As from assessment year 2014, "large" companies are subject to a new tax called the "fairness tax". As soon as it entered into effect, a series of questions arose with respect to its application in practice. By recently publishing an administrative circular letter, the tax authorities have attempted to provide more certainty.
The fairness tax: what is it?
The fairness tax is a tax assessed separately for corporate income tax (CIT) purposes, at a distinctive rate of 5.15% (including 3% additional surcharge) in cases where dividends are distributed by a company which pertain (totally or partially) to taxable profit not effectively subjected to the CIT rate normally applicable because of setting off with the notional interest deduction (NID) and/or tax losses carried forward.
In essence, the fairness tax that would be due can be determined from the following formula :
The example below illustrates the application of the fairness tax, assuming that the fiscal result of a company would be as follows:
- Distributed dividend: 600
- Distributed dividend originating from reserves taxed previously and during assessment year (AY) 2014 at the latest: 0
- Dividends received deduction: 300
- Notional interest deduction: 800
- Tax losses carried forward (TLCF): 50
- Taxable result after the first operation: 1,600
- Final taxable basis effectively subject to corporate income tax: 1,600 – 300 – 800 – 50 = 450
Calculation of the fairness tax:
(600 - 450 – 0) * ((800 + 50)/1,600) * 5.15%
= 150 * 53.12% * 5.15% = 4.10
However, the new article 219ter of the CIT Code with respect to the fairness tax, introduced by the Act of 30 July 2013, needed clarification. The tax authorities have made a first attempt by publishing a circular letter dated 3 April 2014. The following aspects will be discussed:
- the practical significance of the transitional provision,
- the application of the fairness tax where exempted capital gains on shares are realised, and
- the set-off between certain elements and the fairness tax.
Application of the transitional provision
In order to avoid the fairness tax entering into effect retroactively, a transitional measure provides that taxed reserves built up prior to its entering into effect can be deducted from the distributed gross dividend (the so-called "good" reserves). However, because of the confusing manner in which this measure was drafted, it was difficult to determine which reserves qualified as "good" ones. Quite some discussion arose about the interpretation of (i) the expression "distributed dividend originating from previously taxed and during [in French]/for [in Dutch] assessment year 2014 taxed reserves" (which are not subject to fairness tax), and (ii) the rule that dividend distributions pertaining to AY 2014 "can never be deemed as taxed reserves from that same assessment year".
In essence, the question was whether reserves built up during assessment year 2014 at the latest could qualify as "good" reserves, or if only the reserves which were built up until assessment year 2013 inclusive could qualify as "good" reserves. Moreover, the transitional provisions seemed even more ambiguous because, although the new tax is applicable as from AY 2014, it was nevertheless provided that the distribution of reserves built up during AY 2014 at the latest would not be subject to the fairness tax.
The circular letter states that the two expressions are to be read jointly. According to the tax authorities, only dividend distributions linked to AY 2014, which originate from the taxed reserves built up during AY 2013 (financial year 2012) at the latest, are not subject to the fairness tax. The reserves taxed and built up during AY 2014 can only be distributed without fairness tax as from AY 2015. This seems logical, because it is from that moment that they actually qualify as "taxed" reserves. In other words, reserves built up during AY 2014 ("bad" reserves) which are subsequently distributed as dividends during AY 2015 will qualify as "good" reserves at that moment, and they will thus not be subject to the fairness tax.
The circular letter also provides more explanation with respect to the applicability of the fairness tax to intermediate and interim dividend distributions linked to AY 2014.
By virtue of a decision of the general meeting of shareholders, intermediate dividends can be distributed pertaining to distributable profit as recorded in the last closed annual accounts. In that respect, the circular letter provides that distributed intermediate dividends linked to AY 2014 which originate from previously taxed reserves, or from reserves taxed at the latest during AY 2013, will not be subject to the fairness tax. In this way, the tax authorities comply with the corporate legal meaning given to an intermediate dividend, according to which it should always originate from profit taxed during a previous financial year.
However, interim dividends are distributed by virtue of a decision of the board of directors, and must originate from the profit for the current financial year, with the possible addition of profit carried forward from the previous financial years which was not "reserved". In that respect, the circular letter states that an interim dividend distribution linked to AY 2014 will not be subject to the fairness tax, insofar as the distribution pertains to profit carried forward which was previously taxed. Insofar as the interim dividend pertains to the profit for the current financial year (FY), linked to AY 2014, the fairness tax will fall due.
Based on the foregoing, in the event of dividend distributions linked to AY 2014 (e.g. when the FY closes on 31 December 2013), and assuming that the company would have the choice to allocate the dividends either to available reserves (or profit carried forward), or to profit for the current FY, it will be important – in practice – to clearly mention that the distributed dividends pertain to available reserves in the annual accounts, in order to be distributed without the fairness tax. The profit of the current FY could then be "reserved" and be distributed the following year, also without the fairness tax.
For determination of the taxable basis for the fairness tax, the law provides that, for the allocation to previously taxed reserves (good reserves), priority must be given to the reserves last built up (LIFO method). This entails that the dividend distributions will first be allocated to the most recent reserves (which can be "bad" if built up after AY 2014), and it is only afterwards that the possible remainder can be allocated to good reserves, if any. Thus, a company with good reserves will have to document and monitor the origin and the destination of those reserves, in order to distribute them in the future, free of any fairness tax.
The table below illustrates this. We have assumed that the FY coincides with the calendar year, that the intermediate dividends distributed during a year are linked and pertain to the prior year, and that the annual accounts of the prior year have already been closed. This table is based on our interpretation of the law and the circular letter, although it cannot be excluded that the tax authorities might view things differently:
- The distribution of an intermediate dividend is not subject to the fairness tax.
- The distribution of an interim dividend. Insofar as it pertains to profit carried forward from previous FYs, it will not be subject to the fairness tax. The portion pertaining to the profit for the current FY will be subject to the fairness tax.
- The distribution of an intermediate dividend is not subject to the fairness tax.
- The distribution of an interim dividend. The portion pertaining to the profit for the current FY is subject to the fairness tax. Insofar as the interim dividend pertains to profit carried forward (in compliance with the LIFO method), it will not be subject to the fairness tax.
- The distribution of an intermediate dividend. The portion of the reserved or carried forward profit of AY 2015 will be subject to the fairness tax. Insofar as the dividend pertains to profit reserved or carried forward linked to AY 2014 or even previous years (in compliance with the LIFO method), it will not be subject to the fairness tax.
- The distribution of an interim dividend. The portion pertaining to the profit for the current FY and the profit carried forward from AY 2015 is subject to the fairness tax. Insofar as the interim dividend pertains to profit carried forward linked to AY 2014 or even previous years (in compliance with the LIFO method), it will not be subject to the fairness tax.
The fairness tax and exempted capital gains on shares for "large" companies
Another important clarification provided by the circular letter pertains to the scope of the fairness tax where an exempted capital gain on shares is realised. The technical manner of obtaining the exemption in the CIT return consists of excluding the capital gain from the taxable basis of the CIT (by adding it to the starting situation of the reserves).
However, as from AY 2014, exempted capital gains on shares – only for "large" companies – are henceforth subject to a separate assessment at a distinct rate of 0.412%. In order to calculate the fairness tax, this method of recording in the CIT return (exclusion of the taxable basis) would have had a double negative effect. On the one hand, the distributed profit not effectively subject to CIT would rise (the first step in the calculation of the fairness tax), and on the other hand, the denominator of the formula (the second step) would be reduced. In extreme cases, this would have resulted in levying the fairness tax on the total amount of exempted capital gains on shares, which was not the legislator's intention.
The circular letter now states that the capital gains that are subject to the separate assessment of 0.412% cannot be excluded from the taxable basis as resulting from the first step in the CIT return. Hence, these capital gains will still be a part of the taxable basis, as well as being included in the denominator in the formula required for calculating the fairness tax.
Although this new technical treatment of the qualifying capital gains is positive news, in our view it causes another negative effect. If a company is in a loss position and cannot exclude this capital gain (consequently reducing its fiscal losses), it will effectively be subject to CIT on the capital gain in the future.
This can be demonstrated with the following example: Assuming that a company has an operational loss of 3,000, and realises an exempted capital gain on shares of 1,000, then its accounting result will amount to -2,000. Before, the company would have had a tax result of 3,000, which could have been carried forward. Pursuant to the circular letter, however, the company will only have tax losses carried forward amounting to -2,000. Therefore, we are of the opinion that this administrative viewpoint is inaccurate.
Elements that can be set off
Finally, the circular letter confirms that possible remainders of withholding tax and tax prepayments can be offset against the fairness tax, as is also the case with lump-sum foreign taxes, the fictitious withholding tax and the tax credit for research and development.
Conclusion
Numerous problems arose in practice due to the introduction of the fairness tax. The circular letter is the first attempt to resolve the most urgent issues, but it also raises new problems with respect to the "exempted" capital gains on shares realised by "large" companies. A lot of questions remain unanswered, though, such as the applicability of the fairness tax to Belgian branches of foreign companies and the profit of foreign branches of Belgian companies, as well as regarding the compliance of the fairness tax with double tax treaties, with the Parent-Subsidiary Directive and with the constitutional principle of equality. It is to be hoped that either another circular letter or a statutory amendment will bring further clarification.