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Unlike many other EU member states, the UK does not impose withholding tax on the payment of dividends by UK companies. Corporate shareholders with holdings of 10 per cent or more in other EU companies can claim the benefit of the Parent-Subsidiary Directive, but UK individuals and portfolio investors (i.e. those who hold less than 10 per cent of a company's share capital) who hold shares in companies in other EU member states can suffer from foreign dividend withholding tax.  Even where relief is ultimately available under a double tax treaty or domestic law, investors can suffer cash flow disadvantages.  The European Commission has recognised this issue as well as the fact that dividend withholding tax can give rise to double taxation problems, discrimination against non-resident investors and distort the effective functioning of the internal EU market.

In light of this, the Commission is consulting on six suggested solutions to the dividend withholding tax problems faced by individuals and portfolio investors:

• the abolition of withholding taxes on cross-border dividend payments within the EU to these investors;
• requiring the investor's state of residence to provide full credit for the withholding tax in the source state, even if this exceeds the tax actually payable by the investor;
• requiring the source state to tax the dividend payment net of all tax allowances a local investor would be entitled to;
• the introduction of an EU wide reduced rate of withholding tax (provided the investor accepts greater information exchange);
• restrictions on both the source state and the state of residence taxing dividend; and
• the removal of withholding tax in the source state and the taxation of dividend income in the investor's state of residence (i.e. effectively extending the scope of the Parent-Subsidiary Directive to these investors).

The Commission have requested responses to provide information on these tax problems, as well as comments on the solutions proposed and any other suggestions to resolve these issues.

The potential for cash flow disadvantages and double taxation can pose a significant disincentive for cross border investors.  Accordingly, the Commission's consultation in this area is to be welcomed.  It is also to be hoped that the Commission will make proposals in due course to address the shortcomings of the Interest and Royalties Directive, to minimise the effect of withholding on other payments between EU companies.

For the full text of the consultation paper click here.

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