Dividend taxation : the implications for Cross-Border Investments and a search for the Optimal Investment Route

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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)

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CONFIDENTIAL

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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

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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%.

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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

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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

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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:

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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

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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}

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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

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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 N u m b er o f t reat ies 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.}

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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

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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.

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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

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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)

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

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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 (half-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.

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

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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

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:

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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)

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

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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

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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}

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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.

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

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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 Treaty Country 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%.

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.

Dividend taxation : the implications for Cross-Border Investments and a search for the Optimal Investment Route

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

CONFIDENTIAL

Dividend Taxation: The Implications for Cross-Border

Investments and a Search for the

Optimal Investment Route

Abstract

Contents

-Summary

1.

Introduction

2.

The Dutch Dividend Taxation Legislation

3.

The International Dividend Taxation