Can any corporate group structure be questioned?

This question is particularly relevant for entrepreneurs who conduct business activities not only in Latvia but also abroad.

Recently, the Lithuanian tax administration denied a Lithuanian company within a corporate group the right to apply a withholding tax exemption on dividends paid to its parent company registered in Cyprus. Although the dividends were formally paid to a parent company registered in another European Union Member State, the Lithuanian tax administration considered the corporate group structure to be artificial, as its primary purpose was to channel dividends to the group’s ultimate beneficial owner – a natural person who controlled the respective corporate group.

The Lithuanian tax administration’s suspicion regarding the artificiality of the corporate group structure was raised by the fact that the dividends paid by the Lithuanian company matched the amounts that the Cypriot parent company subsequently transferred to the ultimate beneficial owner. Generally, this ultimate beneficial owner – a natural person – would be obliged to pay personal income tax on the dividends received. However, in this specific case, the respective amounts were paid not as dividends, but as the repayment of a loan previously received by the parent company, which is not subject to income tax.

In the view of the Lithuanian tax administration, the parent company’s liabilities to the ultimate beneficial owner were created artificially. Accordingly, the entire corporate group structure was also considered artificial. This, in turn, allows the tax administration to deny the application of the withholding tax exemption on dividends and tax them in the country of payment.

On the one hand, one can agree with the Lithuanian tax administration that the framework of the Parent-Subsidiary Directive is not intended to provide a withholding tax exemption in situations where the benefits of the Directive are being abused. In other words, the Directive does not protect structures whose primary purpose is to obtain unjustified tax advantages.

However, the approach chosen by the Lithuanian tax administration in this case seems problematic. Its assessment of corporate group structures is so broad that almost any holding structure could potentially become questionable. Such an approach creates a risk that the very existence of a holding structure or the further redirection of dividends within a group is perceived as sufficient grounds for establishing abuse. This, in turn, can lead to situations where tax administrations refuse to apply the benefits provided for in the Directive even if the specific structure is fully legitimate and economically justified.

The View of the Advocate General of the Court of Justice of the European Union

The Advocate General of the Court of Justice of the European Union also believes that the approach of the Lithuanian tax administration is too broad. In his view, anti-avoidance rules must be applied narrowly and cautiously. They are not intended to automatically question any holding or corporate group structure simply because dividends are further distributed within the group.

The Advocate General emphasizes that the mere fact that a parent company further distributes dividends after receiving them does not, in itself, imply abuse. On the contrary, the receipt and further distribution of dividends is a normal function of a holding company. Furthermore, the fact that the amounts received and subsequently paid out match, or that the payments are made within a short period of time, is not in itself sufficient grounds to conclude that there has been abusive conduct.

A taxpayer has the right to use the structuring options provided for in regulatory enactments and to organize their business activities in such a way that the tax burden is as low as possible.

The benefits provided for in the Directive can only be denied if the structure has been established primarily for the purpose of obtaining tax advantages, i.e., if an abusive common plan exists. Therefore, a link must exist between the structure used and the tax advantages obtained, and the tax administration is obliged to prove this link.

The tax administration may conclude that such an abusive common plan exists if the Parent-Subsidiary Directive is used to generate income for the benefit of the natural persons controlling the corporate group, which cannot be taxed in those persons’ country of residence. This is the case, for example, if a subsidiary pays dividends to its parent company in order to hide them through further transactions via non-cooperative jurisdictions. As a result, the country of residence of the final recipient does not receive information about the distribution of profits and cannot apply the relevant taxes.

It remains to be hoped that the Court of Justice of the European Union will concur with the opinion expressed by the Advocate General.

What does this mean for Latvian companies?

In corporate groups with a vertical structure, it is common for a Latvian company to receive dividends from its subsidiaries and then pay them further to its owners. For these so-called flow-through dividends, the Corporate Income Tax Law provides for a specific framework that, upon fulfillment of certain conditions, allows for the avoidance of double taxation.

Compared to Lithuania and other European Union Member States where a classical corporate income tax model is applied, the Latvian corporate income tax regime is not considered a withholding tax for the purposes of applying the Parent-Subsidiary Directive. Therefore, it might initially seem that the mentioned case does not affect Latvian companies.

However, this is not the case. A Latvian company can be part of an international corporate structure both as a holding company and as an intermediate company which, similar to the situation discussed, redirects dividends further to its parent company or the ultimate beneficial owner.

Therefore, any tax planning, including the establishment and structuring of companies in other jurisdictions, must be carried out with special care. Otherwise, a tax administration of some country may conclude that the respective structure is artificial and established primarily to obtain tax advantages.