DRD carried forward and neutral mergers: the European Court of Justice confirms the pro rata rule
Locations
Pro rata rule for neutral mergers
In the event of a tax neutral merger, the Dividend Received Deduction carried forward ("DRD") of the companies involved, which may be kept after the merger, is prorated based on the net tax assets of these companies (Article 206, §2, subparagraph 1, ITC 92,). As a consequence, the transfer/maintaining of the DRD of the absorbed/absorbing company is limited in proportion to the share that its net tax assets represent in the total net tax assets of the absorbed and absorbing companies (the "pro rata rule").
Confirmation by the ECJ
In a decision of 20 October 2022 (Allianz Benelux), the European Court of Justice ("ECJ") confirmed the compatibility of the pro rata rule with Directive 90/435, the old version of the Parent-Subsidiary Directive, before it was repealed by Directive 2011/96/EU.
Illegality of the pro rata rule applied to DRD?
In this case, a series of mergers had taken place between 1995 and 1999. On each occasion, the absorbing companies retained the full amount of DRD from the absorbed companies and deducted it for the years 2004 to 2007. However, the tax authorities objected, arguing that the DRD should be maintained only to the extent of the pro rata rule, even though at the time this rule was only applicable to carried-forward losses. The companies in question appealed to the courts, arguing that the application of the pro rata rule to DRD was contrary to Directive 90/435.
The ECJ says no
The ECJ, however, disagrees. Its position is based mainly on the following three considerations:
In the event of a tax neutral merger, the Dividend Received Deduction carried forward ("DRD") of the companies involved, which may be kept after the merger, is prorated based on the net tax assets of these companies (Article 206, §2, subparagraph 1, ITC 92,). As a consequence, the transfer/maintaining of the DRD of the absorbed/absorbing company is limited in proportion to the share that its net tax assets represent in the total net tax assets of the absorbed and absorbing companies (the "pro rata rule").
Confirmation by the ECJ
In a decision of 20 October 2022 (Allianz Benelux), the European Court of Justice ("ECJ") confirmed the compatibility of the pro rata rule with Directive 90/435, the old version of the Parent-Subsidiary Directive, before it was repealed by Directive 2011/96/EU.
Illegality of the pro rata rule applied to DRD?
In this case, a series of mergers had taken place between 1995 and 1999. On each occasion, the absorbing companies retained the full amount of DRD from the absorbed companies and deducted it for the years 2004 to 2007. However, the tax authorities objected, arguing that the DRD should be maintained only to the extent of the pro rata rule, even though at the time this rule was only applicable to carried-forward losses. The companies in question appealed to the courts, arguing that the application of the pro rata rule to DRD was contrary to Directive 90/435.
The ECJ says no
The ECJ, however, disagrees. Its position is based mainly on the following three considerations:
- Member States, while having to choose between the exemption or imputation system provided for by the Parent-Subsidiary Directive to avoid the economic double taxation of dividends, remain free to determine the modalities for implementing either system;
- the EU law does not provide the right to an unconditional carryover of DRD from the absorbed company to the absorbing company; and
- the application of the pro rata rule to DRD (combined with its application to tax losses carried forward) would not give rise to heavier taxation than that in which the dividends would have been directly excluded from the tax base of the company benefiting from the DRD regime ("litmus test" developed by the ECJ in its decision Brussels Securities).
In particular, the ECJ recalls that Directive 90/435 only requires that the DRD be treated at least as favorably as losses carried forward. As long as the pro rata rule applies equally to both types of carried-forward latencies (DRD and losses), Directive 90/435 is not violated.
The ECJ therefore concludes that the application of the pro rata rule to the transfer of DRD from the absorbed company to the absorbing company is not contrary to Directive 90/435 (insofar as tax losses carried forward receive the same treatment).
In case of questions, please do not hesitate to reach out to your regular contact within the Fieldfisher Belgium tax team.
The ECJ therefore concludes that the application of the pro rata rule to the transfer of DRD from the absorbed company to the absorbing company is not contrary to Directive 90/435 (insofar as tax losses carried forward receive the same treatment).
In case of questions, please do not hesitate to reach out to your regular contact within the Fieldfisher Belgium tax team.