European Union Tax implications for Non-Resident Investors

If you are an investor who resides outside the European Union (EU), you may be wondering how your investments in EU countries are taxed. In this blog post, we will provide an overview of the main tax implications for non-resident investors in the EU, focusing on withholding tax procedures, cross-border mergers and acquisitions, and the consequences of Brexit.

Withholding tax procedures

Withholding tax is a tax that is deducted at source from payments of dividends, interest, royalties, or fees to non-resident investors. The withholding tax rates vary depending on the country of source and the type of income. However, some EU countries have implemented specific provisions to reduce or eliminate withholding tax for non-resident investors who are residents of other EU member states, based on the principle of free movement of capital within the EU.

For example, according to a recent decision by the European Court of Justice (ECJ), France’s withholding tax on dividend payments to non-French resident investment vehicles is not compatible with EU regulations. Therefore, non-resident investors who have suffered such withholding tax may be entitled to claim a refund from the French tax authorities.

However, withholding tax refund procedures for cross-border payments have proved to be lengthy, resource-intensive and costly for both investors and tax administrations, as tax administrations have difficulties in assessing the entitlement to reduced withholding tax rates. On top of that, these procedures have sometimes been abused, as reported by journalists in the “Cum/Ex” and “Cum/Cum” scandals in some EU member states.

To address these issues, the European Commission has published a public consultation on an initiative to improve withholding tax procedures for non-resident investors. The initiative aims to provide member states with the information needed to prevent tax abuse in the field of withholding taxes and, at the same time, accommodate the swifter and more efficient withholding tax refund or relief procedures for investors, tax administrations and financial intermediaries alike. The public consultation is open until 26 June 2022.

Cross-border mergers and acquisitions

Another area of interest for non-resident investors in the EU is cross-border mergers and acquisitions (M&A). Cross-border M&A transactions involve various tax implications depending on the structure and nature of the deal. Some of the key tax aspects to consider are:

  • The taxation of capital gains arising from the sale or exchange of shares or assets
  • The availability of tax benefits such as rollover relief, participation exemption, or consolidation regime
  • The impact of anti-avoidance rules such as controlled foreign company (CFC) rules, exit taxation, or general anti-abuse rule (GAAR)
  • The applicability of double taxation treaties and EU directives such as the merger directive or the parent-subsidiary directive

Each EU country has its own set of rules and regulations governing cross-border M&A transactions. Therefore, it is advisable to seek professional advice before engaging in such transactions. For example, India has recently introduced some changes in its taxation of cross-border M&A that may affect non-resident investors. Some of these changes are:

  • Goodwill of a business or profession will not be considered as a depreciable asset and tax depreciation will not be allowed even with respect to purchased goodwill
  • Slump exchange transactions (transfer of undertaking for a lump sum consideration for non-monetary consideration) will be considered taxable as slump sale transactions
  • Equalization levy will be applicable on online sale of goods or online provision of services or facilitation of the same by foreign e-commerce operators

Brexit consequences

Finally, non-resident investors in the EU should also be aware of the consequences of Brexit on their investments. Brexit refers to the withdrawal of the United Kingdom (UK) from the EU, which took effect on 31 January 2020. However, a transition period was agreed until 31 December 2020, during which most EU rules continued to apply to the UK.

After the end of the transition period, some specific provisions applicable to residents of other EU member states under income tax for non-residents (IRNR) will no longer be applicable to taxpayers resident in the UK. For example:

  • UK residents will not be able to apply for a reduced withholding tax rate on dividends paid by Spanish companies under the parent-subsidiary directive
  • UK residents will not be able to opt for taxation under IRNR instead of personal income tax (IRPF) on income derived from real estate located in Spain
  • UK residents will not be able to benefit from a reduced withholding tax rate on interest paid by Spanish entities under the interest and royalties directive

However, some provisions under IRNR will still apply to UK residents based on their status as residents of a country with which Spain has signed a double taxation treaty. Moreover, some provisions under other taxes such as value added tax (VAT) or inheritance and gift tax (ISD) will also continue to apply to UK residents based on their status as residents of a third country.

Here are some key points to consider:

Withholding Taxes:

Non-resident investors may be subject to withholding taxes on certain types of income, such as dividends, interest, and royalties. The rates and exemptions vary between countries and may also depend on tax treaties between the investor’s home country and the EU member state.

Tax Treaties:

Many EU member states have entered into bilateral tax treaties with other countries to avoid double taxation and provide relief for non-resident investors. These treaties typically determine the taxing rights between the countries involved and provide provisions for reducing or eliminating withholding taxes on certain types of income.

Capital Gains Tax:

Non-resident investors may be subject to capital gains tax in the EU country where the capital gains are realized. The tax rates and rules for determining the taxable amount may vary. Some countries may have exemptions or reduced tax rates for certain types of investments or specific holding periods.

Investment Vehicles:

The tax implications for non-resident investors can also depend on the investment vehicle used. For example, investing through a mutual fund or an investment fund may have specific tax treatment, including the application of withholding taxes at the fund level.

Permanent Establishment:

Non-resident investors who conduct business activities in the EU through a permanent establishment (e.g., a branch or office) may be subject to taxation on the income generated by that establishment. The rules for determining the existence of a permanent establishment and the allocation of profits can be complex and vary among countries.

Value Added Tax (VAT):

Non-resident investors may also have VAT obligations if they engage in taxable transactions within the EU. For example, if an investor provides services in an EU member state, they may need to register for VAT and comply with VAT reporting requirements. The specific rules for VAT vary among countries.

Compliance Requirements:

Non-resident investors are generally required to fulfill certain compliance obligations, such as filing tax returns and keeping appropriate records. These requirements may vary depending on the country and the nature of the investment.

Double Taxation Relief:

EU member states often provide mechanisms to relieve double taxation for non-resident investors. This can include unilateral tax credits, exemptions, or a tax deduction for taxes paid in another jurisdiction. Tax treaties between countries can also provide relief by allocating taxing rights and specifying mechanisms for eliminating or reducing double taxation.

Holding Structures:

Non-resident investors may choose to hold their investments in EU countries through specific holding structures, such as holding companies or investment vehicles. These structures can offer certain tax advantages, such as reduced withholding taxes on dividends or capital gains, tax deferral, or more favorable tax treatment of income. However, the use of such structures should be carefully evaluated in terms of their legal and tax implications, including substance requirements and anti-avoidance provisions.

Tax Residence Status:

The determination of an individual’s tax residence status can have significant implications for non-resident investors. Tax residence rules vary among EU member states and depend on factors such as physical presence, duration of stay, and personal or economic ties to a particular country. Tax residence status can affect the applicable tax rates, available deductions, and overall tax liability.

Wealth and Inheritance Taxes:

Some EU member states impose wealth taxes or inheritance taxes on non-resident investors who hold significant assets or inherit property within their jurisdiction. The rates and exemptions can vary, so it’s important to consider these factors when planning investments or estate matters.

Transfer Pricing:

Non-resident investors engaged in transactions with related parties within the EU may need to comply with transfer pricing regulations. Transfer pricing rules aim to ensure that transactions between related entities are conducted at arm’s length prices. Documentation requirements and penalties for non-compliance can vary among EU member states.

Exit Taxes:

Certain EU member states have exit tax provisions that may apply when a non-resident investor transfers assets or relocates outside the country. Exit taxes can trigger immediate tax liabilities based on the deemed disposal of assets at market value. The availability of deferral or installment payment options can vary, and tax treaties may provide relief or mitigate the impact of exit taxes.

Compliance and Reporting:

Non-resident investors are generally required to comply with tax reporting obligations in the EU member state where they have investments. This can include filing tax returns, providing relevant information about investments, and maintaining appropriate records. Compliance requirements may differ among countries and depend on the nature and scale of the investments.

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