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Belgium Reinforces its Arsenal Against Foreign Low-taxed Entities… and Risks Further Frustrating EU Freedom of Movement

Published on : 18/10/2024 18 October Oct 10 2024
Expertise / Tax law

Disregarding entities for tax purposes when they benefit from foreign low-taxed regimes is the latest trend in the Belgian set of rules to fight tax evasion.
A bill of 22 December 2023 illustrates this tendency perfectly. It introduces amendments to two existing measures which will sensibly change Belgium’s approach to look-through taxation:
  • The bill reinforces Belgium’s so-called controlled foreign company regime (CFC) which allows the Belgian tax authorities to disregard foreign entities controlled by Belgian companies by taxing their passive income directly to the Belgian controlling entity as if it were its own;
  • The bill also makes considerable changes to the Belgian so-called "Cayman Tax" which applies to Belgian natural persons who reside in Belgium and hold interest in a low-taxed foreign entity.
If the CFC regime is a well-known anti-abuse provision that Belgian law incorporated under EU pressure when it transposed the ATAD Directive, the Cayman Tax is a Belgian invention which aims to make ineffective the holding, by natural persons, of private assets through "offshore" entities which are little to not taxed (referred to as "floating estates").
This tax was introduced in the Belgian income tax Code by a law of 10 August 2015 and has since undergone several changes, the last of which came with the aforementioned bill which entered into force on 1 January 2024.
This bill was intended to amend the Cayman Tax in areas identified as lacking to reach its purpose. In practice, however, this translates into a system which reaches far beyond this purpose and could entail material breaches of EU Law. Belgian resident shareholders of entities which were never intended to avoid taxes are likely to be impacted.
The Cayman Tax in a Nutshell
Entities that qualify as legal structures
Entities that fall under the purview of the Cayman tax are referred to as "legal structures". The Cayman Tax knows three categories of legal structures:
 
  • Category 1: trusts;
  • Category 2: low- or non-taxed entities with legal personality; and
  • Category 3: an entity of category 1 or 2 combined with an insurance contract.
The present contribution will concentrate on category 2 structures (companies and associations).
Entities that are established in a non-EEA state qualify as a low or non-taxed entities of category 2 when they undergo taxation in their state of residence at a level lower than 15% of a taxable base determined under Belgian law. This rate is lowered to 1% when the entity is established in the EEA.
Belgium based companies and associations, by definition, exceed these minima and will therefore never qualify as legal structures. Entities based outside of Belgium may very well fall under its purview, if only because of country differences in the calculation of taxable bases.
A common example of these differences is the implementation of the participation exemption in the different EU member States, with certain States requiring companies to meet lower thresholds to benefit from the regime than those applicable in Belgium. The Soparfi can be a striking example of such a situation if, for a given year, its sole income is tax exempt dividends distributed by its daughter company in which it holds a participation which meets the Luxembourg minimum of EUR1.2 million but not the Belgian minimum of EUR 2.5 million
Other differences could lead to the same result, such as the difference in rules regarding disallowed expenses or abnormal or gratuitous benefits.
Accordingly, Belgian residents who hold shares in foreign companies should in theory assess every year whether these can be considered "reasonably taxed" under the Cayman Tax. In practice, this assessment is not always carried out, especially for companies which carry out an economic activity as these are excluded from the Cayman Tax’s effects.
Look-through taxation
Legal structures are treated as transparent for fiscal purposes: their income is taxed to their Belgian resident founder – in the meaning provided for in the law – as if it were their own (ie, no conversion of the income’s nature).

Excluded from the look-through regime are entities:
  • established in a state which exchanges information with Belgium;
  • that exercise an economic activity (except management of their founders’ assets); and
  • that have premises, staff and equipment at their disposal.
This exception is referred to as the substance-based exception.
Whether this look-through regime is always applicable or should rather give way to the relevant double tax treaty (DTT) remains a question mark. It can be argued that an entity which qualifies as a "person" and "resident" of one of the contracting states under the DTT can claim its application and therefore not be subject to transparent taxation (another reason why tax payers do not automatically carry out the yearly Cayman Tax assessment). Unfortunately, there is only one recorded instance of an agreement being reached by a tax payer and the tax authorities on the topic and the legislator chose not to address the question in his latest bill. 
Taxation of distributions as dividends
Any and all distributions made by legal structures are taxable as dividends. The legal structure, considered non-existent when it receives income, therefore regains a fiscal reality when it makes distributions.
To prevent double taxation of the same income (first upon receipt and then upon distribution), the Cayman Tax provides that income which has already been taxed transparently in Belgium is exempt from taxes when it is distributed. The oldest income is presumed to be distributed first to ensure that an entity’s accumulated reserves prior to becoming a legal structure are used up first (the "first in, first out" or "fifo" rule).
Distributions made by entities with sufficient substance do not fall under the aforementioned rule.
Other implications
Other consequences arise when an entity qualifies as a legal structure.
The existence of the legal structure has to be mentioned by the relevant tax payer in their tax return. Not doing so could lead to a EUR6,250 fine, applicable per tax year and per legal structure.
When the tax payer’s return mentions/should mention the existence of a legal structure, the statute of limitations to tax an incorrect or incomplete filing is automatically extended to ten years. 
The Cayman Tax: Unpredictable, Penalising and Contrary to EU Freedom of Movement
The Cayman Tax’s unpredictable application to foreign category 2 entities, especially holding companies which cannot claim the substance-based exclusion, is an ongoing issue. A reasonably-taxed foreign holding structure could, from one year to the next, qualify as a legal structure, or not, simply because of country differences in calculation of taxable bases. Applied to EU-based companies and associations, this unpredictable scope of application has raised serious questions of conformity with EU laws and the four principles of freedom of movement: persons, capital, goods and services.
One would have hoped the new bill of 22 December 2023 would have resolved the issue. However, in pursuit of strengthening the Cayman Tax, the Belgian legislator seems to have lost sight of the tax’s objective, extending the existing issue of predictability and – in some situations – penalising the use of legal structures with no legitimate reason. This can be illustrated by the following amendments.
The existing issue of predictability
If the European case law allows for restrictions to the freedom of movement, these must be based on a legitimate objective and be proportionate to that objective. One aspect of a provision’s proportionality is its legal certainty: is it clear, precise and predictable with regard to its effects, in particular where it may have unfavourable consequences for individuals and undertakings? When a rule of law is unpredictable, it is not proportionate to the legitimate objective it pursues as it risks targeting situations that are outside that objective.
The European Court of Justice confirmed the application of these principles to tax provisions seeking to prevent tax evasion/avoidance. The Court confirmed a tax provision is unpredictable and therefore never proportionate to its legitimate anti-tax avoidance objective when its scope of application is not circumscribed with sufficient precision at the outset and its application remains a matter of uncertainty.
The Cayman Tax’s uncertain application to EU based holding companies from year-to-year raises a real question of compliance with these principles and can have important implications in practice. Take for instance the situation of a holding company which from one year to the next qualifies as a legal structure. Its income and its distributions will qualify as taxable dividends. If it no longer qualifies as such when it distributes the income taxed transparently, the Belgian resident shareholder will never be able to mitigate double taxation: they cannot claim the exemption on the basis of the past transparent taxation as it only applies to legal structures. In such a situation, the Cayman Tax’s unpredictable application leads to double taxation of the same income.
A new imperfect look-through regime
One of the major changes to the Cayman Tax pertains to the aforementioned exemption of distributions when the distributed income has already been taxed transparently in Belgium. Starting 1 January 2024, the exemption of distributions will only apply to income which, when it was taxed transparently in Belgium, has effectively led to payment of taxes in Belgium.
Prior to this change, effective taxation was not required, as long as the income had undergone its normal tax regime in Belgium. This meant a 30% flat tax rate for interest and dividends and an income tax exemption for most capital gains on shares. The look-through regime was "perfect" in the sense that it acted as if the legal structure did not exist.
Moving forward, all distributions of dividends and interest will be exempt but distributions of tax exempt capital gains will qualify as a taxable dividend. The entire Cayman Tax’s logic is turned on its head: rather than treating income placed in low or non-taxed foreign entities as if they didn’t exist, they are now treated more harshly.
An illustration of the harsh nature of this rule can be found in its combination with the new presumption applicable to dedicated UCIs. From 1 January 2024 onwards, foreign UCIs are presumed to constitute legal structures when they are "not collective" or "dedicated". Other UCIs are excluded from the Cayman Tax’s scope of application provided they meet the requirements of the UCITS directive 2009/65/CE or their manager meets the requirements of the AIFM directive 2011/61/UE.
A UCI is dedicated when more than 50% of its shares are held by a single person or by several persons linked to each other. A person is considered linked:
  • to relatives to the fourth degree;
  • spouses;
  • legal cohabitants;
  • individuals domiciled at the same address; and
  • individuals or entities that exercise control over another entity (eg, majority of voting rights).
Except if proven otherwise, a UCI is presumed to be dedicated when its manager receives instructions from the UCI’s shareholders or when no independent asset manager has been appointed.
The legislator did not want the fiscal advantages generally granted to UCIs to be misused for purposes that are not linked to promoting and facilitating investment, say by families who might be tempted to make use of these types of structures and their fiscal advantages to retain their assets.
If the perfect look-through regime could reach that objective, the new imperfect regime goes far beyond. All capital gains on shares realised by foreign dedicated UCIs are from now on taxable – if not upon receipt, upon distribution. This includes capital gains realised and reserved before 1 January 2024 and distributed after.
But why should investing via a foreign dedicated UCI be more heavily taxed? The dedicated UCI does not facilitate avoidance of taxes on capital gains – there would have been none had the assets been held directly. Rather than counteract tax avoidance, the Cayman Tax now penalises, with no legitimate reason, the use of foreign structures such as foreign dedicated UCIs.
The use of dedicated UCIs is generally justified by a family’s wish to professionalise their investment taking into account their shareholder structure (only members of the same family) and investment type (not limited to listed transferable securities).
Belgium does not offer the legislative framework to reach these families’ objective: Belgian investment vehicles either don’t allow the shareholder structure to be exclusively composed of members of the same family (the Belgian private Pricaf) or, when they do, their investment category is exclusively limited to real estate (the Belgian FIIS). In the absence of a Belgian solution, families have looked elsewhere for a legislative framework which matches their needs. The Luxembourg RAIF is one such example.
There are many other reasons a Belgian resident tax payer may have opted for a foreign structure at a given time. For instance, expatriates might hold shares in foreign holding companies according to a set up that is perfectly common in their home country but could qualify as legal structures under the Cayman Tax.
These tax payers made a choice at a given time which suited their personal needs and situation. If a perfect look-through regime can be justified to some extent, there is no legitimate reason an additional tax burden should now be imposed on them. When the foreign dedicated UCI or holding company is a EU-based entity, this is a clear violation of EU freedom of movement.
The new notion of intermediary structure
Starting 1 January 2024, the notion of intermediary structure is introduced in the Cayman Tax. This is, according to the legislator, to prevent avoidance of the Cayman Tax through the addition of a reasonably taxed entity between the Belgian resident founder and the legal structure.
Accordingly, a company, regardless of where it is located and whether or not it is itself a legal structure, is considered an intermediary structure when there is a legal structure at any level further down the chain of ownership. The intermediary structure will itself not be subject to the Cayman Tax, however, its existence will not prevent the fiscal transparency and taxation of distributions of any and all entities further down the chain of ownership which qualify as legal structures.
Again, this is inconsistent with the Cayman Tax’s objective. When a company does not fall within the scope of the Cayman Tax, it is precisely because it is reasonably taxed and, therefore, the income it would receive from a daughter entity will be taxable to it, as the parent company, and, when it distributes the income to its own shareholders, the income will again be taxable to these shareholders. There is no taxation void which needs to be filled with the introduction of this new notion of intermediary structure. 
With EU-based companies, any risk of tax evasion or avoidance is further covered by the CFC regime and the mother-daughter regime exclusion that applies to non-genuine entities. Thankfully, to prevent dual application of transparency regimes, an exclusion is provided for when the entity is already taxable transparently to its parent company under the Belgian CFC regulations.
No reasonable explanation can however be found as to why this exception only applies when the intermediary structure is a company subject to Belgian income taxes. As the product of a EU directive, the CFC regime was transposed in every other member state and a CFC held through a parent company established in another member state must therefore also be covered by the exclusion. Any other conclusion violates the EU’s fundamental principles of freedom of movement.
With the new notion of intermediary structure, a new look-through layer of taxation is introduced: the daughter company’s income is taxable transparently to the Belgian resident founder as if it were their own, even if their share in said entity is held through another, reasonably taxed, entity. In addition to exceeding the Cayman Tax’s objective, this new notion is likely to be highly penalising for Belgian income tax residents.
Not only will they be exposed to a risk any entity in a group could randomly fall under the Cayman Tax (issue of legal certainty), when an entity does qualify as a legal structure, its income will be taxable to the Belgian shareholder and that shareholder will be faced with the practical issue of mitigating the double taxation he suffers from this new and unforeseen look-through taxation.
In theory, mitigation is achieved by allowing the transparently taxed income to flow up the chain of ownership to be distributed to shareholders tax free. In practice however, for shareholders, this entails having perfect knowledge and understanding of the chain of ownership as well as having access to all of the data which will allow them to know whether an underlying entity is a legal structure or not, what income it receives, and what it distributes to its parent company.
When asked about this issue, the Finance Minister confirmed publicly listed companies and (non-dedicated) UCIs would never constitute intermediary structures as it is impossible for their shareholders to obtain the necessary information. Confirmation cannot be found in the text itself but is included in the bill’s preparatory works.
For unlisted companies, on the other hand, shareholders – even those with a minority shareholding – are considered able to gather all the necessary data. In our opinion, this conclusion is presumptuous and, if they can’t obtain it, they won’t be able to mitigate the new look-through taxation. What of a group with a listed entity further down the chain of ownership for instance?
Even if the information can be obtained, there is also the additional issue of shared jurisdiction to levy taxes on dividends distributed by foreign intermediary structures: if the Belgian taxes on the dividend can be mitigated, what about the foreign withholding tax (widely allowed at a reduced rate by DTTs)? Will the applicable DTT offer a solution? It is highly doubtful: how could these international treaties foresee a situation which was created after their adoption?
As for the absence of a grandfathering clause, it creates yet another predictability issue. All legal structures which, until now, have not been taxed transparently (because they were held through an intermediary structure) will see their distributions taxed as dividends, at least until the reserves they have accumulated prior to qualifying as legal structures have been entirely drained (fifo).
Exit tax
As part of the Cayman Tax’s measures to prevent tax payers from avoiding its application and to encourage the repatriation of assets to Belgium, the new law introduces two cases in which an exit tax is due.
All of a structure’s "accumulated profits" is "deemed to have been distributed" to its founder when:
  • the economic rights, shares or assets of the legal structure are transferred to another legal structure or entity or are transferred to another state (other than Belgium); and
  • the legal structure’s founder transfers their fiscal residence to another state.
A fictional dividend is therefore deemed distributed which means, in the absence of a grandfathering clause, that all accumulated reserves will be taxable as dividends, even when they were constituted before the founder became a resident of Belgium and even if, at that time, the entity was not a legal structure.
The text does not provide for any possibility to exclude the application of the exit tax by proving the transfer does not occur for tax purposes. The text also does not provide for the possibility to take into account a situation "upon entrance".
For instance, what of the situation of the shareholder of a Luxembourg Soparfi who intends to move to another state? If the move occurs in a year when the Soparfi qualifies as a legal structure, all of its undistributed profits would qualify as a taxable dividend, irrespective of the fact that it might not have qualified as a legal structure in the years prior to the move or that the move is not driven by any fiscal motives. When the transfer occurs within the EU, this is in our opinion another clear violation of EU freedom of movement.
This is a major issue for Belgium. Any person who moves to Belgium for professional or personal reasons for a couple of years before moving elsewhere could fall under this rule if they are the founder of – directly or through an intermediary structure – an entity that qualifies as a legal structure.
Fortunately, the liquidation fiction does not apply when the exceptions to transparent taxation are met, in particular the exception applicable to foreign entities with sufficient substance. The notion of intermediary structure however complicates things: it is not sufficient to prove the company the Belgian resident holds shares in has sufficient substance, all further entities have to meet this requirement to also benefit from the exclusion.

***

With these newly adopted amendments, the Cayman Tax is not only unpredictable in its application, it is disproportionate to its purpose. It is expected that the Cayman Tax’s numerous EU law violations will soon be addressed by the competent courts.

 
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