According to the Court of Justice of the European Union, the Biscayan rules on non-resident income tax grant different treatment to withholdings borne by national shareholders as compared with those borne by non-resident shareholders, which is contrary to the Treaty on the Functioning of the European Union.
The distribution of a dividend by a company resident in Spain may be subject to withholding or payment on account. Depending on the status of the shareholder, the withholding obligations and their treatment by the recipient will be as follows:
- When the shareholder is an individual resident in Spain, the dividend will be subject to a withholding tax of 19%. The shareholder will credit and deduct this withholding in his personal income tax return, giving rise to an eventual tax refund in the event that the withholdings for the year exceed the amount of the net tax payable.
- When the shareholder is a legal entity resident in Spain, the general rule is that there will be a withholding obligation, unless an exemption applies (for example, when the company and the shareholder form part of the same tax consolidation group or when the shareholder is entitled to consider the dividends received as exempt from corporate income tax). When dividends are subject to withholding tax, the shareholder will deduct the withholding tax in his corporate income tax return, giving rise to a possible refund when the withholding tax paid exceeds the amount of the net tax payable for the year.
- Finally, when the shareholder is a non-resident and, once again, unless an exemption provided for in the Non-Resident Income Tax Act (IRNR) or the Double Taxation Treaty (DTT) is applicable, the dividend will also be subject to withholding. However, unlike in the previous cases, such withholding becomes a definitive tax, subject to refund only to the extent (and for the amount) in which the IRNR withholding tax rate exceeds the rate corresponding to the DTT that, if applicable, is applied. In any other case, the Spanish tax authorities do not return such withholdings to the shareholder, but, where appropriate, the shareholder must try to obtain a refund in his country of residence by means of the international double taxation deduction mechanism.
The High Court of Justice of the Basque Country (TSJPV) heard a case in which the shareholder of a company resident in Bizkaia, who obtained a dividend subject to withholding tax on account of IRNR, claimed a full refund of such withholdings from the Bizkaia Provincial Treasury. The taxpayer claimed that, since he obtained tax losses in the year in which he received the dividends, he could not make the double taxation deduction effective in his country of residence, the United Kingdom, and could not obtain an immediate refund of the withholdings. It argued that, had it been resident in Bizkaia, it would have obtained a full and immediate refund of the withholdings despite being in a situation of tax loss, like any other company subject to corporate income tax in Bizkaia that bears withholdings subject to Spanish corporate income tax withholding.
The TSJPV referred a question to the Court of Justice of the European Union (CJEU) for a preliminary ruling to clarify whether it is contrary to the Treaty on the Functioning of the European Union (TFEU) for a regulation, the Biscayan regulation in this case, not to refund to non-residents the withholding tax levied on the payment of a dividend, while to residents the withholding tax is refunded in full, even if they make tax losses in the financial year.
On 19 December 2024, the CJEU ruled in case C-601/23 declaring that, in effect, if by applying the DTT in question, the non-resident shareholder does not obtain a full and immediate refund of the withholding tax paid in Bizkaia (as is usually the case), since the DTT only allows the deduction of the foreign tax against the tax paid in the residence), the Biscayan legislation gives rise to a restriction on the free movement of capital prohibited by Article 63 TFEU, which is not justified by any of the exceptional grounds provided for in Article 65 TFEU.
In its judgment, the CJEU continues the case law established in case C-575/17 Sofina, in which it held that the fact that the state that levies the withholding tax has a limited capacity to tax profits compared to the state of residence does not place resident and non-resident shareholders in an objectively different situation, since, like the country of residence, the state of source may tax those dividends when the company makes profits and not do so when it records losses.
Having considered the taxation in the state of residence when assessing the comparability of the situation of residents and non-residents, the CJEU rejects the possible justifications for the restriction on the free movement of capital to which this difference in treatment leads. Thus, it states that the need to ensure effective collection of the tax is not compromised, given that the non-resident shareholder must provide evidence of his tax situation, and this must be verified by means of the existing mutual assistance mechanisms. Nor is it possible to invoke an adequate allocation of taxing powers when resident shareholders have been relinquished, nor is there double exploitation of losses (in residence and at source), since the dividend will end up being taxed in both states when the losses are exhausted.
Consequently, the CJEU declares that legislation applicable in a Member State under which dividends distributed by a company domiciled in that Member State are subject to a withholding tax which, when received by a resident company subject to corporate income tax in that territory, is equivalent to a payment on account of that tax and is refunded in full if that company closes the corresponding tax year with a loss, is contrary to the TFEU. However, when these dividends are received by a non-resident company in the same situation, no refund is envisaged.
Although this ruling refers to Biscayan legislation, the conclusions would be applicable in the same terms to taxpayers subject to the IRNR Law throughout Spain, as well as to other entities that are subject to withholdings for dividends distributed by entities resident in EU Member States that have similar withholding obligations, and even when other types of income are paid.
On the other hand, the case analyzed by the CJEU referred to the impossibility of obtaining a full and immediate refund of withholdings due to the non-resident shareholder obtaining losses, but it could be extrapolated to any other situation that prevents or delays the refund of withholdings (application of other deductions that reduce or eliminate the net tax payable, limitations on the amount of the applicable double taxation deduction, etc.).
It is therefore advisable to analyze the cases that are occurring in practice, in which non-resident shareholders or entities may not be obtaining an effective refund of the IRNR withholdings made by their EU resident investees, for which it will be necessary to gather the appropriate evidence.
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