Dividend Taxation: The Implications for Cross-Border Investments and a Search for the

Optimal Investment Route

Martijn N.A. Vennik Department of Economics University of Amsterdam

Master’s Thesis (15 ects) ID number: 9933077

Supervised by: Prof. Dr. J.A. McCahery (UvA)

2nd Examiner:

Prof. Dr. S.J.G. Van Wijnbergen (UvA)

F. Van Deth (Oyens & Van Eeghen)

Hand-in final version: 18 May 2007

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Dividend Taxation: The Implications for Cross-Border Investments and a Search for the

Optimal Investment Route

Abstract

The European Union (EU) strongly tends to uniformity, even in taxation legislation. In 2006 the European Commission (EC) has urged six EU-countries, including the Netherlands, to change their dividend rules. According to the EC these EU-countries tax dividend payments to foreign investors more heavily than dividend payments to national investors. The Dutch government responded to the unequal treatment of home and foreign shareholders of companies incorporated in the Netherlands by introducing a new taxation legislation 2007. This development is a first step towards a uniform EU dividend taxation system. Meanwhile, the market opportunities are not being used optimally as a consequence of the differences in rules and taxation between countries. The main issue in this survey is the search for an optimal investment route concerning the differences in international dividend taxation and whether this will be profitable. The analysis puts emphasis on the foreign institutional investors who invest in Dutch corporations.

Keywords: Dividend Taxation, International Investments, Government Policy and Regulation,

Brokerage

JEL codes: F32, F51, G18, K34

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Contents

SUMMARY - 6 -

1. INTRODUCTION - 7 -

2. THE DUTCH DIVIDEND TAXATION LEGISLATION - 12 -

2.1 DIVIDEND WITHHOLDING TAX ACT 1965 - 12 - 2.1.1 THE LEGISLATION - 12 - 2.1.2 TRANSITION TO NEW LEGISLATIVE REGIME - 13 - 2.1.3 CALCULATING AND DISTRIBUTING THE DIVIDEND - 14 - 2.2 UPDATING THE REGIME: THE DIVIDEND TAXATION LAW 2007 - 16 -

3. THE INTERNATIONAL DIVIDEND TAXATION - 19 -

3.1 THE EU-COUNTRIES - 20 - 3.1.1 BELGIAN DIVIDEND TAXATION - 21 - 3.1.1.1 THE BASICS - 21 - 3.1.1.2 BILATERAL TREATY WITH THE NETHERLANDS - 22 - 3.1.1.3 EXEMPTIONS - 22 - 3.1.1.3.1 THE PARTICIPATION EXEMPTION - 23 - 3.1.1.3.2 THE VVPR-STRIP - 24 - 3.1.2 FRENCH DIVIDEND TAXATION - 24 - 3.1.2.1 THE BASICS - 24 - 3.1.2.1.1 FRENCH RESIDENT SHAREHOLDERS - 25 - 3.1.2.1.2 NON-RESIDENT RECIPIENTS - 26 - 3.1.2.2 BILATERAL TREATY WITH THE NETHERLANDS - 26 - 3.1.3 GERMAN DIVIDEND TAXATION - 27 - 3.1.3.1 THE BASICS - 27 - 3.1.3.2 BILATERAL TREATY WITH THE NETHERLANDS - 28 - 3.1.4 DIVIDEND TAXATION IN THE UNITED KINGDOM (UK) - 29 - 3.1.4.1 THE BASICS - 29 - 3.1.4.2 BILATERAL TREATY WITH THE NETHERLANDS - 30 - 3.1.4.3 EXEMPTIONS - 31 - 3.1.5 DIVIDEND TAXATION IN LUXEMBOURG - 31 - 3.1.5.1 THE BASICS - 32 - 3.1.5.2 BILATERAL TREATY WITH THE NETHERLANDS - 32 - 3.1.5.3 A SPECIAL CASE; THE ‘HOLDING’ COMPANY LAW - 33 - 3.2 EU DIVIDEND TAXATION RULES - 34 - 3.2.1 EU CORPORATE DIVIDEND TAXATION RULES - 34 - 3.2.2 EU DIVIDEND TAXATION RULES OF INDIVIDUALS - 37 - 3.3 THE NON EU-COUNTRIES: SWITZERLAND AND THE UNITED STATES - 39 - 3.3.1 SWITZERLAND - 40 - 3.3.1.1 THE BASICS - 40 - 3.3.1.2 BILATERAL TREATY WITH THE NETHERLANDS - 40 - 3.3.1.3 A SPECIAL CASE; THE SWISS HOLDING COMPANY - 41 - 3.3.2 THE UNITED STATES - 44 - 3.3.2.1 THE BASICS - 44 - 3.3.2.2 BILATERAL TREATY WITH THE NETHERLANDS - 45 -

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4. A LEGAL FRAMEWORK TOWARDS OPTIMALITY - 48 -

4.1 CROSS-BORDER DIVIDEND WITHHOLDING RATES - 49 - 4.2 THE STRATEGY - 54 - 4.2.1 A CASE STUDY - 54 - 4.2.2 DIVIDEND STRIPPING AS A TAX AVOIDANCE - 55 - 4.2.2.1 FORMS OF DIVIDEND STRIPPING - 56 - 4.2.2.2 STATUTORY REGULATIONS AGAINST DIVIDEND STRIPPING - 57 - 4.2.2.3 SOLUTION TO AVOID ANTI-DIVIDEND STRIPPING MEASURES - 59 - 4.3 THE STRUCTURE; DIVIDENDS AND DERIVATIVES - 60 - 4.3.1 AEX-INDEX FUTURE SWAP - 60 - 4.3.2 SALE / REPO OR LENDING? - 62 -

5. CONCLUSIONS AND RECOMMENDATIONS - 64 -

REFERENCES - 66 -

ADDITIONAL LITERATURE - 67 -

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Summary Recent developments in the international dividend taxation legislation show changes in the taxation of dividends on cross-border investments. Especially the European Court of Justice has made some important judgments in this context. On national level, the Netherlands has adjusted its taxation legislation to international standards as well by reducing the dividend withholding rate from 25% to 15% since 1 January 2007. Although the international dividend taxation legislation tends towards uniformity, there are still major arbitrage opportunities to investors. The international taxation legislation practices strict rulings concerning cross-border transactions, but there are opportunities for investors to avoid dividend withholding though. Low tax jurisdictions i.e. already provide advantages for certain types of investors to either reduce or avoid dividend tax. The paper searches for an optimal investment route by reducing or avoiding dividend tax for cross-border investors. Cross-border transactions in combination with derivative hedging shows there are arbitrage possibilities to investors by covering the share lending with derivatives. In contrast with selling and repurchasing shares, lending is inexpensive, does not affect exposure to the stock and is not a taxable event. In the long run, however, dividend tax will be possibly reduced to zero because of conflicting international rules in dividend taxation legislation. Still, many countries discriminate foreign investors by levying a higher dividend withholding. Instead, domestic investors face lower dividend withholding rates. According to European Law, this conflicts with the free movement of capital. In consequence, international barriers will be removed to avoid double taxation on cross-border investments.

It is important to note that dividend taxation is subject to continuous changes in legislation, meaning that the advantageous dynamic feature of avoiding dividend taxation can be disadvantageous as well. Governmental regulations play an important role in this matter incase any arbitrage opportunity exists. Then, laws will be updated and less arbitrage opportunities will be upheld for investors.

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1. Introduction

The Netherlands has a relatively small-scale but very open economy. It has always recognized

that the tax system should not impede the international expansion of business. Consequently,

the Dutch tax system has many features that make the Netherlands an attractive location for

businesses operating on an international scale. Examples include the tax treatment of business

profits, the participation exemption, the large number of tax conventions to which the

Netherlands is a signatory and the absence of withholding taxes. The dividend tax is an

exemption, however.

A dividend is a taxable payment declared by a company’s board of directors and approved by

shareholders, which is distributed to shareholders of record out of the company’s retained

earnings, usually on a quarterly basis. Dividends supply investors with an incentive to own

stock in stable companies even if they are not experiencing significant growth. Clearly,

companies are not required to pay dividends. However, the companies that typically offer

dividends are companies that have progressed beyond the initial growth phase, and no longer

benefit sufficiently by reinvesting their profits, and consequently choose to pay them out in

order to attract new investors.

A high dividend payout is important for investors because dividends provide certainty

about the company’s well being. Dividends are also attractive for investors looking to secure

current income. Also, there are many examples of how changes in dividend distributions can

affect the price of a security. Companies that have a long-standing history of dividend payouts

would be negatively affected by lowering or omitting dividend distributions. Conversely,

these companies would be positively affected by increasing dividend payouts. Furthermore,

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companies without a dividend history are generally viewed favourably when they declare new

dividends.

Double taxation of dividends is a major concern for investors. For some scholars, there

are few justifications for allowing home country taxation of dividends since the company has

already been taxed. The most important reason for justification is the fact that a legal persona

and legal entity are required to pay tax when their income in terms of dividends increases. In

particular, a company must pay corporation tax and a shareholder is compelled for payment of

the dividend tax. In this respect, the company is obliged to deduct the dividend tax from the

total dividend payout to the shareholders.

In the international context, the existence of dividend taxation is more practical than

fundamental. The taxation of company dividends paid to foreign institutional investors is not

easily justified because in principal, foreign income of dividends needs to be paid to the

foreign government. However, like many other governments, the Dutch government justifies

its taxation of dividends paid to foreign investors on the basis of the non-reinvestment of

Dutch profits into the Dutch economy. Since other countries tax dividends, the Dutch

government taxes dividend as well in order to maintain its competitive negotiating power vis-

à-vis third counterparts. We can see the importance of remaining competitive as the expected

total dividend tax income for the Dutch government in 2007 amounts to 2.8 billion Euro,

which covers 1.78% of the total governmental income tax in 2007 (Ministerie van Financiën,

2006).

In order to avoid double taxation, lawmakers will often enter into mutual agreements between

countries. Naturally, bilateral treaties and international agreements tend to make the situation

more complicated and in certain cases incompatible. For example, there are two important

cases which are currently pending before the European Court of Justice (ECJ) in

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Luxembourg. The Denkavit1 case concerned the application of the French withholding

exemption in a Netherlands-based parent company, and the Amurta case addressed the

questions regarding an exemption from the Dutch withholding tax in a matter involving a

Portuguese parent company.

This survey will analyze the forms of unequal treatment between home and foreign

shareholders of companies incorporated in the Netherlands. In response to the EU’s concerns

about unequal treatment, the Dutch government has responded by introducing a new

corporation law in 2007, which effectively reduces the dividend taxation tariff from 25% to

15%. However, the differences in dividend taxation between countries are reduced but not

completely eliminated. Still, foreign shareholders of Dutch corporations face a disadvantage

by investing in Dutch corporations compared with the Dutch shareholders who invest in

Dutch corporations. The more the government reduces the dividend taxation tariff to zero, the

less taxation income the government generates. Consequently, foreign shareholders in Dutch

corporations will be more willing to invest in Dutch corporations if the government reduces

its tax rate on dividends.

Pension funds for example operating in other EU Member States already have the

right to a Dutch dividend tax refund. From 2007, the modification of the refund regulation

will also apply to other exempted bodies established in other EU Member States. In the note

of modification, it will be stipulated that a Dutch dividend paying corporation does not need

to withhold dividend tax if the dividend is paid to a company that is established in another EU

member state and holds at least 5% shares of the Dutch company. Currently this exemption

applies to shareholders of 20%.

1 See opinion of Advocate General Geelhoed, Case C-170/05, delivered on 27 April 2006.

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The aim of this survey is to determine whether foreign investors in Dutch corporations, due to

the differences in dividend taxation between countries, are able to maximize their profits by

choosing an optimal investment route.

The structure of this survey is two-folded. The first part will attempt to place the country-

specific features of international dividend taxation in context. Then a subdivision of the

different types of investors will be made, because particular types of investors -from

particular countries- are taxed differently with regard to dividend taxation. These investors

can be categorized as pension funds, insurers, investment funds and hedge funds.

The second part of the survey answers the question whether there are opportunities for

foreign investors to pay less dividend tax by searching for each investor’s optimal investment

route as a consequence of differences in the international dividend taxation systems. Taking

into account the differences in dividend taxation across countries, foreign shareholders in

Dutch corporations will search for the optimal investment route in order to pay the minimum

amount of dividend tax. Within the rules of international dividend taxation legislation it may

be profitable for foreign investors to find a way to avoid dividend tax as much as possible. A

small percentage of reduction in dividend taxation tariff gives a substantial investor the

incentive to optimally utilize the arbitrage opportunities in the market.

As noted earlier, identifying the optimal investment route is the principal goal of this survey.

Should we identify an optimal investment route for foreign investors, the question arises as to

whether such an approach will be practicable, implement able and profitable and whether it is

likely to persist given the dynamic pace at which law reform evolves in this area.

This survey consists of five sections. The first section offers an historical account of the

development of Dutch legislation concerning the taxation of dividends, beginning with an

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account of the 1969 legislation and the revised law enacted by Parliament in 2007. Our review

catalogues the differences in dividend taxation rules between the first generation legislation

and latter amendments. Section 2 will provide an account of the operation of the international

dividend taxation system. In particular, we examine the place of the Netherlands in relation to

five EU-countries, and third countries such as Switzerland and the United States. In this

regard, we will take into account the legal dividend taxation regimes in the above countries in

respect with their individual dividend taxation policies and the international policies in

relation to the Netherlands. Section 3 overviews the international dividend taxation and

considers the role of foreign shareholders in Dutch corporations and the fiscal rules that

govern their domestic investments. Then section 4 empirically examines the effect of dividend

taxation on investments in Dutch equity and index derivatives. Besides the general corporate

rate we identify four sub-categories of investors; pension funds, insurers, investment funds

and hedge funds. Each has to comply with a specific taxation system and is treated differently

in the international dividend taxation system. A strategy and structure considers the arbitrage

opportunities towards an optimal investment route. Section 5 concludes.

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2. The Dutch Dividend Taxation Legislation

This section will analyze the differences between the initial tax code on dividends and the

most recent amendments to the legislation. It will discuss the problems that led to lawmakers’

reform the act. In this regard, we will give a brief overview of the 1965 Dutch Dividend

Withholding Tax and then will examine the reformation of the Dutch Company Law 2007,

which includes the new amendments to dividend taxation legislation.

2.1 Dividend Withholding Tax Act 19652

The old 1965 Dutch Dividend Withholding Tax Act replaced the Decree Dividend Taxation

case law from 1941. Since 1 January 2007 the adjusted dividend taxation legislation has in

turn replaced the 1965 dividend taxation law as part of the new Dutch Corporate Income Tax

Law 2007. The aim of this section is to provide an account of the main components of the

Dutch dividend taxation system and its shortcomings, with a special interest in the reasoning

of the adjustments being made in the most recent dividend tax regime.

2.1.1 The Legislation

The 1965 Dividend Withholding Tax Act (1965 Act) was actually a technical reform based on

the pre- existing case law originating from 1941. As the 1965 Act was essentially a

restatement of existing jurisprudence, there was no deviation from existing practice that

emerged in this piece of legislation. Even though the act was merely procedural in form, there

was, however, an important change introduced, namely the increase of the tariff from the

original 15% to a higher 25% dividend taxation rate. Previously, the Dutch government 2 Stb. 1965, 621

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embraced the international accepted standard that the tax on dividends should be charged by

the country in which the recipient of the dividend is established as the source country of the

dividends had already charged tax on its profits. (Marres, Wattel; 2006)

This new legislation changed the Netherlands’ tax policy. It was no longer a creditor state

since a consequence of the Act was that profits and dividends were being taxed by the Dutch

government. As noted earlier, the increase of the tariff rate gave the Dutch government ample

opportunity to negotiate tax agreements with other governments. Such negotiations would

lead naturally, if successful, to both countries being able to lower their dividend tax as a

consequence of having made concessions during the bilateral treaty negotiations. A by

product of the change in policy was the breakthrough in negotiations with Switzerland, which

was made possible by the tariff rate increase.

2.1.2 Transition to New Legislative Regime

Between 1966 and the beginning of the 1990’s, the Dutch dividend taxation regime remained

unchanged. In contrast, since the beginning of the 1990’s, the dividend taxation has become

more a point of concern. Since the introduction of Article 44 IB 1964 and the into force

coming of the Parent-Subsidiary Directive3 concerning international participation dividends,

both the prominent Members of the Parliament and Board of the EC started to engage with the

dividend taxation matter. The amount of judicial general rules has increased and in particular

the amount of changes in legislation has increased substantially. The most important

development was the involvement of the jurisprudence of European law. The role of the ECJ

is substantial due to its ability to overrule national dividend taxation legislation. These

3 Article 4a and 4b, Wet op de Dividendbelasting 1965.

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decisions of the ECJ may have the effect of undermining national fiscal policies concerning

dividend taxation. The main factors responsible for change in the Dutch law on dividends are:

1) the increasing international mobility of capital; and 2) the enhance role played by European

Union law, and the corresponding decisions of the ECJ.

2.1.3 Calculating and Distributing the Dividend

The tariff of the Dutch dividend taxation amounts to 25% of the gross revenues4, without the

deduction of costs being made by the dividend entitled person. The shareholders thus only

receive 75% of the dividend. The party to whom compliance is mandated by the Act is the

owner(s) of the certificates. The legislation states that the owner can be can either a legal body

or a legal entity. It is not relevant where the party to whom the obligation runs resides or is

established, but only to the entitled person itself. The dividend withholding tax withheld by

the company, like taxes on wages, may be set off against the income tax payable and operates

like an advance levy.

When distributing dividends to a (foreign) entity, a dividend tax of 25% applies in principle.

However, there are a number of dividend taxation exemptions. The Corporate Income Tax

Act provides for a participation exemption, which is applicable to both domestic and foreign

shareholdings. This exemption is one of the main pillars of the Dutch corporate income tax

and is motivated by the desire to avoid double taxation when the profits of a subsidiary are

distributed to its parent company. In principle, participation is regarded to exist if the

taxpayer:

4 Article 5, Wet op de Dividendbelasting 1965.

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• holds at least 5% of the nominal paid-up capital of a company of which the capital is

partially or wholly divided into shares or

• holds less than 5%, but ownership of the shares is necessary for the conduct of normal

business, or the acquisition of the shares serves a general interest.

The participation exemption is not applicable if the taxpayer or subsidiary company is deemed

to be an investment institution, or applies internationally when shares in a foreign corporation

are held as an investment. Another requirement for an exemption to be granted is that the

foreign company in which the shares are held is subject to tax on its profits in the country

where it resides. If a company distributes a dividend to an entity, and the stock of which falls

under the participation exemption, and this participation belongs to a company that operates

in the Netherlands, then the dividend payment is exempt from dividend taxation. If the

recipient entity is established in a Member State of the EU, and this entity holds more than

25% of the stock of the distributing company, a dividend tax exemption also applies

(Ministerie van Financiën, 2004).

In addition, the EU Parent-Subsidiary Direction is an extension of the participation

exemption. The Dutch legislation was amended in line with EU Directive on parent

companies and subsidiaries. The participation exemption has been extended in several

respects. For example, acquisition of an interest in a company established in another EU

Member State may be regarded as a participation to which the participation exemption

applies. In order to qualify, ownership of at least 15% of the share capital is required. In some

circumstances a holding of at least 15% of the voting rights in a company may also be

regarded as a participation, even if the shareholding is less than 5%. Under this Directive, a

dividend withholding tax is not withheld on a dividend paid to a company established in

another Member State. In this case, the recipient company must have an interest of at least

15% in the company paying the dividend. The minimum shareholding will be 10% from

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1 January 2009 (European Commission, 2003). The exemption is applicable, if certain

conditions are met, when the shareholder has an interest of at least 10% in the company’s

nominal paid-up share capital, or holds at least 10% of the voting rights.

2.2 Updating the Regime: The Dividend Taxation Law 2007

The Dutch dividend taxation legislation is a major component of the new Dutch Corporate

Income Tax Act (Wet Vpb), which was introduced on 1 January 2007.

During an earlier parliamentary debate, it was mentioned that the Dutch government

anticipated the abolishment of the dividend withholding tax over a number of years because

of trends in the ECJ case law. In light of these trends, one major change introduced was a

reduction of the withholding tax from 25% to 15%. This new rate is - not coincidentally -

equal to the reduced rate for portfolio dividends in most Dutch tax treaties.

The effect of the reduction in withholding tax is twofold. Firstly, it is no longer necessary for

foreign recipients of Dutch portfolio dividends to file a formal request in order to receive a

partial repayment of the Dutch dividend tax from 25% to 15% (in situations where a tax treaty

reduces the 25% dividend tax rate to 15%). Secondly, for situations where no reduced treaty

applies, e.g., when the recipient is located in a jurisdiction which has not concluded a tax

treaty with the Netherlands or a recipient is not a qualifying resident for treaty purposes, the

tax burden is lowered from 25% to 15%.

Another major change in the new dividend taxation concerns the simplification of the

participation exemption. Under this exemption, dividends and capital gains deriving from

qualifying shareholdings in (Dutch and foreign) subsidiaries are exempt from corporate

income tax at the level of the shareholder. The exemption contains two anti-abusive

provisions that should prevent income from low taxed jurisdictions becoming exempt under

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the participation exemption. These are the so-called “subject-to-tax-test” and the “passive-

investment test5”. These anti-abusive provisions distinguish between Dutch and foreign

subsidiaries. Recent ECJ case law shows that the differences in the conditions applying to

resident and non-resident subsidiaries are very likely to be in conflict with EU law. Therefore,

the old provisions needed to be amended.

The new participation exemption will apply if a shareholder has an interest of 5% or more in

the share capital of a subsidiary. An exemption applies to subsidiaries, located in a low tax

jurisdiction, that are considered ‘passive’ (“the activity test”). The activity test does not only

take into account the activities of the relevant subsidiaries, but also the activities of entities in

which it is a shareholder.

If a subsidiary is considered passive, it can still qualify under the participation

exemption to the extent that its profits are subject to a local tax that is considered reasonable

from a Dutch perspective. The threshold is an effective tax rate of at least 10%, computed in

accordance with Dutch tax principles. However, if the subsidiary fails to pass the stringent

subject-to-tax-test, the participation exemption is replaced by a tax credit.

Figure 1 clarifies the changes that have been made in case of the dividend taxation regime.

The figure represents the Dutch internal dividend taxation system without taking any cross-

border dividend flows into account.

5 Interests of less than 5% are deemed passive investments of the subsidiary. Subsidiaries will be considered passive investment companies if they engage in portfolio investments or in passive group financing.

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Figure 1. The Internal Dutch Dividend Taxation System

Dutch Dividend Taxation System

Dutch Dividend Withholding Tax

Act 1965

The Adjusted Dutch Dividend

Regime 2007

Private Investors

Institutional Investors

Private Investors

Institutional Investors

Participation with < 5% of shares

Participation with ≥ 5% of shares

Participation with < 5% of shares

Participation with ≥ 5% of shares

25% Dividend

Withhholding Tax

15% Dividend

Withholding Tax

25% Dividend Withholding

Tax

0% Dividend Withholding Tax Participation

Exemption

Passive Investments;

15% Dividend Withholding Tax

0% Dividend Withholding Tax Participation

Exemption

Passive Investments Exemption;

≥10% Withholding Tax

See Next Chapter on Cross-Border

Dividends

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3. The International Dividend Taxation

Typically international dividend taxation rules are more complicated than national based

legislation. There are a number of competing explanations. Most commentators agree that the

complexity is due to the large number of incompatible rules. To avoid international double

dividend taxation, a jurisdiction may be needed to implement a kind of international

legislation that is predominantly bilateral and multilateral in nature. The Netherlands is

signatory of many such treaties. Treaties are intended to avoid double taxation with regard to

income tax. In earlier treaties, double taxation on wealth was often avoided simultaneously.

Figure 2. Number of Dutch Tax Treaties in Time

Cumulative number of tax treaties concluded by the Netherlands

0

10

20

30

40

50

60

70

80

90

100

1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003

year

Num

ber o

f tre

atie

s

Series1

Source: http://www.taxci.nl/read/tax_treaties_Netherlands

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In practice the Dutch government distinguishes unilateral, bilateral and EU-regulations to

avoid or decrease double dividend taxation. Unilateral regulations are intended to avoid

double dividend taxation concerning developing6 countries. In contrast, bilateral regulation

decreases both the national withholding on dividends and deducts the residual withholding of

the other country with the national revenue or corporate tax. The EU-regulations prohibit the

withholdings on cross-border participation dividends within the parent-subsidiary directive of

the EU-Board.

Given this background, this chapter provides an overview of the fiscal policy on dividends of

five EU countries, the US and Switzerland. These countries were selected due to their strong

commercial ties with the Netherlands and their similarity to the Dutch system of dividend

taxation.

3.1 The EU-countries

As noted, the EU law on dividends is considered superior to the national level regulation

should a dispute arise between two EU-countries. In this light, we will distinguish between

cross-border dividends paid to individual investors and dividends paid to companies.

Cross-border dividends paid to companies are largely governed by the Parent Subsidiary

Directive7. Dividends that are paid to individual portfolio investors may require a markedly

different approach. In general EU Member States use different systems of taxation when

individuals are involved. In the case of domestic dividends, most EU Member States use an

imputation system to avoid or reduce economic double taxation. This results in corporate tax

6 All countries that are on the list of Art. 2. Uitv. Reg. Bvdb 2001. 7 See paragraph 3.2 of this chapter which covers the Parent-Subsidiary Directive.

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and then income tax that is being levied on the same income. If EU Member States apply

different tax treatment to domestic, inbound or outbound dividends in such systems, this may

restrict cross-border investment, leading to the fragmentation of capital markets in the EU.

This is contrary to the rules governing the free movement of capital.8 The main conclusions

that can be drawn about the design of Member States taxation regimes is that they cannot levy

higher taxes on inbound dividends than on domestic dividends. It is possible to provide

methods of tax relief that are compatible with the EC Treaty while maintaining possibilities to

tax dividends in a relatively straightforward and transparent way. The Dutch government has

already implemented this method by decreasing the dividend tax tariff to 15%. This change

should help to optimize the allocation of capital in the internal market, even though full

neutrality remains out of reach in the absence of tax harmonization.

3.1.1 Belgian Dividend Taxation

Dividends paid by a domestic corporate taxpayer are generally subject to a rate of withholding

tax. If paid to residents of treaty countries, the withholding tax is often reduced or exempted

under the double taxation treaty provisions. For dividend paid to European companies, an

extra basis for exemption can often be found in the Parent-Subsidiary Directive.

3.1.1.1 The Basics

Resident companies must withhold a 25% tax (25.75% when the crisis tax is included) on

dividends distributed to resident and non-resident shareholders. Most tax treaties reduce this

withholding tax to either 15% or to 5% in the case of a Parent-Subsidiary relationship when at

least a 25% shareholding applies. (KPMG, 2006). Moreover, the Royal Decree of 14 October 8 Article 56 EC Treaty.

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1991 deals with the withholding tax applicable to dividend distributions to parent companies

established in an EU Member State (including Belgian resident companies). Under certain

conditions, withholding tax is fully exempted. In order to obtain an exemption, a foreign

parent company should deliver a statement to the Belgian subsidiary in which the parent

company declares that all these conditions are met. (Federale Overheidsdienst Economie,

2003)

3.1.1.2 Bilateral Treaty with the Netherlands9

On 5 June 2001, Belgium has signed a bilateral tax treaty with the Netherlands.

Dividends paid by a company which is a resident of one Contracting State to a resident of the

other Contracting State may be taxed in that other State. However, such dividends may also

be taxed in the Contracting State of which the company paying the dividends is a resident and

according to the laws of that State, the tax so charged shall not exceed

• 5% of the gross amount of the dividends if the beneficial owner is a company which

holds at least 10% of the capital of the company paying the dividends;

• 15% of the gross amount of the dividends in all other cases.

3.1.1.3 Exemptions

The participation exemption applies equally to Belgian resident companies as to non-resident

companies with respect to dividends attributable to Belgian permanent establishment. Another

special case concerns the VVPR-strips.

9 Double Taxation Treaty, Trb. 2001, 136.

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3.1.1.3.1 The Participation Exemption

Under the exemption, the dividends received are first included in taxable income and then

95% of the dividends are deducted from profits, when available. If insufficient profits are

available, or if the Belgian company is in a loss position, the qualifying dividends cannot be

deducted.

Belgium imposes both quantitative (a minimum shareholding requirement on behalf of the

receiving company) and qualitative conditions (on behalf of the distributing company). The

investing company must have a participation of at least 5% in the distributing company. A

minimum holding period is not imposed. The quantitative restriction requires that the

distributing company must be subject to tax. The participation exemption generally

(exceptions are available) does not apply to dividends:

• received from a company not subject to corporate tax, or a company that has its

registered office in a tax haven;

• received from a Belgian or foreign financing company (involved mainly with

financial transactions for the benefit of non-related companies), that benefits from a

favourable tax regime;

• received from a Belgian or foreign treasury company (involved mainly in treasury

deposits), that benefits from a favourable tax regime;

• received from a Belgian or foreign investment company (involved mainly in

collective investment of capital), that benefits from a favourable tax regime;

• originating from profits (not dividends) realised in a different country from the

country where the paying company has its registered company office and that are

subject to a particularly favourable tax regime;

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• paid by a company that realised the paid profits in a foreign establishment which is

subject to a particularly favourable tax regime; and

• paid by an intermediary company that does not pass as an investment company.

3.1.1.3.2 The VVPR-Strip

The VVPR-Strip (Verminderde Voorheffing / Précompte Réduit) is a coupon which allows

benefiting from a reduced withholding tax of 15% (rather than 25%) on the dividends paid by

the company. The strip is listed separately from the ordinary share and is freely negotiable.

The shareholder must present the coupon of the share and the coupon of the strip sheet

carrying the same number simultaneously to benefit from the deduction at source of 15%.

(Bollen, 2007)

3.1.2 French Dividend Taxation

Under French domestic law, unless otherwise provided by a tax treaty, withholding taxes may

be levied on dividends. Dividends paid by a French company are distributed out of income

which in principle has been subject to corporate income tax.

3.1.2.1 The Basics

The domestic dividends can either be received by French resident shareholders and non-

resident recipients.

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3.1.2.1.1 French Resident Shareholders

Article 93 of the Finance Law 2004 provides for a regime with respect to the taxation of

distributions made by French and foreign companies. Under this regime, the dividend

distributions to French resident individuals will no longer carry the tax credit which was

cancelled in 2005. As a counterpart, the taxable basis of the dividends was reduced by 50%.

In addition, this deduction applies not only to distributions by French companies, but also to

those distributions by foreign companies, provided that they are established in a country

protected by a tax treaty with France or in an EU Member State. (Ministère de l’Économie des

Finances et de l’Industrie, 2005). Tax credits corresponding with the withholding tax levied at

source should be fully extinguished against the French income tax due to the dividend

discounted by the 50% reduction. As a result, French individuals holding equity stakes in

foreign companies will be the main beneficiaries of this regime since dividends received from

the latter did not benefit from any particular rebate under the previous regime.

Since the 2005 cancellation of the tax credit, the French resident corporate shareholders no

longer benefit from any tax credit with respect to dividend distributions by French companies.

On the other hand, the situation of parent companies was slightly improved since the tax

credit was no longer taken into account for the determination of the 5% lump sum of charges

and expenses on which they were taxable.

Regarding the redistributions by parent companies of French source dividends, the

amount before tax received by their French shareholders should be roughly the same due to

the cancellation of both the tax credit and the advanced levy. On the other hand, the

redistributions of foreign-source dividends should be subject to a much more favourable tax

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treatment due to the cancellation of the tax credit, which was only partially compensated by

the imputation of foreign tax credits.

3.1.2.1.2 Non-Resident Recipients

Dividend distributions to non-resident shareholders are subject to withholding tax at a rate of

25%, unless a double-tax agreement sets a lower rate. Individuals who are not residents of

France for tax purposes will not benefit from the new 50% deduction on the amount of

dividend paid, whereas the tax credit was transferred to certain non-resident individuals under

certain relevant tax treaties.

As of 1 January 2005, the non-French resident corporate shareholders will no longer benefit

from any fiscal tax credit and thus will not give rise to any refund. However, any dividends

paid by a qualifying French subsidiary to its qualifying parent company resident of another

EU member state may be exempt (EC Parent-Subsidiary Directive). (The Economist

Intelligence Unit Limited, 2006)

3.1.2.2 Bilateral Treaty with the Netherlands10

Under the Bilateral Treaty signed with the Netherlands, dividends paid by a company which is

a resident of one of the States to a resident of the other State may be taxed in that other State.

However, such dividends may be taxed in the State of which the company paying the

dividends is a resident, and according to the law of that State, but the tax so charged shall not

exceed

10 Double Taxation Treaty, Trb. 1973, 83 (ned).

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• 5% of the gross amount of the dividends if the recipient is a joint-stock or limited

company which holds directly at least 25% of the capital of the company paying the

dividends;

• In all other cases, 15% of the gross amount of the dividends.

3.1.3 German Dividend Taxation

Individuals who are domiciled in Germany for tax purposes are subject, in principle, to tax on

their worldwide income (unlimited tax liabilities). Germany’s right of taxation is limited by

double taxation treaties with foreign countries.

3.1.3.1 The Basics

Dividends distributed to domestic corporate shareholders are tax exempt. However, 5% of the

dividend amount is deemed to be a non-deductible expense, triggering income taxes. Thus, in

total, 95% of dividend income, for example, will be tax exempt. The rationale behind that

broad exemption was to foster business activity in Germany by avoiding the layer of double

taxation on inter-company dividend. (Beck, Plurka; 2006)

To avoid double taxation in the hands of the domestic individual shareholder only 50% of the

dividends received are subject to personal income tax at the moment of distribution (half-

income method). Since 50% of the company profits distributed are subject to income tax only

50% of all related expenses and losses can be deducted from the taxable income. Given that

the ‘half-income method’ only applies in the case of a profit distribution, the retention of

profits is therefore ‘privileged’ with a relatively low tax rate of 25% (plus solidarity

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surcharge) compared to a profit distribution. (Lübeck Business Development Corporation,

2005)

Unless otherwise provided by a double tax treaty, withholding taxes may be levied on

dividends. Dividends distributed to resident or non-resident shareholders are subject to a

withholding tax at a rate of 20% (25% if the tax is borne by the debtor). Withholding tax is

final for non-resident shareholders.

3.1.3.2 Bilateral Treaty with the Netherlands11

Double taxation treaties typically reduce the rates to 15% for individuals as shareholders and

5%, 10% or 15% for parent corporations owning at least 10% or 25% of the shares in the

subsidiary. Foreign shareholders may have to claim the treaty benefits in a refund procedure.

The tax treaty between the Netherlands and Germany was signed on 16 June 1959. Dividends

received by a person domiciled in one of the Contracting States from the other State shall be

subject to taxation by the State of domicile. To the extent that in the other Contracting State

the tax on income form capital is collected by deduction (at the source). The right to make

such tax deductions shall not be affected.

Tax deducted shall not

• Exceed 15% of the dividends.

• However, exceed 10% of the dividends if these are paid by a joint-stock company

domiciled in one of the Contracting States to a joint-stock company domiciled in the

11 Double Taxation Treaty, Trb. 1960, 107 (dui).

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other State and holding at least 25% of the voting rights of the first mentioned

company.

3.1.4 Dividend Taxation in the United Kingdom (UK)

Dividends paid by a UK resident company are distributed from income which, in principle,

has been subject to income corporation tax. Such dividends are exempt from corporation tax

in the hands of the recipient of the dividend. As UK resident companies are generally exempt

from UK corporation tax on dividends, there is no need for a special regime for dividends

paid by a UK resident subsidiary to its UK resident parent.

3.1.4.1 The Basics

There are two different Income Tax rates on dividends. The rate paid depends on whether the

overall taxable income (after allowances) falls within or above the basic rate income tax limit.

The basic rate Income Tax limit is £33,300 for the 2006-2007 tax year.

Dividend income is taxed at 10% up to the basic-rate limit and 32.5% above that. However,

this is offset by a dividend tax credit, which reduces the effective to 0% and 25% respectively.

This means that, for basic-rate taxpayers, company profits paid out as dividends are taxed

once (via corporation tax on the company profits) rather than twice (via both corporation tax

and income tax). (HM Revenue and Customs, 2006)

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Source: www.direct.gov.uk

3.1.4.2 Bilateral Treaty with the Netherlands12

In contrast, dividends paid by a UK resident company to non-residents may be applicable

under an appropriate double taxation treaty to enable the recipient of the dividend to obtain a

repayment from the UK tax authorities attributable as part of the corporation tax paid by the

company paying the dividend. Any such credit will be calculated by reference to the tax credit

available to a UK resident individual with respect of the receipt of a dividend from a UK

resident company. The rules relating to taxation of such dividends in the hands of UK resident

individuals have been changed with the effect of reducing the tax credit available to non-

residents under any applicable double taxation treaty often to zero.

On 7 November 1980 the UK has signed a Treaty with the Netherlands. Dividends derived

from a company that is a resident of one of the States by a resident of the other State may be

taxed in that other State. However, such dividends may be taxed in the State of which the

company paying the dividends is a resident and according to the law of that State. But where

such dividends are beneficially owned by a resident of the other State the tax so charged shall

not exceed:

12 Double Taxation Treaty, Trb. 1980, 205 (ned) and Trb. 1981, 54 (eng).

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• 5% of the gross amount of the dividends if the beneficial owner is a company of which

is wholly or partly divided into shares and it controls directly or indirectly at least 25%

of the voting power in the company paying the dividends;

• In all other cases 15% of the gross amount of the dividends.

3.1.4.3 Exemptions

Generally, foreign dividends from a non-UK resident company received by a UK resident

company will be subject to corporation tax. However, credit will be available with respect of

any tax withheld from that dividend. Additionally, if a UK resident company holds shares in

the non-UK resident company, which carry voting rights at least equal to 10% of the total

voting rights of the non-UK resident company, then a further credit is available with respect

of any equivalent to UK corporation tax payable by the dividend-paying company in its own

jurisdiction.

3.1.5 Dividend Taxation in Luxembourg

For individual residents of Luxembourg, a 15% withholding tax applies on Luxembourg

domestic dividends (this withholding tax is not in full discharge) (Atoz Tax Advisors, 2006).

For final taxation, dividend income is subject to progressive income tax rates. A 50% tax

exemption can be obtained on dividend income paid by a company resident in a European

Union Member State or a State that has concluded a tax treaty with Luxembourg. (Roumieux,

2006)

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3.1.5.1 The Basics

The withholding tax regime requires companies to deduct withholding tax from payments

made with respect of dividends with a 15% tariff rate. Under the EU participation exemption

rules, dividends paid to a company having at least a 25% share in the paying company are

exempt from withholding tax (the stake must have been held for 12 months before the end of

the accounting period in respect of which the dividend is being paid; and the paying company

must be subject to a ‘high-tax’ corporation tax regime, which includes Luxembourg). Changes

to the Parent-Subsidiary Directive in 2004 have reduced the holding requirement to 20% for

2005-06; to 15% for 2007-08; and to 10% for 2009 onward. (www.lowtax.net)

3.1.5.2 Bilateral Treaty with the Netherlands13

Luxembourg has signed Double Tax Treaties with 55 countries, most of which follow the

OECD Model Tax Convention14. Broadly speaking the Tax Treaties provide that the

corporate entities are charged to tax in the country in which they are resident, except that if an

entity which is resident in one country has a permanent establishment in the other country

then the income from that permanent representation is taxed in the second country.

The double taxation treaty with the Netherlands was signed on 8 May1968. The rate of tax

shall not exceed:

• 2.5% of the gross amount of the dividends if the recipient is a company the capital of

which is wholly or partly divided into shares or corporate rights assimilated to shares

13 Trb. 1968, 76 (ned) and Trb. 1969, 220 (fra). 14 The OECD Model Tax Convention serves as a model used by countries when negotiating bilateral tax agreements. These agreements are entered into by countries to clarify the situation when a taxpayer might find himself subject to taxation in more than one country. The model Tax Convention is dynamic in that it is constantly monitored and updated as economies evolve and new tax questions arise.

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by the taxation law of that other State and which holds directly at least 25% of the

capital of the company paying the dividend;

• In all other cases, 15% of the gross amount of the dividends.

3.1.5.3 A Special Case; the ‘Holding’ Company Law

A special case in the Luxembourg taxation regime concerns the ‘Holding’ Company Law15.

The 1929 holding companies were exempt from all Luxembourg taxes, with the exception of

the annual subscription tax levied on their net asset value and the capital contribution tax.

Thus, a 1929 holding company could receive dividends from a foreign subsidiary and claim

an exemption, even if the distributing subsidiary is not subject to tax or is subject to a tax

regime that is notably more advantageous than the regime applicable to fully taxed

Luxembourg resident subsidiaries.

However, Luxembourg was being forced to comply with the EU Code of Conduct

Committee’s campaign against ‘harmful tax practices’ by modifying the dividend taxation

regime for 1929 holding companies (KPMG, 2006). Under the 2005 legislation, a 1929

‘Holding’ company loses its tax-exempt status if at least 5% of its dividends received relate to

foreign participations that are not subject to tax at a rate comparable to the Luxembourg

corporate income rate.16 For newly incorporated 1929 holding companies, the amendment

applied as from 1 January 2004. For existing 1929 holding companies incorporated under the

law applicable before 1 January 2004, the new rules will apply as from 1 January 2011.

15 The 1929 Holding is a company whose statutory object is the acquisition and management of participations in other Luxembourg or foreign companies. Participation in partnership is permitted subject to some conditions. The 1929 Holding may own financial assets and may issue debt, subject to some thin capitalization rules; it may also own patents. Direct ownership of real estate is not permitted, except for the 1929 Holding’s own premises. 16 An effective rate is considered to be comparable if it is at least 11%, equating to approximately one-half of the current corporate income tax rate that applies to regular resident regular resident taxpayers and is in line with the tax rate generally applicable to dividends received from participations that do not qualify for a full exemption.

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3.2 EU Dividend Taxation rules

To give a better understanding of the EU dividend taxation rules, this chapter makes a

distinction between corporate and individual dividend taxation rules. In many cases,

corporations are treated differently from individuals

3.2.1 EU Corporate Dividend Taxation Rules

An important feature of the EU corporate taxation rules concerns the Parent-Subsidiary

Directive. In addition, by signing the EU Treaty, the Netherlands as an EU member is bound

to the EU-Treaty regulations which overrule the national law.

When profits are distributed by company (a) to non-resident shareholders (b), they are taxed

in the shareholders’ country of residence (B) in the form of capital yields tax. However, under

international law, the right to tax is not exclusive. State (A), where company (a) is resident,

may also deduct at source. The rate of tax and arrangements for its deduction are laid down by

the convention.

The 1990 Directive was designed to eliminate tax obstacles in the area of profit distributions

between groups of companies in the EU by abolishing withholding taxes on payments of

dividends between associated companies of different Member States and preventing double

taxation of parent companies on the profits of their subsidiaries. (European Commission,

2003a)

The new Directive is based on a Commission proposal of 8 September 200317 and was

implemented on 22 December 2003. In view of the enlargement of the EU, the European

17 See press release IP/03/1214 on www.ec.europa.eu.

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Economic and Social Committee (EESC) believed that effective removal of tax obstacles

requires progressive harmonization of Member State rules. The EESC supports the underlying

purpose to amend the Parent-Subsidiary Directive which is to consolidate corporate groups

located in several Member States. Thereby, the broadening and widening of the range of

companies contributes to the harmonization of EU taxation rules (European Economic and

Social Committee, 2003)

The 2003 Directive contains three main elements. The first element concerns the updating of

the list of companies that the directive covers. The second element concerns the relaxation of

the conditions for exempting dividends from withholding tax (reduction of the participation

threshold). The third element concerns the elimination of double taxation for subsidiaries of

subsidiary companies. (European Commission, 2003)

First of all, the new Directive updates the list of companies covered by the Parent-Subsidiary

Directive which already included co-operatives, mutual companies, non-capital based

companies, saving banks, funds and associations with commercial activities. The new list

includes the European Company18 which may be created from 2004 and the European Co-

operative Society19 which may be created from 2006. This means that companies and co-

operatives operating in more than one Member State will have the option of establishing

themselves as single entities under Community law.

The second element relaxes the conditions for exempting dividends from withholding tax.

Dividends paid by a subsidiary company to its parent company were exempted from

withholding tax. This was also the case where the two companies were located in different

18 Council Regulation (EC) 2157/2001 and Council Directive 2001/86/EC. 19 Council Regulation (EC) 1435/2003 and Council Directive 2003/72/EC.

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Member States. The new Directive relaxes the conditions of this exemption. The parent

company used to hold at least 25% of the shares in the subsidiary company for the exemption

to apply. The minimum shareholding will be reduced gradually to 10%.

• From 1 January 2005 to 31 December 2006 the minimum shareholding was 20%.

• From 1 January 2007 to 31 December 2008 the minimum shareholding is 15%.

• From 1 January 2009 the minimum shareholding will be 10%.

The third element eliminates double taxation for subsidiaries of subsidiary companies. The

new Directive renders more completely the mechanism for the elimination of double taxation

of dividends received by a parent company located in one Member State from its subsidiary

located in another. Since the subsidiary company used to be taxed on the profits out of which

it paid dividends, the Member State of the parent company had to exempt profits distributed

by the subsidiary from any taxation or impute the tax already paid in the Member Sate of the

subsidiary against its own tax.

The new Directive deals with imputing tax paid by subsidiaries of these direct subsidiary

companies. Member States must impute against the tax payable by the parent company any

tax on profits paid by successive subsidiaries downstream of the direct subsidiary. This

ensures that the objective of eliminating double taxation is better achieved.

An Example: The Amurta Case

An example of the improved and amended EU Parent-Subsidiary concerned the ‘Amurta’

case. In 2002, a Dutch company paid dividends to a Portuguese corporate shareholder which

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holds 14 % of the issued and paid up shares in the Dutch company. The Dutch company

withheld 25 % Dutch dividend tax from the dividend distributed to the Portuguese

shareholder. On basis of the tax treaty concluded between the Netherlands and Portugal, the

Netherlands refunded 15 % of the tax withheld. No refund was granted of the remaining 10%,

as the Portuguese shareholder is not resident in the Netherlands and does not have a

permanent establishment in the Netherlands to which the shares in the Dutch company can be

attributed. (Ernst&Young, 2006)

Pursuant to Article 4 of the Dutch Dividend Tax Act, no dividend would have been due if,

under circumstances similar to those in the case at hand, the dividends had been paid to a

corporate shareholder resident in the Netherlands. The main issue in the national proceedings

is whether the differential tax treatment of a foreign-based and a Netherlands-based

shareholder is in conflict with EC-rules, in particular the freedom of capital as laid down in

Articles 56 and 58 of the EC Treaty. On the basis of the amended Parent-Subsidiary Directive,

the withholding of the Dutch company will be either reduced or eliminated in the future.

3.2.2 EU Dividend Taxation Rules of Individuals

The taxation of dividends received by individuals is not harmonized at EU level, nor does the

Commission intend to harmonize it. However, Member States may not restrict the free

movement of capital within the EU. This means that dividends from another Member State

received by individual shareholders cannot be subjected to higher taxation than domestic

dividends. (European Commission, 2004)

If Member States cannot agree on a solution, the Commission is obliged to initiate legal

action against those Member States whose dividend tax rules do not comply with the Treaty.

Member States operate different systems for taxing dividend income in the hands of

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individual shareholders. For domestic dividends, most Member States prevent or reduce

economic double taxation. Where Member States differentiate between the tax treatment of

domestic and inbound and outbound dividends in applying their systems, this may constitute a

restriction on cross-border investments and can result in fragmented capital markets in the

EU.

Analysis of case law leads to certain conclusions on the design of dividend taxation systems.

Member States cannot levy higher taxes on inbound EU dividends than on domestic dividends

or outbound EU dividends than on domestic dividends. Member States should re-examine

their systems in light of this law. Any necessary changes will help to optimize capital

allocation in the Internal Market. Moreover, a coordinated approach to ensure the rapid

removal of any tax obstacles will help to create a more stable and investment-friendly

environment and remove uncertainty created by potential legal conflict and litigation.

An Example: The Verkooijen Case20

An example concerning the case law of individuals is the so called Verkooijen case.

Verkooijen resided in the Netherlands. He was employed there by a subsidiary of the Belgian

company Petrofina NV. Under an employee’s savings plan he acquired shares in that

company. The Dutch legislation on the taxation of dividends provided for a system of

exemption, subject to certain limitations, from the tax chargeable on dividends and income

from shares. Dividends were, limited to a specific amount (up to NLG 2000 for married

persons), exempted from income tax for persons subject to that tax. Because the dividends

were paid by a corporation that was established in the Netherlands, as such, the investor was

already subject to Belgian tax on their dividends. Thus, the Dutch investor suffered a more

20 Case C-35/98, Verkooijen, 6 June 2000, ECR 2000 I-4071.

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onerous tax liability by investing in a Belgian company than he would have done if he had

invested in a Dutch company.

The Dutch Supreme Court sought a ruling from the Court of Justice as to compatibility of the

Dutch legislation with Community law: was the grant of an exemption from income tax with

respect of dividends paid to natural persons – an exemption that was conditional upon such

dividends being paid by a company whose seat was in the Member State levying the tax –

contrary to the principal of free movement of capital?

First, the Court observed that Community law allowed the application of tax provisions which

drew certain distinctions between taxpayers based on their place of residence, provided that

they applied to situations which were not objectively comparable or could be justified by

overriding reasons in the general interest. Such overriding reasons in the general interest

included cohesion of the tax system. The Court has held that such differences of treatment

should not in any circumstances constitute a means of arbitrary discrimination or a disguised

restriction on the free movement of capital. Finally, the Court held that the decrease in tax

revenue could not be relied on as an overriding reason in the general interest to justify a

measure contrary to the principle of free movement of capital21.

3.3 The Non EU-Countries: Switzerland and the United States

As non-EU member states, both Switzerland and the United States are free to promulgate their

own rules and regulations. Therefore these countries are treated separately from the EU-

countries.

21 Judgement of the Court of Justice in Case C-35/98. Staatssecretaris van Financiën v B.G.M. Verkooijen, 6 June 2000.

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3.3.1 Switzerland

Switzerland is not viewed strictly as an offshore jurisdiction, such as the Cayman Islands or

Jersey. It is nonetheless a low-tax jurisdiction, having a series of specialized corporate entities

that can be used by international investors and multinational companies to reduce their tax

bills to a significant extent. The regular economy in Switzerland is moderately taxed, but

locals have access to the tax-privileged company entities as much as foreigners, if they

comply with the rules which broadly prevent any local business operations.

3.3.1.1 The Basics

The Swiss federal withholding tax rate on dividends is 35%. The 35% dividend withholding

tax is also levied on hidden profit distributions. The withholding tax must be shifted to the

shareholder. Thus, the company must only pay out 65% of gross dividends and the 35%

withholding tax must be remitted to the Federal Tax Administration.

3.3.1.2 Bilateral Treaty with the Netherlands22

As an OECD country, Switzerland has double taxation treaties with more than 70 other

countries. The general effect of the treaties for non-residents from treaty countries is that they

can obtain a partial or total refund of tax withheld by the Swiss paying agent. Although the

full amount of withholding tax is deducted at source, the difference can be reclaimed by the

non resident from the Swiss Tax Authorities. Where there is no double taxation treaty in place

withholding taxes deducted in the foreign jurisdiction on remittances paid to a Swiss entity

give rise to a tax credit in Switzerland. Switzerland has a zero withholding tax rate on

22 Double Taxation Treaty, Trb. 1951, 148 (ned, fra).

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dividend distributions under treaties with several countries. (www.lowtax.net, 2005a) With

respect to tax treaties of other countries, generally a final withholding tax of 5% to 10%

remains on dividend distributions. Since January 1 2005 Switzerland grants a relief at source

under all double taxation treaties for qualifying investments of 20% or, regarding US parent

companies, of 10% respectively. (Morf, Wyss; 2006)

On November 12 1951, Switzerland signed a Treaty with the Netherlands. In the case of tax

on income from movable capital levied by one of the two States by deduction at source, the

recipient of such income domiciled in the other State may, within a period of two years,

request reimbursement through the State in which he is domiciled, subject to the production of

an official certificate of domicile and of liability to direct taxation in the State of domicile in

respect of dividends:

• Of the total amount of tax, where the recipient of the dividends is a joint-stock

company which owns at least 25% of the authorized capital of the company paying

the dividends, provided that the relationship between the two companies was not

established, or is not maintained, primarily in order to obtain the benefit of such total

reimbursement;23

• Of the amount of the tax which exceeds 15% of the dividends, in all other cases.

3.3.1.3 A Special Case; the Swiss Holding Company

As more and more multinationals are setting up operations in Switzerland, holding functions

are often added to platform. The absence of such anti-abusive provisions makes Switzerland

23 Switzerland entered into a bilateral agreement with the EU on January 1 2005. The bilateral agreement allows Switzerland to benefit from rules derived from the Parent-Subsidiary Directive. The purpose was to eliminate the withholding tax on intra-group cross-border dividend payments between Switzerland and the EU Member States.

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the preferred European holding location for so-called ‘difficult participations’, i.e. subsidiaries

on-shore and off-shore that do not pay corporate income tax in their home country.

(www.lowtax.net, 2005b) Swiss holding companies enjoy the following relief from corporate

income tax:

• At federal level a holding company pays a reduced level of corporate income tax on

any dividend income received from the subsidiary or the company in which it holds a

“participating shareholding”. The reduction in the level of corporate income tax

payable depends on the ratio of earnings from “participating shareholding” to the total

profit generated.

• At cantonal or municipal level no corporate income tax is payable on income

represented by dividends as long as the corporate entity meets the cantonal definition

of a holding company.24

The position of Switzerland as a holding location is further enhanced by the entry-into-force

of measures equivalent to the EC Parent-Subsidiary Directive. Figure 3 illustrates the holding

structure.

24 Although the definition of a holding company varies among cantons a corporate entity is a holding company for cantonal corporate income tax purposes so long as it either derives at least 51%-66% of its income from dividends remitted by the subsidiary or holds at least 51%-66% of the subsidiary’ s shares.

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Figure 3. The Holding company structure

Parent Company in Treaty Country

Holding Company

Subsidiary in TreatyCountry

Subsidiary in Non-Treaty Country

Subsidiary in EU Country

Parent Company in EU Country

CIT depends on local legislation

0-15% DWT depending on treaty

0-15% DWT depending on treaty

DWT depends on local legislation

CIT depends on local legislation

Dividends and ownership relations

CIT depends on local legislation

0% DWT under EU PSD

0% DWT under EU PSD

CIT depends on local legislation

CIT: Corporate Income Tax

DWT: Dividend Withholding Tax

PE: Participation Exemption

PSD: Parent-Subsidiary Directive

0% CIT under PE

Source: Center for Research on Multinational Corporations (SOMO), 2006

Qualifying dividends and capital gains derived from participations in a Swiss company can

generally benefit from a tax deduction, the so-called participation deduction, which is applied

at all three tax levels (i.e. federal, cantonal and municipal). Furthermore, at the cantonal and

municipal levels a special holding privilege may be available, providing for a full exemption

from cantonal and municipal income tax.

For qualifying dividends and capital gains, the participation deduction is granted as follows:

all income, including all dividends and capital gains are derived from participations, is

normally included in the taxable income. On this taxable income, the income tax (federal rate

8.5%) is calculated. Subsequently, a deduction of income tax is granted for qualifying

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dividends and capital gains derived from participations. The deduction is equal to that part of

the income tax that is attributable to the net profit of such dividends and capital gains.

In the case of dividends, it means dividends from a participation of which at least 20% of the

nominal share capital is held, or alternatively, which has a fair market value of at least CHF 2

million. There is no minimum holding period. (Boitelle, 2005)

3.3.2 The United States

The problem facing the United States was that dividend and capital gains taxes were too high

for America to remain competitive in the global economy. Individuals who would normally

invest in US firms were being deterred by lower investment returns and, consequently,

invested in operations abroad where dividends were not taxed. A study at the time by the Cato

Institute concluded in 2003 showed that the US had the second highest top dividend tax rate

of the 30 OECD countries (Edwards, 2003). The OECD data included corporate and

individual taxes imposed by both national and sub national governments.

3.3.2.1 The Basics

On 28 May 2003, President George Bush signed into law The Jobs and Growth Tax relief

Reconciliation Act of 2003. One of provisions of this Act included changes in how dividends

are taxed. The maximum tax rate on dividends was reduced from 38% to 15%. A related

provision in the bill lowered the top rate on long-term capital gains from 20% to 15%, thereby

equalizing those two tax rates for the first time since 1990.

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In the past, dividend income was just another source of ordinary income, taxed at the normal

tax rate, which could be as much as 35%. Beginning in 2003 the maximum rate on

qualifying25 dividends was dropped to 15% for most people. And for the people in the 15% or

10% bracket, qualifying dividends would be subject to a maximum tax of only 5%.

3.3.2.2 Bilateral Treaty with the Netherlands26

On 18 December 1992 the United States has signed a double taxation Treaty with the

Netherlands.

Dividends paid by a company that is a resident of one of the States to a resident of the other

State may be taxed in that other State. However, such dividends may also be taxed in the State

of which the company paying the dividends is a resident and according to the laws of that

State, but if the beneficial owner of the dividends is a resident of the other State, the tax so

charged shall not exceed:

• 5% of the gross amount of the dividends if the beneficial owner is a company which

holds directly at least 10% of the voting power in the company paying the dividends;

and

• 15% of the gross amount of the dividends in all other cases.

In 2004, the Netherlands-US Protocol exempts dividend paid to corporate shareholders from

(withholding) tax that held at least 80% voting power of the company. Tax (by way of

withholding) is eliminated only for companies that are the beneficial owners of shares

25 A qualified foreign corporation is one that is incorporated in a US possession or is incorporated in a country that has a current tax treaty with the US and meets various other qualifications. 26 Double Taxation Treaty, Trb. 1993, 77.

- 46 -

representing at least 80% of the voting power of the distributing company during 12 months

ending on the dividend declaration date. (Galavazi, 2004)

Main Findings

There is a global trend toward lower tax rates on all forms of capital income, including

corporate income taxes and individual taxes on dividends and capital gains. Figure 4

illustrates on average a trend towards diminishing top marginal tax rates on dividend income

in the 30 OECD countries between 2001 and 2006. Policymakers in many countries are

recognizing that high capital income taxes distort savings and investment and reduce

economic growth.

In addition, the concept of non-discrimination has long been included in the OECD

Model income tax treaty, as it has been generally considered important in all areas involved in

bilateral economic relationships between treaty partners. The prevention of discriminatory

taxation is an important role of tax conventions. Tax conventions, however, recognize that

residents and non-residents are in a different situation and must often be treated differently for

tax purposes. For this reason, the principle of non-discrimination has been carefully

incorporated in tax conventions through a set of provisions that are found in Article 24 of the

OECD Model Tax Convention (which serves as the basis for the negotiation, application and

interpretation of tax conventions). In the OECD Model, under Article 24, nationals (citizens)

of one of the signatory countries (“home country”) are not to be made subject to, in the other

signatory country (“host country”), “any taxation or any requirement connected therewith

which is other or more burdensome than the taxation and connected requirements” to which

nationals (citizens) of the host country are subjected.

- 47 -

As to dividend withholding taxes, it has long been recognized by tax theoreticians that such a

tax was a second (double) tax on the earnings of corporations .The same can be said for

taxation, on an assessment basis rather than by way of withholding, of domestic dividends to

local shareholders. It is thus notable that the trend is in the right direction, at least in OECD

countries. In this connection, Article 24 should be used to eliminate dividend withholding

taxes, unless unilateral legislation in the host country has accomplished this.

Figure 4. Top marginal tax rates on dividend income27

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

DN

KF

RA

SW

IG

ER

CA

NN

LDS

PA

SW

EIR

LU

SK

OR

NO

RU

KA

US

JAP

HU

NIT

ALU

XB

EL

AU

TT

UR

PO

RF

INN

ZL

CZ

EP

OL

GR

CM

EX

ICL

SV

K

2001 2006

Source: OECD Tax Database

27 The overall (corporate plus personal) rate on distributions of domestic source profits to a resident individual shareholder, taking account of imputation systems, dividend tax credits etc.

- 48 -

4. A Legal Framework towards Optimality

This chapter will describe the main components of the optimal investment route. Such a route

involves three steps.

In order to find an optimal investment-route we first need to know the dividend withholding

rates between countries. We make a distinction between private investors and institutional

investors because certain countries apply different rules concerning the type of investor.

However, our main focus will be on the (different types of) institutional investors.

The next step is to make a strategy. In this study we make use of derivative wholesale

brokerage which is one of the companies’ main activities. Derivatives have the advantage of

entering risk free transactions without taking care of share price fluctuations when capital

flows from one party to another. In addition, the dividend-stripping transaction activities have

to be in accordance with the law.

The final step is to create a structure whereby both parties will be better off. The structure

involves two different parties from two different countries. Party 1 has the opportunity to use

a more profitable dividend withholding rate than Party 2. Therefore, party 2 will be better off

by using a structure where party 2 profits from parties’ 1 reduced dividend withholding rate.

In turn, party 1 takes a piece of parties’ 2 profit by the ‘creation’ of the lower dividend

withholding opportunity for party 2.

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4.1 Cross-Border Dividend Withholding Rates

As noted, we distinguish private and institutional investors. These figures represent the

dividend rate between countries. In both figures the left column of countries represents the

investors’ home country and in both figures the first row of countries represents the country in

which they are investing.

Private Cross-border Investors

a: Since 1 January 2007 the dividend withholding rate has been reduced from 25% to 15%. http://www.belastingdienst.nl/zakelijk/dividendbelasting b: Dividends paid by a French corporation to French residents (individuals or corporate) are free from withholding tax, but the tax authorities must be notified of the distribution. The Economist Intelligence Unit (2006), www.eiu.com. c: In general 20% withholding tax plus solidarity surcharge is to be withheld from the dividends. The withholding tax is credited against the income tax liability of the recipient of the dividends. Half of the dividends received from domestic or foreign corporations are tax exempt. ‘German Tax Card 2006’, KPMG, 2006. http://www.kpmg.de/library/pdf/060601_German_Tax_Card_2006_en.pdf d: Dividends paid to non-resident natural person shareholders are paid under deduction of a withholding tax of 20% (previously 25%). Where a treaty reduces the rate to 15%, the dividend withholding will be deducted at 15%. e: As from 2007 the withholding tax is 15%. The withholding tax will be deducted at source by the company from the dividends paid to all shareholders. ‘Corporation Taxation System in Luxembourg’, Atoz Tax Advisers Luxembourg. www.atoz.lu f: http://www.internationaltaxreview.com/?Page=10&PUBID=35&ISS=22808&SID=660300&TYPE=20 g: http://www.direct.gov.uk/en/MoneyTaxAndBenefits/Taxes/TaxOnSavingsAndInvestments/DG_4016453. h: http://www.horwathcw.com/publications/taxintheUK.pdf. i: Offset in full against Swiss tax on income and net worth due by a Swiss resident. http://www.multigroupservices.com/en/virtlib/dir_links_pdf/doub_tax.pdf. j: Dividend are taxed at long-term capital gain rates until 2011 under the Jobs and Growth Tax Relief Reconciliation Act of 2003. This rate increases from 5% to 15% after the ordinary income rate increases to 25%. http://www.smbiz.com/sbrl001.html. k: http://www.irs.gov/publications/p515/15019904.html. l: www.eiu.com. m: The 15% applies with VVPR-strips. The 25% is the domestic private dividend taxation rate. http://mineco.fgov.be. n: ‘Investment in Belgium’, KPMG. www.kpmg.fi/Binary.aspx?Section=3268&Item=355. o: http://www.taxci.nl/read/bronbelastingdividendbelasting.

The

Netherlands Belgium France Germany United

Kingdom Luxembourg Switzerland United States

The Netherlands 15% a 15% n 15% l 15% d 0% h 15% f 15% h 15% k Belgium 15% o 15-25% m 15% l 15% d 0% h 15% f 15% h 15% k France 15%o 15% n 0% b 15% d 0% h 15% f 15% h 15% k Germany 15% o 15% n 15% l 20% c 0% h 15% f 15% h 15% k United Kingdom 15% o 10% n 15% l 15% d 10-32.5% g 15% f 15% h 15% k Luxembourg 15% o 15% n 15% l 15% d 0% h 15% e 15% h 15% k Switzerland 15% o 15% n 15% l 10% d 0% h 15% f 35% i 15% k United States 15% o 15% n 15% l 15% d 0% h 15% f 15% h 5-15% j

- 50 -

Institutional Cross-border Investors

The

Netherlands Belgium France Germany United

Kingdom Luxembourg Switzerland United States The Netherlands 15% a 5-15% b 0-5-15% c 10-15% d 0-5-15% e 0-2.5-15% f 0-15% g 0-5-15% h Pensionfunds 0% l 0% pp 0% rr 0% rr 0% bb 0% aa 0% ii 0% j Insurers 0% k 5-15% b 5-15% c 0% w 0% bb 2.5-15% f 0-15% hhh 5-15% h Investmentfunds 0-15% m 0-5-15% ccc 15% eee 0-15% ddd 0% bb 0% zz 0-15% bbb 15% i

Hedgefunds 0-15% u N/A 15-25% n 0-5-15% ww 0% jj 0% bb 0% aa 0-15% ss 5-15% uu Belgium 5-15% b 25% oo 0-10-15% r 15% nn 0% bb 0-10-15% x 10-15% g 5-15% mm Pensionfunds 0% l 0% pp 0% rr 0% rr 0% bb 0% aa 0% ii 0% ff Insurers 5-15% b 25% iii 10-15% r 0% w 0% bb 10-15% x 10-15% hhh 5-15% mm Investmentfunds 0-15% m 15% yy 15% eee 0-15% ddd 0% bb 0% zz 0-15% bbb 0-5-15% aaa

Hedgefunds 0-15% qq 15-25% xx 15% ww 0% jj 0% bb 0% aa 10-15% ss 5-15% uu France 0-5-15% v 0-10-15% r 25% o 5-15% nn 0% bb 0-5-15% x 5% ee 5-15% mm Pensionfunds 0% l 0% pp 0% rr 0% rr 0% bb 0% aa 0% ii 0% q Insurers 5-15% v 10-15% b 25% vv 0% w 0% bb 5-15% x 0-5% hhh 5-15% mm Investmentfunds 0-15% m 0-10-15% ccc 25% eee 0-15% ddd 0% bb 0% zz 0-5% bbb 0-5-15% aaa

Hedgefunds 0-15% qq N/A 15-25% n 25% vv 0% jj 0% bb 0% aa 0-5% ss 5-15% uu Germany 10-15% d 15% nn 0-15% r 0% w 0% bb 0-10-15% x 0-15% ff 5-15% mm Pensionfunds 0% l 0% pp 0% rr 0% w 0% bb 0% aa 0% ii 0% fff Insurers 10-15% d 15% nn 0-15% r 0% w 0% bb 10-15% x 5-15% hhh 5-15% mm Investmentfunds 0-15% m 0-15% ccc 15% eee 0-20% ddd 0% bb 0% zz 0-15% bbb 0-5-15% aaa

Hedgefunds 0-15% qq N/A 15-25% n 0-15% ww 0% jj 0% bb 0% aa 5-15% ss 5-15% uu United Kingdom 0-5-15% f 5-10% oo 0-5-15% r 15% nn 0% bb 0-5-15% x 5-15% g 0-5-15% dd Pensionfunds 0% l 0% pp 0% rr 0% rr 0% bb 0% aa 0% ii 0% cc Insurers 5-15% f 5-10% oo 5-15% r 0% w 0% bb 5-15% x 5-15% hhh 0% ggg Investmentfunds 0-15% m 0-5-10% ccc 15% eee 0-15% ddd 0% bb 0% zz 0-15% bbb 0-5-15% aaa

Hedgefunds 0-15% qq N/A 15-25% n 5-15% ww 0% jj 0% bb 0% aa 5-15% ss 0-5-15% uu Luxembourg 0-2,5-15% f 0-10-15% y 0-5-15-25% r 0-10-15% y 0% bb 0% z 0-5-15% y 5-10-15% y Pensionfunds 0% l 0% pp 0% rr 0% rr 0% bb 0% z 0% ii 0% fff Insurers 2,5-15% f 10-15% y 5-15% r 0% w 0% bb 0% z 0-15% hhh 5-15% y Investmentfunds 2,5-15% m 0-10-15% ccc 15% eee 0-15% ddd 0% bb 0% zz 0-15% bbb 0-5-15% aaa

Hedgefunds 2,5-15% qq N/A 15-25% n 5-15% ww 0% jj 0% bb 0% z, jj 0-15% ss 5-15% uu Switzerland 0-15% g 10-15% g 5-15% s 0-15% ff 0% bb 0-5-15% x 35% hh 5-15% gg Pensionfunds 0% j 0% pp 0% rr 0% rr 0% bb 0% aa 0% ii 0% fff Insurers 0-15% g 10-15% g 5-15% s 0% w 0% bb 5-15% x 35% hh 5-15% gg Investmentfunds 0-15% m 0-10-15% ccc 15% eee 0-15% ddd 0% bb 0% zz 35% hh 0-5-15% aaa

Hedgefunds 0-15% qq N/A 15-25% n 0-15% ww 0% jj 0% bb 0% aa 35% kk 5-15% uu United States 0-5-15% h 5-15% jjj 5-15% p 5-15% nn 0% bb 0-5-15% x 5-15% gg 5-15% ll Pensionfunds 0% j 0% pp 0% q 0% rr 0% bb 0% aa 0% ii 0% fff Insurers 5-15% h 5-15% jjj 5-15% p 0% w 0% bb 5-15% x 5-15% hhh 5-15% ll Investmentfunds 0-5-15% i 0-5-15% ccc 15% eee 0-15% ddd 0% bb 0% zz 0-15% bbb 0-5-15% aaa

Hedgefunds 5-15% qq N/A 15-25% n 5-15% ww 0% jj 0% bb 0% aa 5-15% ss 0-5-15-35% tt

- 51 -

a: Since 1 January 2007 the dividend withholding rate has been reduced from 25% to 15%. http://www.belastingdienst.nl/zakelijk/dividendbelasting b: The 5% rates applies with a minimum required participation rate of 10%, the so called qualifying companies. Otherwise the rate of 15% applies. http://www.taxci.nl/read/belasting_dividend_belgie c: The 5% rates applies with a minimum required participation rate of 25%, the so called qualifying companies. Otherwise the rate of 15% applies. http://www.taxci.nl/read/belasting_dividend_frankrijk d: The 10% rates applies with a minimum required participation rate of 25%, the so called qualifying companies. Otherwise the rate of 15% applies. http://www.taxci.nl/read/belasting_dividend_duitsland e: The 5% rates applies with a minimum required participation rate of 25%, the so called qualifying companies. Otherwise the rate of 15% applies. As long as an individual resident in the United Kingdom is entitled under United Kingdom law to a tax credit in respect of dividends paid by a company which is resident in the United Kingdom, the 5 and 15% rates shall not apply to dividends derived from a company which is a resident of the United Kingdom by a resident of the Netherlands. Then the 0% rate applies. http://www.taxci.nl/read/belasting_dividend_verenigdkon. f: The 2.5% rates applies with a minimum required participation rate of 25%, the so called qualifying companies. Otherwise the rate of 15% applies. http://www.tax-consultants-international.com/read/Luxembourg_dividends_tax g: The lower rate applies where the recipient of the dividends is a joint-stock company which owns at least 25 per cent of the authorized capital of the company paying the dividends, provided that the relationship between the two companies was not established, or is not maintained, primarily in order to obtain the benefit of such total reimbursement. In all other cases the 15% rate applies. http://www.tax-consultants-international.com/read/Switzerland_dividends_interest and http://www.lowtax.net/lowtax/html/jsw2tax.html#table. h: The 5% rates applies to companies with a minimum of 10% of the voting power. Otherwise the rate of 15% applies. The 2004 Netherlands-US Protocol exempts dividends paid to corporate 80% shareholders from (withholding) tax. http://www.tax-consultants-international.com/read/United_States_dividends_tax i: The 5% rate of the gross amount of the dividends -if the beneficial owner is a company which holds directly at least 10 percent of the voting power in the company paying the dividends- shall not apply in the case of dividends paid by a Regulated Investment Company (RIC) or a Dutch ‘beleggingsinstelling’. http://www.tax-consultants-international.com/read/United_States_dividends_tax j: The Competent Authorities of the United States and the Kingdom of the Netherlands have entered into a mutual agreement to clarify the entitlement of exempt pension funds to benefits under the Convention between the United States of America and the Kingdom of the Netherlands for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income, signed on December 18, 1992, and amended by Protocol signed on October 13, 1993. http://www.irs.gov/newsroom/article/0,,id=108186,00.html k: The dividend withholding rate of 15% can be fully settled with the corporate income tax. http://www.pwc.com/Extweb/pwcpublications.nsf/docid/1EA9A32461B19F668025713A00329202/$file/PwC_Verzekering_Update_augustus-2005.pdf l: Dutch and EU-based pensionfunds have the right to a reinbursement of the Dutch dividend withholding. http://www.minfin.nl/nl/onderwerpen,belastingen/belastingen_op_inkomenx_winst_en_vermogen/dividendbelasting.html m: The Dutch government has published a legislative proposal comprising the introduction of a new tax-exempt regime for investment funds (vrijgestelde beleggingsinstelling-'VBI'). The VBI-regime provides an exemption from a dividend withholding tax on profit distributions. http://www.minfin.nl/binaries/minfin/assets/pdf/actueel/bijlage-kamerstukken/2006/04/db06-127a.pdf n: In the case of non-transparent hedge funds, dividends will be subject to a Belgian withholding tax at a rate of 25% or 15%. When a hedgefund is transparent, numbers are not available. ‘The regulation, Taxation and Distribution of Hedge Funds in Europe’, PriceWaterhouseCoopers, June 2006. o: Dividends paid by a French corporation to French residents (individuals or corporate) are free from withholding tax, but the tax authorities must be notified of the distribution. Normally, only 5% of dividends from affiliated companies are subject to tax at the 33.33% rate (if the parent company owns at least 5% of the affiliated shares). ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. p: The tax treaty with the United States sets withholding tax at 5% of dividends. This rises to 15% for dividends distributed to US residents individually owning less than 10% of the equity of the French company. ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. q: The US-France double-tax treaty reduces the withholding tax on dividends and payments to US pension funds to zero. ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. r: Dividends paid by a French corporation to foreign companies based in other EU countries are exempt from withholding tax, in line with the EU directive from 1990. The 15% rate applies to double taxation treaties. To qualify for exemption at the time of distribution, the parent company must be subject to corporate tax at the standard rate; the parent company must own at least 10% of the capital of the subsidiary. ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. s: Dividends paid by a French corporation to foreign companies based in other EU countries are exempt from withholding tax, in line with the EU directive from 1990. ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. t: Corporates and banks are taxed at 25% on distributed/accumulated income generated by the hedge fund. ‘The regulation, Taxation and Distribution of Hedge Funds in Europe’, PriceWaterhouseCoopers, June 2006, p.17. u: Dutch funds are either transparent or subject to a special tax regime (0% corporate income tax). A fund is tax exempt when a hedge fund is tax transparent. ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. v: Under the EU’s parent-subsidiary directive, dividends paid by a French subsidiary to an EU-parent company that holds at least 25% of the

- 52 -

capital should be payable, subject to certain conditions, without withholding tax. ‘Corporate Taxes’, The Economist Intelligence Unit (2006), www.eiu.com. w: The dividend income of German resident companies is free of corporation tax. The intention is to avoid multiplying the inherent corporation tax burden in dividend income once it is received by natural persons subject to income tax, merely because the shares are ultimately held through a chain shareholdings. ‘The main Features of the Corporate Tax Reform’, Dresdner Bank AG, Frankfurt. x: http://www.lowtax.net/lowtax/html/jlx2tax.html y: http://www.lowtax.net/lowtax/html/jlx2tax.html z: http://www.fidomes.com/en/luxembourg/index.asp?idLux=56. aa: Due to strong growth in investment schemes, Luxembourg has introduced a new vehicle for the well informed investors which is a flexible UCI (Undertaking for Collective Investment). It can be used by private funds, family offices, HNWI, families, pension poolings or hedge funds. The fund is tax exempt when the hegde fund is tax transparent. http://www.fidomes.com/EN/luxembourg/index.asp?idLux=128. http://www.pwc.com/Extweb/pwcpublications.nsf/docid/8A6E6D7920DA08A7802570AF003EA769/$file/pwc_PensionfundsA4.pdf. bb: Companies pay no tax on dividends received. http://www.dyerpartnership.com/corptax.html. http://www.horwathcw.com/publications/taxintheUK.pdf. cc: http://www.hmrc.gov.uk/bulletins/tbse6.pdf. dd: ‘UK/US Double Taxation Agreement’, Tax Bulletin, April 2003, p.7. http://www.hmrc.gov.uk/bulletins/tbse6.pdf. ee: Only 20% is refundee (making the effective rate 15%) if non residents of France have substantial interests in the recipient company, if the recipient company controls at least 20% of the Swiss company and if the shares of either company are neither quoted at a stock exchange nor traded over the counter. http://www.lowtax.net/lowtax/html/jsw2tax.html#table. ff: On Dec 7, 2001 a protocol was signed to reduce withholding tax rate from 5% to 0% on dividends for substantial share holdings of at least 20%. Once this protocol is ratified the reduction of withholding tax rate on dividend shall apply retrospectively to all dividends due on and after January 1, 2002 whereas the remainder of treaty will take effect from January 1, 2003. http://www.multigroupservices.com/en/virtlib/dir_links_pdf/doub_tax.pdf. gg: Rate of 5% is not applicable for dividends of Regulated Investment Companies. The 5% applies with a minimum shareholding of 10%. http://www.multigroupservices.com/en/virtlib/dir_links_pdf/doub_tax.pdf. http://www.swissnetwork.com/?page=ViewArticle&id=54&category=Taxation%2FInternational+Taxation. hh: Switzerland provides for a withholding tax at a rate of 35% on dividends. ii: Accumulated income is not subject to tax on an unrealized basis. Pension funds may be exempt from income tax if certain conditions are satisfied. http://www.multigroupservices.com/en/virtlib/dir_links_pdf/doub_tax.pdf. jj: Hedge funds are tax exempt. ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. kk: Can either be tax tranparent or opaque depending on form. If opaque, taxed as a corporate and if transparent, no tax at fund level. : ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. ll: Dividend are taxed at long-term capital gain rates until 2011 under the Jobs and Growth Tax Relief Reconciliation Act of 2003. This rate increases from 5% to 15% after the ordinary income rate increases to 25%. http://www.smbiz.com/sbrl001.html. mm: Under US tax treaties, the withholding tax is reduced to 15%. Holders of 10-50% voting rights in a corporation reduce the withholding tax rate to 5%, depending on the country. http://www.irs.gov/publications/p515/15019904.html. nn: ‘Taxation of Business Operations in France, Germany and the United Kingdom’, Latham and Watkin, 2004. www.lw.com. oo: ‘Investment in Belgium’, KPMG. www.kpmg.fi/Binary.aspx?Section=3268&Item=3551. pp: ‘Aanvullende Pensioenen: Belangrijke fiscale nieuwigheden’, Loyens & Loeff, January 2007. www.loyens.com/download.php?pub=Aanvullende%20pensioenen_belangrijke%20fiscale%20nieuwigheden.PDF&type=nb. qq: Dutch funds are either tax transparent or subject to a special tax regime. ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. rr: ‘Discriminatory Treatment of EU Pension Funds. Making Cross-Border Portfolio Investments in Bonds and Shares within the European Union’. PriceWaterhouseCoopers, 2006. http://www.efrp.org/downloads/efrp_publications/Executive%20summary%20-%20EFRP%20-PwC%20complaints%20-%202006-03-30.pdf. ss: Can be either tax transparent or opaque depending on form. If opaque, taxed as a corporate and if transparent, no tax at fund level. The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. tt: Depending on the type of fund, the income is taxed at graduated rates, with the highest rate being 35%. However, certain types of qualified dividends are taxable to the individual investors at the rate of 15%, depending on their income-tax bracket. The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. uu: Double Taxation treaties reduces the maximum withholding to 15%. Depending on the type of fund, the income is taxed at graduated rates, with the highest rate being 35%. However, certain types of qualified dividends are taxable to the individual investors at the rate of 15%, depending on their income-tax bracket. ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. vv: Corporations, banks and insurance companies are taxed on the receipt of dividends and taxed annually on the adjusted liuqidation value of the shares. ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. ww: ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. xx: ‘The Regulation, taxation and distribution of hedge funds in Europe’, PriceWaterhouseCoopers, June 2006. yy: The Belgian SICAV Investment fund sets dividend distributions to 15% withholding tax. ‘Benelux Fund Briefing’, Loyens & Loeff,

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January 2007. zz: The Luxembourg SICAV Investment Fund is not subject to withholding tax. ‘Benelux Fund Briefing’, Loyens & Loeff, January 2007. aaa: http://www.fairmark.com/mutual/ordinary.htm, http://www.ici.org/funds/inv/bro_g2_ce.html#P102_12461, http://www.investorwords.com/5161/Unit_Investment_Trust.html, http://www.ici.org/funds/inv/bro_g2_uits.html#P74_11700 bbb: A withholding tax applies in case of distribution to foreign investors, however, if at least 80% of the income is generated from foreign sources the withholding tax does not apply. Pallesi, N., (2007); ‘The Application of Tax Treaties to Investment Funds’, University of California, Berkeley. ccc: The Belgian withholding tax depends on the type of investment fund vehicle. The Belgian non-tax transparent SICAV dividend distributions are subject to 15% withholding tax. Contrary, the Belgian tax-transparent Fonds Commun de Placement (FCP) is not subject to withholding tax. ‘Benelux Fund Briefing’, Loyens & Loeff, January 2007. ddd: A German transparent investment fund is subject to a refund of the withholding. The higher rate applies to intransparent investment funds. ‘New German Legislation on Investment Funds’, Ernst & Young, 2003. www.ey.com eee: Generally speaking, France is not an attractive location for individuals or companies seeking to limit taxation. Without taking Local Investment Funds into account, French Investment Funds are subject to withholding tax. http://www.lowtax.net/lowtax/html/offon/france/fraspec.html fff: http://www.ustreas.gov/press/releases/reports/hp16801.pdf ggg: http://apostille.us/news/the_2003_united_states__united_kingdom_income_tax_treaty_kicking_in.shtml hhh: http://www.pwc.com/sg/tax/instax2005/switzerland.pdf iii: http://www.deloittetaxguides.com/report_dl.asp?mode=pdf&issue_id=588322858 jjj: http://www.deloittetaxguides.com/report_dl.asp?mode=pdf&issue_id=588322858

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4.2 The Strategy

A strategy can only be advantageous when a structure is innovative and legal. This section

explains a legal strategy by a case study. The first part contains a case study whereas the

second part explains the statutory regulations of dividend stripping activities.

4.2.1 A Case Study

Suppose a Belgian mutual fund, call it Taxwise International Fund, has 100,000 shares of

TransDutch GasPipelines, due to pay €1.00/share to shareholders of record on 30 June 2007.

Absent arbitrage, Taxwise will get (0.85) (€1.00) (100,000) = €85,000 in cash and the

remaining €15,000 as a credit. Here is a structure, represented in Figure 6, by which Taxwise

converts the credit into cash:

A Belgian arbitrageur shorts 100,000 shares cum-dividend to a Dutch arbitrageur,

and repurchases them ex-dividend, borrowing the shares from Taxwise. The

Belgian arbitrageur earns market interest on the short-sale proceeds.

The arbitrageurs enter a swap whereby the Dutch pays his price return plus €85,000,

and gets market interest on the proceeds minus a discount D.

(Note: The Dutch arbitrageur receives 100% of dividend!)

The Belgian arbitrageur pays €85,000 to Taxwise as reimbursement for the

dividend, and also pays a lending fee F.

All put together, Taxwise exchanges the €15,000 credit for F in cash, the Belgian arbitrageur

makes D-F, and the Dutch arbitrageur makes €15,000-D.

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Figure 6. Structure of withholding-tax arbitrage between Belgium and the Netherlands

Dutch Firm

OvernightBorrower

Dutch Arbitrageur

Belgian Arbitrageur

Belgian Mutual Fund

Full dividend

Sale price of shares

Sale price

Sale price + i

Repurchase price of shares

Lend shares

i - Discount

85% of Dividend + (repurchase price – sale price)

Recover shares

85% of Dividend + lending Fee

Return swap

Dividend record date

Record date + 1

Dividend date

Source: Oyens & Van Eeghen Wholesale Brokerage (2006)

4.2.2 Dividend Stripping as a Tax Avoidance

In the search for an optimal investment route it might be possible that investors engage in

dividend stripping activities. Statutory regulations allow the tax avoidance activities as long as

certain conditions are being met. Dividend stripping as a tax avoidance scheme distributes

company profits to its owners as a capital sum, instead of as a dividend. The purpose

generally being that capital gains are (or may be) subject to less tax. Basically, the dividend is

being ‘stripped’ from the share.

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4.2.2.1 Forms of Dividend Stripping

As a basic example, consider a company called ShareCo wishing to distribute €X, with the

help of a stripper called StripperCo,

• StripperCo buys ShareCo shares from their present owners for €X+Y.

• ShareCo pays a dividend of €X to StripperCo.

• StripperCo sells its ShareCo shares back to the owners for €Y.

The net effect for the owners is a €X capital gain. The net effect for StripperCo is nothing, the

dividend it receives is income and its loss on the share trading is a deduction. StripperCo

might need to be in the business of share trading to get such a deduction. In addition, both the

ProfCo company and the StripperCo company might gain capital by splitting up the non-taxed

dividend revenues.

During the share-swap, both ShareCo and StripperCo face the risk of an upward or downward

share-price. In particular, the ShareCo faces the risk of an upward share-price and StripperCo

faces the risk of a downward share-price. To reduce this risk, the buyer can sell a call-option

to the seller or the seller can sell a put-option to the buyer.

Another way of dividend stripping can be inserted by lending shares to a low(er) taxed foreign

jurisdiction. The foreign shareholder lends its shares temporarily to a Dutch located bank and

in turn, the bank owes the foreign shareholder a reimbursement which amounts to the term of

the lending of the dividend claims. This reimbursement is not a dividend and therefore not

subjective to dividend withholding. The bank receives the dividend and clears the dividend

withholding of the listed company.

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Selling the dividend coupons to a Dutch located bank is also a way of dividend stripping. The

bank pays -for example- 97% of the gross amount of dividend coupons. The bank receives

100% minus 15% dividend taxation. The dividend taxation can however be cleared the same

year with the bank’s corporation tax. Ultimately, the bank receives 100% of the dividend.

Instead of a 15% dividend withholding, the payment will only be 3% to the Dutch bank.

The same result can be achieved by selling shares in a dividend distributing subsidiary

company or by bringing in shares into another subsidiary company which is -contrary to the

seller- treaty authorized.

To get the optimal investment route, both the investors need to be at least better off when

dividend stripping transactions take place. Investors make the biggest amount of profit when

the difference of the dividend withholding rate in between countries reaches the highest rate.

That means, for example, that party 1 from country A is not subject to dividend withholding

tax and party 2 from country B is fully subject to dividend withholding tax. Ultimately, the

generated profits should lead to a trade-off between the two investors. Their profits depend on

the transaction costs they make and the level of risk they take. Both parties have to agree on

the ratio of profit distribution.

4.2.2.2 Statutory Regulations against Dividend Stripping

Governments try to prevent dividend stripping activities by inserting statutory regulations.

They fear that taxable dividends will otherwise flow to other low taxable and attractive

jurisdictions. On the contrary, more statutory regulations result in the creation of a country

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which will be less attractive to foreign investors. Basically, the governmental trade-off

consists of the regulatory costs against dividend stripping and the dividend tax revenues as a

result of the regulations.

On 26 July 2002 a law came into effect which contained anti-dividend stripping measures and

conditions (Ministerie van Financiën, 2002). One of the conditions concerns the difference

between the entity subjective to dividend withholding and the entity which is ultimately

entitled to the dividend revenues. In case this difference exists, no advanced levy on dividend

taxation will be taken into consideration.

The expression ‘ultimate entitled entity’ is only described in a negative manner. In official

terms, an ultimate entitled entity is eventually not entitled when it is plausible that the

beneficial entity has been involved in a construction of transactions and compensated for

doing business whereby

• The revenues are partly or wholly directly or indirectly beneficial to natural or legal

people who are less authorized to benefit the reduction, clearing or refund of

dividend taxation than the compensating counterparty; and

• The natural or legal person has a position in shares which equals the moment

before and after the construction of the transactions took place.

Likewise, a construction of transactions that has been initiated on a regulated stock exchange

or market which indicates to a short term occurrence of transactions will be assigned

negatively as well. (Marres, Wattel; 2006)

The burden of proof rests with the tax inspector. The provision specifically targets dividend

stripping schemes following predetermined steps. For purposes of practical flexibility, it does

not give an exhaustive definition of dividend stripping scheme (Van Weeghel, De Boer; 2006,

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p.363). On the basis of Dutch tax law and case law there would seem to be ample room for

dividend-stripping transactions.

In order to demonstrate the viability of this route, we employ a case study which demonstrates

the techniques needed to secure the outcome.

4.2.2.3 Solution to Avoid Anti-Dividend Stripping Measures

There is a major restriction that a trade has to avoid when engaging a dividend stripping

activity. The dividend stripping activity should avoid to be identified as a series of interrelated

transactions that lead to a complete circular set. To be specific, the sale of shares before ex-

dividend date and the buy-back of those shares after ex-dividend date. There is a practicable

construction to avoid this.

The solution is to deposit the Dutch shares in a company established in the Netherlands and

issue synthetic shares that can be held abroad. The dividend is received in the Netherlands and

the dividend tax that is withheld can be settled with the Dutch company income tax.

In order to calculate at which point it is feasible to establish such a company, the following

example. The average AEX-Index price of a share is € 30.96 and the average annual

distribution of AEX-Index dividends is € 0.91 makes an average AEX-Index dividend yield of

2.94%.28 The tax burden is 15% which equals € 0.137 per share of € 30.96. This means

€ 0.137 / € 30.96 = 0.0044 = 44 bps. Per € 1 million underlying value, which represents

32,300 shares of € 30.96, the effective tax burden will be € 4,400.

28 www.bloomberg.com. Date: 30 April 2007.

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When the founding and initial operating costs for a Dutch company established in the

Netherlands are €100,000, then the break-even point expressed in underlying value is

€100,000 / 44 bps, being € 22,727,272 or 734K shares of € 30.96 each. Thus, investors with a

minimum investing amount of € 23 million should consider this investment strategy in order

to save money.

4.3 The Structure; Dividends and Derivatives

The basics to find an optimal investment route consists of two different jurisdictions with two

different dividend tax rates and two parties who are willing to participate in the transactions.

Derivatives have the advantage to hedge the capital transactions against market volatility and

are easy and relatively in-expensive to trade. This section illustrates a very specific and

practical way to avoid dividend withholding with the use of derivatives.

4.3.1 AEX-Index Future Swap

The derivative broker’s most preferable dividend stripping construction favors derivatives.

Figure 5 illustrates such a construction. Party 2 buys the shares from party 1. At the same time

party 2 sells futures29 to party 1. The value of the basket of AEX shares has to be equal to the

value of the AEX-Index futures. In consequence, party 2 ‘owns’ the shares temporarily

depending on the expiration date of the futures. After the dividend distribution by the

company and before expiration of the future, the reverse transaction takes place and both

parties will be better off by avoiding the dividend tax of party 1.

29 A futures contract is a standardized contract, traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. Basically, a future is compounded as follows: Future = spot + interest – dividend.

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Figure 5: AEX-Index Future Swap

Source: Oyens & Van Eeghen Wholesale Brokerage (2007) Instead of using a future in the transaction, the same result can be achieved by using a

synthetic option. By using a synthetic option position the value of the AEX-Index portfolio

equals the AEX-Index Futures position (FTI). The price of the underlying does not affect the

outcome.

AEX Shares (Basket)

AEX-Index Futures

(FTI)

Buy AEX Shares (basket)

Sell AEX-Index Futures

Party 1

Party 2

Receive Dividends from AEX shares

(basket)

Reduced Dividend Tax Rate

t = 0 : Cum Dividend t = 1 : Ex dividend

Sell AEX Shares

(Basket)

Buy AEX-Index

Futures

Note: REVERSE TRANSACTION !

AEX-Index Futures (FTI)

AEX Shares (Basket)

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E.g., suppose a trader has the following position where all options are European (no early

exercise permitted):

• Long a June 100 call

• Short a June 100 put

What will happen to this position at expiration? If the underlying contract is above 100, the

put will expire worthless, but the trader will exercise the 100 call. This results in his buying

the underlying contract at 100. Conversely, if the underlying contract is below 100, the call

will expire worthless, but the trader will be assigned on the 100 put. This also results in his

buying the underlying contract at 100. However, the AEX-shares basket should be weighted

equally to the AEX-Futures (FTI) market capitalization. Ultimately, party 2 enjoys the benefit

of a reduced or either non-taxed dividend, and in consequence both parties benefit from

engaging into this swap transaction.

4.3.2 Sale / Repo or Lending?

The goal is to ‘move shares’ from another country to investors in that country, and for this

movement disadvantaged investors have two principal options:

1. Sale / repurchase

2. Lending

Of these, lending is likely the most preferred route for several reasons. The main reason is that

selling shares cum-dividend and buying them back ex-dividend on the open market would

involve roundtrip transactions likely to dwarf the tax. For example, if a stock pays a 2% yield

in quarterly installments, then the tax on a payment is 15% of 50bp, or 7.5bp, miniscule for a

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roundtrip transaction. Besides, in case of a sale and repurchase of shares, the series of

interrelated transactions might be conflicting with national and international legislation. Also,

trading out and back in, misses a period of exposure to the stock. Finally, for the fund’s

taxable accounts, selling and buying back realizes capital gains or losses. A given dividend

date is unlikely to be the best moment to do this. By contrast, share lending is inexpensive,

does not affect exposure to the stock and is not a taxable event.

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5. Conclusions and Recommendations

The paper surveyed the implications of cross-border investments and searched for an optimal

investment route concerning dividend taxation. Several components were needed to get to the

optimal investment route. After the introduction of the topic in the first chapter, the second

chapter described the past and present aspects of the Dutch dividend taxation. Chapter 3 gave

an overview of the aspects in international dividend taxation, largely covered by the EU

legislation. Unilateral, bilateral and multilateral agreements played an important role in this

chapter. The last chapter presented the components of an optimal regime. First these were the

collection of the cross-border dividend withholding rates. Secondly, the strategy to create an

optimal investment route by using the derivative market, taking anti-dividend stripping

measures into account. And third, a legal structure of cross-border dividend transactions,

which is capable of generating substantial profits for the investors, without breaking the law

or running large exposure.

In the international context, foreign investors face a disadvantage in relation to home

investors. In particular, foreign investors have to pay (a reduced) dividend tax when home

investors are ruled out of any tax on dividend distributions. Despite EU attempts to fully

equalize the cross-border dividend taxation with national dividend taxation, in many cases this

process still contradicts with EU regulations. Nonetheless, the EU-challenge to create a

uniform taxation system is supported by recent judgments of the ECJ concerning cross-border

dividend taxation. Developments in the ‘Denkavit’- and the ‘Amurta’-cases confirm the trend

towards European fiscal unity.

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Is the end of the discrimination in the dividends in sight? This may be the case, especially

given that tax-payers are becoming more and more aware of the potential impact of the EU

law in the field of taxation, and the possibility of bringing it to bear on the domestic scene.

The ECJ has already upheld the position that a higher tax levied on inbound dividends than on

outbound dividends infringes the free movement of capital. It could well confirm that this is

also the case if discrimination arises from a foreign withholding tax levied abroad, under the

implementation of an income tax treaty by the country of residence of the shareholder. In

November 2005, former Dutch Assistance Minister of Finance Wijn already stated that there

will be no long future for the continued existence of Dutch dividend tax. However, the

importance of these tax revenues are a significant source of governance income, but in the

long run it will be very likely that the dividend tax will gradually disappear.

Nonetheless, (foreign) investors still have the opportunity to bypass dividend withholding tax

as long as there is no uniformity in the international dividend taxation rules. The bypass can

be achieved by either making use of a countries’ low tax opportunities by setting up more

expensive local branches in low tax jurisdictions or by creating a cheaper structure where

derivative transactions play a dominant role. Especially the latter offers arbitrage

opportunities for the company.

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