Short-selling and application of the withholding tax exemption

In a decision dated 21 November 2024, the Luxembourg Administrative Court of Appeal ruled on a the possible application of the withholding tax exemption in a context of securities lending transactions and short positions.

1. Context:

A French public limited company held shares in a Luxembourg public limited company through two segregated securities accounts. In one of these accounts, the French company had blocked a number of shares whose acquisition price exceeded €1.2 million (the holding account), while in the other, the number of shares fluctuated according to trading and securities lending (the trading account).

The specificities of the case lie in the fact that, in the trading account, transactions could lead to a theoretical negative position: by selling, buying and lending securities, the account could be in an intraday negative situation – also called short position whereby the stock is sold before being repurchased at a lower value, trying to benefit from the difference.

Within this context, the Luxembourg company distributed dividends in 2016, 2017, and 2018, and some of the dividends paid to the French company were subject to withholding tax. The French company therefore filed requests for reimbursement of withholding tax deducted in 2016, 2017, and 2018, which were denied on the grounds that the conditions of Article 147 and 149 of the Luxembourg income tax law were not met. 

The Luxembourg tax authorities considered that the negative position in the trading account was automatically compensated by the positive situation in the holding account, where the position was long, leading however the overall stock position to fall below €1.2 million. By falling below €1.2 million, if only for a split second, the 12 months’ holding period was deemed broken, and one of the cumulative conditions of the Luxembourg withholding tax exemption was therefore no longer met.

This interpretation from the tax authorities was upheld by the administrative tribunal earlier in the year.

2. Court overruled tribunal decision: what you need to know:

• A theoretical negative position on a securities account cannot be offset by a positive position recorded on another, segregated, securities account;
• A refund of withholding tax is only conceivable if the beneficiary of the income is the legal owner of the shares (i.e. has a direct legal relationship with the subsidiary). This condition is not affected by the existence of a legal relationship between the beneficiary of the income and a third party concerning the subsidiary's shares, provided such a relationship does not transfer to the third party the typical rights and risks of a shareholder. In this regard, the Court mentions that securities lending can, in certain circumstances, lead to a dissociation between the legal and economic ownership of lent shares, potentially impacting the application of the withholding tax exemption regime. In the case at hand, in the absence of documents to determine the conditions in which the securities lending by the French company of the Luxembourg company's shares occurred, the Court cannot determine if the French company was indeed the owner of the shares for which it claimed a withholding tax reimbursement and therefore confirms the refusal to apply the withholding tax exemption regime.
• The Court explicitly refers to the so-called Danish cases of the CJEU as regards the criteria for the application of the participation exemption.
• Dividends paid on shares for which transfer operations have not been settled at the time of distribution may be subject to a request for withholding tax reimbursement (provided all conditions are met) if, after the settlement of the operation, the person claiming the reimbursement is indeed the owner.

The court also confirmed that the refund claim must be received by the tax administration by December 31 of the year following the one in which the withholding tax was levied.