The new Belgian CFC regime challenged before the Constitutional Court (September 2024)

The Law of 22 December 2023 has substantially modified the Controlled Foreign Company (“CFC”) regime in Belgium (see our newsflash of January 2024). The new CFC regime applies as of assessment year 2024 (financial years closed on 31 December 2023 or later).

A request for annulment of certain provisions introducing this new CFC regime has been filed with the Constitutional Court.

1. CFC rules: inclusion of low-taxed non-distributed passive income

The CFC rules aim at taxing non-distributed qualifying passive income of low-taxed controlled companies in the hands of its Belgian shareholder company.

A foreign company qualifies as a CFC if (i) the Belgian shareholder company itself and/or its related entities control(s) the company, it being understood that the Belgian shareholder company must directly hold at least one share in the foreign company (so-called “participation condition”), and (ii) the foreign company is, in its jurisdiction, not subject to income tax or subject to an income tax which amounts to less than 50% of the income tax which would have been due in Belgium (so-called “taxation condition”).

Qualifying passive income includes, amongst others, interest, royalties, dividends, capital gains on financial instruments, rental or leasing income and the income arising from the sales of goods and services with low economic value added. 

A foreign company qualifying as a CFC must be declared as such in the corporate income tax return of the Belgian shareholder company. However, a number of exceptions may still apply pursuant to which the CFC undistributed passive income will not be reportable nor taxable in Belgium. One such exception is the substance carve-out as described below.

2. The substance carve-out and its (non-)compliance with EU law

The substance carve-out applies if the CFC carries out a substantive economic activity supported by staff, equipment, assets and premises, as evidenced by relevant facts and circumstances. The carrying out of an economic activity is defined in the law as the “offering of goods and services on a certain market”.

We questioned, in our January newsflash, the compatibility of this relatively narrow definition of “economic activity” with the EU fundamental freedoms and the related CJEU case law on the freedom of establishment. 

Indeed, the Belgian CFC regime is the transposition into Belgian law of the EU ATAD Directive. The “whereas” of said Directive insists on the importance of the substance carve-out for the CFC regime to comply with the EU fundamental freedoms. The EU ATAD Directive does, however, not provide for such a narrow definition of an “economic activity”, contrary to the Belgian legislation.

Furthermore, the CJEU has indicated, in its landmark Cadbury Schweppes decision regarding the UK CFC regime that such regime constitutes a restriction to the freedom of establishment if it would apply to structures that are not “wholly artificial arrangements intended to escape the national tax normally payable”. In the request for annulment filed with the Constitutional Court it is, amongst others, argued that the Belgian CFC regime violates EU fundamental freedoms given that the regime does not only target “wholly artificial arrangements”. In case of doubt as to the interpretation of the substance carve-out, the Constitutional Court is asked to refer a question for a preliminary ruling to the CJEU.

We are of the view that this challenge has reasonable chances of success in relation to CFCs that have their fiscal residence in the EU, especially if the Constitutional Court refers a prejudicial question to the CJEU. 

3. Other provisions contested in the request for annulment

The substance carve-out is not the only provision included in the request for annulment. Other provisions include: 

• the inclusion of income from sales of goods and services with limited or no added value in “passive income”. Under Belgian law, passive income includes income from the sale of goods and services to which little or no economic value is added. The Constitutional Court is requested to annul the relevant Belgian provision to the extent that it goes beyond the scope of the EU Anti-Abuse Directive (“ATAD”), which limits income from such sales to income deriving from associated enterprises only.
• the impossibility for Belgian companies to deduct tax losses incurred by the CFC. The Belgian CFC regime only provides for an income inclusion rule, without providing for any deduction of the CFC’s tax losses. Such loss deduction is, however, explicitly provided for in ATAD. 

4. Timing of the annulment procedure

The Constitutional Court’s decision can be expected by the end of 2025 at the earliest. If questions for a preliminary ruling are referred to the CJEU, the Constitutional Court’s decision will follow (much) later; however, the CJEU generally issues its ruling within 16 – 18 months after being petitioned.

We expect that no tax circular will be issued by the Belgian tax administration before a final decision is rendered by the Constitutional Court.

However, the new federal government may decide to limit the scope of application of the CFC regime to purely artificial constructions as defined by the CJEU. 

We are at your disposal to further discuss the impact of this request for annulment on the filing position of your company under the CFC rules.