New DRD rule - Risk of triggering taxation as CFC or Cayman Tax income

The Belgian government has submitted a draft bill to parliament that would restrict the application of the 100% dividend-received deduction (“DRD”) for participations below 10%, but with an acquisition value exceeding EUR 2.5 million. These participations would only be eligible for the DRD if they have the nature of “fixed financial assets”. We discussed this new rule in a previous blogpost (see link). This rule would apply to all companies except qualifying small companies. 

This rule will not apply to investments held by and in qualifying “investment companies” for DRD purposes (see Article 2, §1, 5°, f) of the ITC). To meet this qualification, it must hold a sufficient number of investments, and also have a sufficient number of unrelated investors.

This new rule may result in additional foreign intermediate holding companies falling in scope of the Belgian CFC rules or the Cayman Tax regime.

1. Belgian CFC rules 

The CFC rules aim at taxing non-distributed qualifying passive income of low-taxed directly controlled foreign companies (“CFC”) in the hands of their Belgian shareholder company. This passive income includes dividends and capital gains on shares held by a CFC.  A CFC is low-taxed if the foreign tax is less than half of the Belgian corporate tax that would have been due if the CFC were a Belgian resident company.

Foreign intermediate holding companies may qualify as CFCs if they benefit from an exemption on dividends or capital gains in circumstances where a Belgian company would not have qualified for such an exemption.

As a result, the CFC rules may apply if a direct foreign subsidiary (other than a qualifying investment company/shareholder of the latter) benefits from an exemption on dividends or capital gains in relation to participations below 10% with an acquisition value exceeding EUR 2.5 million, and which do not qualify as “fixed financial assets” under local GAAP. 

2. Cayman tax

The Cayman tax is a “look-through tax” designed to tax income obtained through a “legal construction” at the level of the founder(s) or beneficiaries (individuals), as if they had directly received that income. Foreign holding companies are considered “legal constructions” if they are either not subject to income tax, or if the income tax due is less than (i) 15% of their taxable income as determined according to Belgian income tax rules or (ii) if they are resident in the EEA, less than 1% of their taxable income as determined according to Belgian income tax rules. Unlike the CFC rules, the Cayman tax also applies to indirect foreign subsidiaries/investments constituting a legal construction. 

As a result of the proposed change of the DRD rules, there is an increased risk that a foreign subsidiary (other than a qualifying investment company/shareholder of the latter) may be a “legal construction” if it only or mostly realises dividends and capital gains on shares that are exempt in its country of residence and which relate to participations below 10% with an acquisition value exceeding EUR 2.5 million, and which do not qualify as “fixed financial assets” under local GAAP. 

Note that the Cayman tax does not apply if the income of the legal construction had already been taxed under the CFC rules in the hands of a Belgian corporate shareholder.  

3. Example 

A Belgian resident individual is a majority shareholder in a Luxembourg holding company (“LuxCo”), which invests in listed and non-listed shares. LuxCo is subject to ordinary corporate income tax in Luxembourg, but benefits from the Luxembourg DRD and capital gains exemption, since the acquisition value of each of the participations exceeds EUR 6 million. None of the participations are recorded as “fixed financial asset” under Luxembourg Local GAAP.  

In this scenario, LuxCo may qualify as a “legal construction” for Belgian Cayman tax purposes, as its income would not have been exempt if LuxCo were a Belgian company. As a result, the Belgian resident individual may be taxed on his proportionate share in the income of LuxCo as if they had received it directly, under the Cayman tax rules.

As outlined above, the new DRD rules may affect Belgian shareholders of foreign companies through the application of both the Cayman tax and CFC rules. The application of these rules in practice will depend on whether the CFC or legal construction derives other types of income that are not exempt (e.g. interest income). In addition, certain exceptions to the CFC and Cayman tax regime may apply, for example where a substance or AIFM carve-out is available.

If you hold (in)direct interests in foreign companies and would like to understand how these new rules might affect your structure, we are happy to assist with a review and impact assessment tailored to your situation.