resident in the Netherlands not be charged corporate income tax on those dividends.
The Spanish courts interpret the tax treaty and its Protocol to mean that in this dividend distribution scenario, the special rule of the Protocol should be applied on its own without adding to it the other requirements established in Article 10 of the tax treaty.
This is an important new development for those entities resident in the Netherlands that have participations in Spanish companies that do not reach 10 percent—a percentage which would qualify them to apply the full exemption currently offered by the Parent-Subsidiary Directive (readers will recall that this full exemption used to require higher participation percentages)—and that are entitled to the participation exemption. Now, they can apply the minimum withholding tax rate of 5% and, if they have previously applied a higher rate, they can claim a refund of the tax paid above that rate.
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