Income from dividends and financial instruments – recent CJEU practice and current tax treatment

A recent judgement of the Court of Justice of the European Union (“CJEU” or “the Court”) on preferential tax treatment of dividends listed on the national stock market sparked the conversation about taxation of dividends and financial instruments within the European Union (“EU”). While there is no unified approach to taxation of dividends or other financial instruments stemming from stocks, listed on the national stock markets and received by either by individuals or by legal persons, all Member States must comply with the Treaty on the Functioning of the European Union (“TFEU”). This entails that all Member States must ensure that their tax rules are not contrary to the free movement of capital, established as a fundamental freedom in Art. 63 TFEU et seq.

With a Judgement of 9 September 2021 in case C-449/20, the Court addressed the free movement of capital within the EU in light of the taxation on dividends, listed on the national and foreign stock exchange. The request for preliminary ruling was made in proceedings between Real Vida Seguros SA – a company, established in Portugal, and the Autoridade Tributária e Aduaneira (“Tax and Customs Authority”, Portugal) concerning the partial deductibility of dividends attached to listed shares for the purposes of determining the basis of assessment for income tax.

The problem of the main proceedings stems from the national tax legislation of Portugal, according to which “ for the purposes of personal income tax or corporation tax, only 50% of the dividends received on shares admitted to trading … shall be taken into account ”. Furthermore, it is established in the Portugal’s Statute governing Tax Benefits that “ Tax benefits are exceptional measures adopted in order to protect non-fiscal public interests that outweigh the fiscal public interests which thus cannot be achieved.

While these tax laws were in force, during 1999 and 2000, Real Vida Seguros received dividends attached to shares listed on both the Portuguese and foreign stock exchanges. Applying the above-mentioned articles, it deducted 50% of those dividends from its total net income. However, following a tax inspection, the competent tax authority made corrections to the taxable amount, because they considered that the benefit in question was conceived in order to stimulate the national stock market and thus applicable only to dividends from that market. After the dispute reached the Supreme Administrative Court in Portugal, the court referred it for preliminary ruling by the CJEU.

The CJEU first considered what the measures prohibited by Art. 63(1) TFEU. Restrictions on movements of capital include those which are such as to deter non-residents from making investments in a Member State or deter residents of that Member State from making investments in other States. In particular, a difference in treatment, where it leads to a less favourable treatment of the income of a taxpayer of a Member State originating in another Member State in comparison with the treatment of income originating in the said Member State, is capable to dissuade such a taxpayer from investing his or her capital in another Member State.

The deductibility rules, as applied by the Portuguese tax authorities, give the recipient of dividends the right to deduct the dividends in part, but only if the shares generating those dividends are listed on the Portuguese stock market. The Portuguese Government denies the existence of a restriction on the free movement of capital, arguing that, during the period of applicability of the articles in question, access to the Portuguese stock market was open to any natural or legal person in any Member State or third country, since shares in both Portuguese and foreign companies could be listed on that stock exchange.

The CJEU agreed with the Portuguese government that no distinction was made between resident and non-resident companies in regards to the Portuguese stock exchange market. However, as established in the case-law of the Court, national legislation which applies without distinction to resident and non-resident companies may constitute a restriction on the free movement of capital, as even a differentiation based on objective criteria may de facto be disadvantage in the context of cross-border situations. The Court held that a practice whereby the favourable tax treatment of dividends is subject to the condition that the shares generating those dividends be listed on the national stock exchange leads to investments in resident companies being favoured and, consequently, investments in non-resident companies being put in as less favourable position.

Accordingly, the Court found that such tax practice for deductibility can deter persons eligible for the tax advantage provided for in the Portuguese law from making investments in non-resident companies, and therefore constitutes a restriction on the free movement of capital prohibited, in principle, by Art. 63 TFEU.

The Court also held that a distinction must be made between the differences in treatment provided for in under Art. 65(1)(a) TFEU and the discrimination prohibited by Art. 65(3) TFEU. Before national tax legislation can be regarded as compatible with the TFEU provisions on the free movement of capital, the difference in treatment resulting from that legislation must concern situations which are not objectively comparable or must be justified by an overriding reason in the public interest. Thus, the CJEU ruled in favour of the applicant – Real Vida Seguros, by determining that the national legislation in question were contrary to EU law.

In Bulgaria financial instruments, which are traded on the regulated market, are not subject to any corporate income tax in case they are sold (Art. 196 CITA). The definition for financial instrument includes dividends which are listed on national and foreign regulated markets. Therefore, CITA does not differentiate between dividends traded on national and foreign stock markets, unlike the Portuguese law in the above-mentioned case. It should be noted, however, that this decision of the Bulgarian legislator is dictated by the EU Directives and Regulations and is made in 2009, two years after Bulgaria was accepted as a Member State of the EU, whilst the Portuguese tax laws were in force in 1999-2000. Additionally, when determining the financial tax result, the accounting financial result is debited with any profit from disposition of financial instruments determined as a positive difference between the selling price and the documented cost of acquisition of the said financial instruments (Art. 44, para. 1 CITA). This does not apply to any profits from a source abroad, in respect of which the method for avoidance of double taxation is exemption with progression, provided for in the respective convention for the avoidance of double taxation.

Furthermore, since the beginning of 2021 the definition of financial instruments include shares, effected on the market of a third country, which is considered to be equivalent to a regulated market and in respect of which the European Commission has adopted a decision in accordance with Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (OJ L 173/349 of 12 June 2014). As of September 2021, 41 third-country markets from USA, Australia, Canada, Japan and Singapore are considered as equivalent to a regulated market in the Union. The link for the official list can be found here: https://www.esma.europa.eu/databases-library/registers-and-data and is constantly updated by the European Securities and Markets Authority.