One and a half years ago, the Law on Corporate Income Tax gave rise to an ambiguous provision that threatened foreign-owned companies in Lithuania. The wording of the law states that dividends paid to foreign holding companies will be liable to corporation tax (15%) if the main goal, or one of the main objectives of these companies, is to obtain tax advantages. The main confusion in the business environment is the fact that dividends can be taxed by the State Tax Inspectorate even if tax advantages are not the main objective, but are important in the business structure. Every student understands that the goal of a business is to make a profit. In order to earn profits, businesses try to reduce their costs, and taxes are one of those costs, in a broad sense. Consequently, tax planning (the desire to take advantage of all tax incentives, to ensure that there is no double taxation, etc) is a natural business condition. If we finally agree that tax planning is a normal matter, how, then, should this provision of corporate income tax be understood, and in what cases will the tax authorities apply this rule? The draft commentary on the recently published Law on Income Tax shows that the State Tax Inspectorate does not want to express a more specific vision on this issue (if such a vision exists). Accordingly, companies controlled by foreign holdings are responsible for solving the issue themselves: whether, after a few years, the tax check carried out by the STI will tax their paid dividends. In the first case, you would have to pay extra penalties and fines, so you would not want to make a mistake on this matter.
Too many open questions
The pursuit of tax advantages is not the only criterion for recognising a tax avoidance structure. Another important aspect is the lack of economic content in such a business structure. However, the economic content of a holding company is not the same as that of an actual company, since holding companies essentially implement the rights of the shareholder. The question whether the shareholder always needs a permanent office, employees and other attributes of a traditional company, remains open. EU member states are in a rather different position when commenting on what economic content means. Lithuania has not expressed any official opinions on this concept (in the context of holding companies). The provisions of the Income Tax Act which brought so much confusion are based on the European Parent-Subsidiary Directive. According to this, not only Lithuania, but other EU countries as well, had to make corrections in the laws of their country. However, there is a big difference between just transposing the provisions of the directive into the law and leaving it to the court to implement practical applications, and making clear recommendations as to how these provisions should be applied without waiting for the first tax disputes. The Netherlands, which has a deep business tradition, explained to its taxpayers how to understand the concept of economic content long ago.
The good wishes of the EU’s old-fashioned initiatives
The primary aim of the Parent-Subsidiary Directive was to eliminate dividend taxation between European Union companies, that is, to stimulate investment in the European Union. However, after the start of the struggle against aggressive tax planning initiatives, amendments to the directive were introduced which restrict the use of dividend advantages. No one challenges the proud aim of EU institutions to fight ‘empty’ business structures and aggressive tax planning; but the question is whether the chosen wording is exactly what is needed to achieve this goal. This question is raised in most European Union countries. The EU is an economic bloc of countries where commodities and capital move freely; and, as a result, the EU has, over the years, removed barriers to investment between the countries of the bloc. Meanwhile, these changes in the context of EU integration are backward not forward steps.It is interesting that the amendments to the directive, along with the entire complex of changes in tax regulation currently being implemented, are mostly initiated by old EU countries, such as France and Germany. These countries apply high rates of tax, and are looking for every possible way to prevent small advanced states, such as Ireland or Luxembourg, from attracting and maintaining foreign investment through their favourable tax regimes.
A forward step
Business plans its steps far ahead. Knowing that they might be subject to additional taxation, companies behave accordingly: they reorganise their structure, create different economic content, or simply leave Lithuania. It is unlikely that Lithuania is trying to frighten entrepreneurs investing here, but in the absence of certainty, businesses will consider the possibility of acting in other countries that do provide certainty. So, after taking one step, transposing the provisions of the directive into the law, it is necessary to go further, and explain how they will be applied. It is definitely possible to draw a line between tax evasion and fair business. Take the example of a Lithuanian company controlling another Lithuanian company. The dividends paid to the first company are exempt. If a business owner decides to relocate a Lithuanian holding company, say, to the Netherlands, he would continue to apply the same tax regime as before, which means that dividends would not be taxed. A holding in another country may be created due to the higher level of protection of investments, the more favourable legal regulation of companies, or the diversification of risk. In this case, there is no tax reason to have a holding company in the Netherlands, and the total tax payable in both cases is the same.
Opportunities for Lithuania
By applying the law, the Tax Authorities are most likely to ‘shake’ Lithuanian businessmen who have taken control of companies abroad. Foreign investors should not come under the scope of the rules applied, as it is clear that their goal is to invest in business in Lithuania, and they do not seek tax relief.
But the reality is different. A significant number of foreign capital companies invest in Lithuania (as well as in other countries) through holding structures abroad, the dividends paid are tax-free, and the economic content of the holding structure itself does not differ in any way from holding structures with Lithuanian capital. Thus, foreign investors face the same sanctions as Lithuanian ones. Nevertheless, Lithuania still has a unique opportunity to be an advanced state and make a clear promise to businesses that there will be no strange solutions in this area. It would also be a significant reputational achievement in Lithuania, which would reassure businesses, provide security, and send a clear message to foreign investors.