Fairness Tax (FaTa)
Points of Attention and Illustrations
Since the publication of the first drafts of the Fairness Tax Bill, it has become clear that the FaTa will have some counter-intuitive consequences and, under certain circumstances, that it may also be overruled by tax treaties or EU law. In order to correctly understand the following points of attention, it should be remembered that the Fairness Tax is only due for a given tax year if a dividend distribution takes place in the course of that tax year. In other words, the FaTa liability can be deferred simply by not distributing dividends. Furthermore, the FaTa does not apply to dividends that are deemed to arise following a liquidation of a Belgian company. We have found it useful to illustrate these points of attention with simplified examples1. The base case is that of a Belgian company with the features as illustrated in Table 1 above and a dividend policy according to which all after-tax income is to be distributed each year. It follows that this company will pay a Fairness Tax of 5,15 in both year X and in year X+1.
Impact of certain forms of exempt income
A first important point of attention relates to tax-exempt income that is not included in the ‘gross’ taxable basis. In Table 2, our base case company is subject to a transfer pricing correction (‘excess profits’) within the meaning of Article 185, §2 of the Belgian Income Tax Code of 1000. Consequently, the ‘untaxed’ part of the distributed profits is increased by 1000. However, that 1000 is not included in the ‘gross’ taxable basis and, thus, does not reduce the proportionality factor, which remains at 50%. The result is that 50% of the amount (or 500) is added to the FaTa base when compared to the base case scenario. The FaTa liability of the Belgian company will increase to 30,9.
Additionally, excluding the amount from the denominator of the proportionality factor may also trigger ‘non-linear’ effects, whereby a small change in the ‘gross’ taxable basis has a disproportionately large effect on the FaTa liability. Table 2bis is identical to Table 2 except for the amount of the ‘gross’ taxable income, which is reduced to 1. As the company enjoys 1 NID, the proportionality factor amounts to 100% and the entire dividend distribution of 1001 will be subject to FaTa.
In Table 2ter, on the other hand, the company has a ‘gross’ taxable basis of zero (0), only 1 less than in Table 2bis. As a consequence, no NID or NOLs are used to reduce the ordinary taxable basis and the proportionality factor and the FaTa are both reduced to zero. When comparing Tables 2bis and 2ter, it becomes evident that a change of only 1 in the ‘gross’ taxable basis of a company, can have the non-linear effect of increasing the FaTa basis with 1000. Other examples of ‘exempt’ income that is are treated in the manner as illustrated above, include among others (i) recaptures of the depreciation on shares, (ii) income that benefits from the tax shelter for the movie industry, (iii) the exempt part of capital gains on company cars, (iv) capital gains resulting from debt forgiveness under the Belgian Law on the continuity of enterprises (equivalent to U.S. Chapter 11 proceedings), (v) repayments of non-deductible taxes and (vi) exempt regional grants.
Impact of other tax benefits
Separately taxed income (e.g. capital gains on shares taxed at 0,412%) and other types of income that benefit from an advantageous tax treatment (e.g. as dividends received, patent income and investment deductions) are taken into account after determining the ‘gross taxable base’. In Table 3, our base case company receives dividends for an amount of 1000, which are included in the ‘gross taxable base’. Only at a later stage will the dividends received deduction be imputed. Consequently, the 1000 is added to the denominator of the proportionality factor, which is thereby significantly reduced. It follows that these types of income will have much less impact on a company’s Fairness Tax liability. Nevertheless, when compared to the base case in Table 1, it follows from Table 3 that part of the dividends received is effectively subject to the Fairness Tax. If such dividends received fall within the scope of the EU Parent-Subsidiary Directive, the question arises whether such taxation is not over-ruled by the Directive’s obligation for EU Member States to ‘refrain’ from taxing such dividends. Moreover, a similar Fairness Tax calculation applies to profits of a Belgian company that are attributed to a permanent establishment located in a jurisdiction with which Belgium has concluded a Treaty for the avoidance of double taxation. Again, the compatibility of the Fairness Tax with such a Treaty can be questioned.
Postponing a dividend distribution
Earnings that are retained as of FY 2014 and that are distributed as a dividend afterwards, will no longer be grandfathered and will be included in the ‘untaxed’ part of the distributed profits. In Table 4, the Belgian company has changed its dividend policy and will only distribute the after-tax earnings of FY2014, amounting to 500, together with the after-tax earnings of 2015. No other element has changed vis-à-vis the base case scenario. Comparing to Table 1, it becomes clear that postponing the dividend distribution has resulted in a higher Fairness Tax base when considered over the two years.
Belgian PE’s of foreign companies
The way in which the Fairness Tax has been made applicable to Belgian PE’s of foreign companies raises a number of practical difficulties and legal questions. Firstly, in order to determine the equivalent amount of ‘dividends distributed’ for a Belgian PE, the Fairness Tax requires that the ‘Belgian accounting income’ of the PE be compared to that of the foreign company. Applying Belgian GAAP to the worldwide activities of non-resident companies, possibly including PE’s in other countries, may prove exceedingly challenging.
Secondly, in its current definition of ‘distributed dividends’ of a Belgian PE, the Fairness Tax does not take into account that a foreign entity may also have loss-making PE’s in other countries, and does therefore not indicate how such losses should be dealt with for the purpose of the calculation of the Fairness Tax.
Finally, the Fairness Tax can apply to a Belgian PE even though it has not actually transferred its earnings outside of Belgium to the ‘head office’ of the non-resident company. Even if the earnings of a Belgian PE are reinvested in its Belgian operations as retained earnings, a dividend distribution by the non-resident company will trigger a Fairness Tax liability in Belgium, regardless of the source of the distributed profits. Again, under certain circumstances, compatibility with the EU freedoms and the tax treaties may be questioned. The “Conformity with other Sources of Law” section will explore in more detail the infringements of Belgian constitutional law, of EU law and of international tax law and will outline possible legal remedies.
1 Please note that the examples given do not purport to cover all relevant aspects of Belgian tax law. They are simply provided to illustrate the operation of the Fairness Tax and they potentially leave out other relevant tax liabilities for reasons of clarity.
2 Please note that the actual DRD is limited to 95% of dividends received.