Have you taken advantage of the CJEU ruling on the Portuguese tax regime applicable to UCIs?

Last year the CJEU issued a favorable ruling in relation to WHT imposed on Portuguese-sourced dividends paid to non-resident UCIs. One year later, why is this topic still relevant?

In the ever-evolving landscape of international tax and finance, staying attuned to regulatory changes and landmark legal decisions is paramount for investment funds. A little over a year ago, the Court of Justice of the European Union (CJEU) delivered a pivotal ruling, declaring that the Portuguese tax regime applied to Undertakings for Collective Investment (UCIs) hindered the free movement of capital within the EU. Now, as we stand one year on from this significant decision, it’s a good time to inform and remind. Luxembourg UCIs are encouraged to take advantage of this ruling and claim their withholding tax (WHT) reimbursements. In this article, we delve into the implications of the CJEU's ruling and why it remains important to the Luxembourg fund community.

Background: taxation of UCIs in Portugal

The Portuguese government acknowledges that UCI taxation plays an important role in encouraging savings and attracting investments. For this reason, a tax framework was put in place to ensure that passive income generated by a UCI would only be subject to tax at the investor level. This was believed to be a mechanism to achieve neutrality between direct investments and investments via a UCI, as long as the UCI and the investments were both located in Portugal.

Under Portuguese domestic tax law, dividends derived by UCIs operating under the terms and conditions of Portuguese regulations are fully exempt from corporate income tax (CIT), meaning that such income will not be considered for the purposes of determining taxable income, nor be subject to withholding tax (WHT) at source upon distribution by resident companies.

In the contrary sense, if a UCI registered under the laws of another EU Member State receives a distribution of dividends from investments in Portugal, such income would be regarded as a regular payment made to a non-resident entity and, in consequence, WHT would be levied at source.

EU law and the direct taxation system of EU Member States

It is evident that such a differentiation in the tax treatment, clearly based on the place of residence, has an impact on the EU fundamental right of freedom of capital movement, regarded as the cornerstone of the single market.

Although Member States maintain their sovereign rights over direct taxation, these rights must be exercised in ways that are compatible with EU law. Domestic tax laws based on non-harmonized taxation systems in the EU need to comply with the fundamental freedom principles enshrined in the Treaty on the Functioning of the European Union (TFEU). This includes, for example, the freedom of movement of capital, which prohibits restrictions on any movement of capital and payments between Member States by imposition of direct taxation, such as CIT, even in the form of WHT withheld at source.

Filing of a claim

In 2020, a major player in the asset management industry (“the Claimant”) requested EY’s support in filing an administrative claim against WHT levied on dividends paid in 2018 and 2019 on one of its Luxembourg-based UCIs in Portuguese resident entities. The claim was later dismissed by the Portuguese Tax Authorities (PTA) on the following grounds:

1. The freedom of movement of capital according to article 65 (1) (a) of the TFEU does not prevent Member States from selectively applying the respective provisions of their domestic tax law based on the place of residency on taxpayers who are not in the same situation;
   
2. The PTA itself is bound to the constitutional principle of legality, therefore is not allowed to disregard domestic tax law provisions on the basis that the latter breaches EU law;
3. The decisions from arbitration courts referred to in the claim would not be considered, as the Portuguese legal system does not follow a binding precedent principle.

The chances of a contrary decision by the PTA were quite high, therefore the dismissal of the administrative claim was not a surprise, but it was a necessary step to move forward to a local court, either judicial or arbitration.

In March 2021, the claim was lodged with the Arbitration Centre in Lisbon (Centro de Arbitragem Administrativa – CAAD). In an attempt to follow the advocate-general’s opinion in the AllianzGI Fonds AEVN case (C-545/19) previously brought before a Portuguese arbitration court by a German UCI , the PTA countered by arguing that a non-resident UCI and a Portuguese resident UCI are not comparable. 

In that case, the advocate-general concluded that the Portuguese regime does not infringe on EU law mainly because non-residents and residents are not in a comparable situation: residents are subject to a stamp tax on their global net value, whereas non-residents are only taxed when income is distributed.

Despite the existence of consistent case law in favor of non-Portuguese UCIs, the arbitrators decided to suspend the arbitration proceeding, upon the PTA’s request, until the CJEU preliminary ruling on whether Portuguese domestic tax law is in line with the fundamental principles of EU law in the case C-545/19.

The decision of the CJEU

The CJEU found that UCIs incorporated under foreign law (non-resident UCIs) and UCIs set up in accordance with Portuguese law (resident UCIs) are in comparable situations, and the differing treatment is thus exclusively based on the place of residency of the UCI, which represents an obvious discrimination that infringes on the fundamental principle of free movement of capital as anchored in the TFEU. It was held that none of the valid justifications commonly accepted to restrict the freedom of the movement of capital, such as the preservation of the coherence of the tax system and the need to preserve a balanced allocation of taxing powers between Member States, could be considered.

The CJEU ultimately confirmed that the reasoning to subject dividends paid to non-resident UCIs to WHT, while dividends distributed to resident UCIs are exempt, is contrary to the principle of the free movement of capital.

The decision of the Arbitration Court

In March 2023, the Claimant was allowed to present a written statement outlining the relevant legal arguments and facts. In less than one month, the arbitral decision over the case filed by the Claimant was announced and was fully in favor of the claimant.

As a result of the positive decision:

1. The total amount of WHT assessed and levied on dividends paid to the Claimant between 2018 and 2019 was annulled and must be refunded.
   
2. The Claimant is entitled to receive compensatory interest on the amount of tax unduly withheld, calculated at an annual rate of 4% from the date of payment (the month following the one in which dividends were distributed) until the date of issue of the credit note by the PTA.
   

In closing, a substantial degree of certainty regarding the taxation of (non-resident) UCIs in Portugal has finally been achieved, considering that domestic courts, including arbitration courts, would be bound by the interpretation followed by the ECJ in the AllianzGI Fonds AEVN case (C-545/19) and that the PTA should no longer be able to argue against administrative claims that the principle of legality prevents them from disregarding domestic tax laws based upon the breach of EU law.

With this in mind, it is strongly encouraged that Luxembourg UCITs, either in the form of a SICAV or FCP, make the most of this ruling and claim the refund of WHT levied on dividends distributed by companies that are resident in Portugal. The refund of WHT requires filing a mandatory administrative claim within two years from the date by which WHT must be transferred by the withholding agent (i.e., the 20th day of the month following the one in which the payment occurs) to the tax authorities.