The European Union's blow to dividend stripping
María Calle
by María Calle
What is dividend stripping?
Dividend stripping involves temporarily transferring shares of companies from a domestic investor to a foreign one so that, when dividends are paid, the withholding tax in the country of origin is avoided.
The purpose is to evade withholding tax on dividends to reduce the tax burden. When the sole purpose is to avoid withholding taxes, these actions may be considered an abuse of rights or a conflict in the application of tax regulations. This can be determined when the same number of shares is repurchased after the company has distributed dividends.
A typical case can be illustrated with the following example:
A Spanish investor purchases shares of a Spanish company that distributes dividends. Before the dividend distribution, the investor sells the shares with a repurchase option to a foreign investor. After the dividend is distributed, the Spanish investor buys back the shares, thereby avoiding part of the tax burden, or, at the very least, deferring the payment of taxes on the potential profit obtained from the price difference between buying and selling.
For this scheme to work, there must be an agreement between the buyer and seller. After the sale and repurchase transactions, the domestic and foreign investors share the benefits gained by avoiding taxation. Normally, the Spanish investor would face a 19% withholding tax on these dividends. However, for investors from other countries with double taxation agreements, the withholding tax may be reduced or even eliminated.
In summary, the Spanish investor avoids the withholding tax this way.
The European Union, however, wants to put an end to these undertakings and is making rapid progress toward implementing what it calls the Faster Directive.
This EU regulation proposes that “financial agreements involving securities transactions must be reported” so the legitimacy of such operations can be verified. Additionally, the directive will introduce a “single, harmonised, electronic certificate of tax residency across the EU, digitising all processes related to the withholding of dividends and interest”. This aims to facilitate information exchange between the various tax authorities in Europe.
The directive is justified by the intention to improve the mobility of securities in the European market, making it instantaneous; and increasing its attractiveness by removing existing obstacles which currently slow down the payment of certain financial assets across countries. However, the true purpose of the Faster Directive is to deliver a decisive blow to dividend stripping and prevent the legitimate reduction of withholding taxes.
This directive, which received the approval of the European Council on 14 May 2024, is pending approval by the European Parliament before it can be definitively adopted by the Council.
GGI member firmRuiz Ballesteros Lawyers and Tax AdvisorsMarbella, SpainT: +34 952 77 98 74
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Ruiz Ballesteros Lawyers and Tax Advisors is a firm of lawyers, economists and tax advisors established over 15 years ago. Highly qualified professionals cover all areas of legal, tax, accounting and commercial requirements for clients. Continuous training, demonstrating excellence, taking care of every detail, and upholding high ethical standards are the guiding principles of the firm.
María Calle is an economist with a degree in Business Administration from Universidad San Pablo CEU and holds a Master's in Financial Management and Direction. She began her career at a Madrid law firm advising SMEs and freelancers, later working in banking and real estate, specialising in client service and commercial advice.Contact María.
