TAX LAAW
Virginia Mondragón
This is the conclusion reached by the European Court of Justice (ECJ) in a December 2024 ruling involving the tax regulations of the Historical Territory of Bizkaia regarding dividend distributions by a company domiciled in Bizkaia to a shareholder based in the United Kingdom.
Dividends, which are profits distributed by an entity to its shareholders, are subject to personal taxation on recipients through the Personal Income Tax (IRPF), Corporate Income Tax (IS), or Non-Resident Income Tax (IRNR) when the beneficiaries of these dividends are non-residents of the Territory of Bizkaia.
It is important to note that dividends are subject to withholding tax as an advance payment toward the applicable tax (IRPF, IS, or IRNR) at the legally established rate. This withholding is applied by the paying entity when the dividends become due, as stated in the distribution agreement, or earlier if payment to the shareholder is made before the due date.
This system means that the dividend recipient prepays part of their tax liability when receiving this income. However, tax regulations to avoid double taxation allow taxpayers to deduct these advance payments from the tax amount due when filing their IRPF or IS returns (depending on whether the shareholder is an individual or a legal entity).
Therefore, focusing on companies specifically, they recover part of the prepayment when filing their IS returns or even the entire amount of withheld taxes if the company declares a loss, meaning the effective tax payable is zero.
When the dividend recipient is a non-resident entity without a permanent establishment, withholding tax is applied under the IRNR rules and within the limits established by the Double Taxation Agreement (DTA) between the countries of the paying and receiving entities, if such an agreement exists.
This implies that non-resident entities are also subject to taxation in the country where the income (dividends) originates, in addition to their country of residence. However, the withholding tax paid in the source country (Bizkaia) can often be deducted from the corporate tax or an equivalent tax in the entity’s country of fiscal residence.
Unequal Treatment for Non-Resident Entities
Unlike resident entities in Bizkaia, non-resident entities that declare losses at the end of the fiscal year cannot deduct the withholding tax paid in Bizkaia from their tax obligations in their country of residence. This results in double taxation on the same income (dividends) and places non-resident entities at a disadvantage compared to resident entities. Resident entities can receive a refund of withheld taxes, enjoying not only a different f iscal treatment but also a cash flow advantage, while nonresident entities face immediate and often final taxation.
ECJ Ruling
The ECJ ruled that this unequal treatment of dividends based on the recipient’s residency status could deter non-resident entities from investing in Bizkaia, violating the principle of free movement of capital. While European law allows for differential treatment in certain cases—such as when situations are not objectively comparable or when justified by public interest—the court found that these exceptions did not apply in this case.
The ECJ acknowledged that member states have the right to enforce tax regulations to achieve revenue objectives. However, denying tax refunds to non-residents solely to maintain the revenue system is not permissible if it infringes on the free movement of capital. Non-residents must not be treated less favorably than residents in identical circumstances.
The court clarified that the refund system, while an exception to states’ taxation authority, must not be applied indiscriminately. Refunds should only apply to entities that declare losses in the f iscal year in which dividends are received. Additionally, nonresident entities must prove that they incurred losses during the f iscal year and that they cannot offset the withholdings paid in the source country (Bizkaia) against taxes owed in their country of residence.
Key Takeaways
The ruling establishes that non-resident entities receiving dividends from companies based in Bizkaia can request a refund of withholding taxes if they declare losses in their country of residence for the corresponding fiscal year.
Although the case involves the tax regulations of the Historical Territory of Bizkaia, the ECJ’s reasoning applies to similar regulations in Gipuzkoa, Álava, Navarra, and the Common Territory, as they have comparable tax frameworks.
This judgment promotes fair treatment for non-resident entities, fostering investment and ensuring compliance with the principle of free movement of capital within the European Union.
