In 2013, the previous Belgian government introduced a new reporting obligation for individual founders and beneficiaries of so-called “legal arrangements” (i.e., trusts, foundations and certain tax haven companies). At the same time, the previous government also internally discussed a draft bill seeking to further discourage the use of such legal arrangements for tax purposes by introducing a regime of tax transparency. This bill was eventually not submitted to Parliament.
On 9 October 2014, the new Belgian federal government announced, in its coalition agreement for the coming term, its intention to introduce a regime of tax transparency for the income of trusts and other foreign legal arrangements (the so-called “Cayman Tax”). The draft bill containing the Cayman Tax was approved by Parliament on 24 July 2015 and the final bill of 10 August 2015 (the “Bill”) was published in the Belgian official Gazette on 18 August 2015. The Cayman Tax is similar to the tax transparency regime provided for in the previous draft bill. Under the Cayman Tax, income received by a legal arrangement will generally be taxed either in the hands of its individual Belgian resident founders (in the absence of any distribution) or, upon distribution, in the hands of Belgian resident beneficiaries. Moreover, distributions made upon liquidation of certain legal arrangements (legal entities) will also be treated as a taxable dividend. The Cayman Tax, and consequently the aforementioned reporting obligation, will also apply to Belgian not-for-profit entities acting as founder or beneficiary of legal arrangements. The Cayman Tax will not apply to Belgian resident companies acting as such. The Bill provides that the Cayman Tax will apply to income received, attributed or made payable by legal arrangements as of 1st January 2015, so with a retroactive effect.
Targeted “legal arrangements”
The Bill provides for two types of legal arrangements:
- Foreign legal entities (i.e. foundations and companies), which are either not subject to an income tax or are subject to an income tax that represents less than 15 percent of their taxable income as determined under Belgian tax law
Foreign legal entities established in the European Economic Area (EEA) will not be regarded as “legal arrangements,” unless they are included in a list of legal arrangements, which is yet to be published. A second (non-exhaustive) list, also to be published, would contain entities established outside the EEA that are deemed to be legal arrangements (unless it can be proven that they are subject to an effective income tax rate of 15 percent, as indicated above). It is likely that many of the foreign entities that are included in the current blacklist for reporting purposes will be included again in the new lists. Public and institutional undertakings for collective investment and pension funds as well as listed companies will not be viewed as legal arrangements under certain conditions. Moreover, a foreign trust or legal entity will not be considered a legal arrangement if it can be proven that (i) it carries out genuine economic activities in connection with the exercise of a business activity at the place where it is established or where it has a permanent establishment, and (ii) there is a proportionate correlation between the activities carried on by it and the extent to which it physically exists in terms of premises, staff and equipment. This counterproof will only be possible for legal arrangements that are established in the EEA or in a country that, pursuant to a tax treaty, agreement or other bilateral or multilateral legal instrument, can exchange with Belgium information relating to tax matters. The explanatory statement on the Bill notes that this exception will not apply to activities that fit in the management of a private estate.
Targeted Belgian taxpayers
The Cayman Tax will apply to Belgian resident “founders” and “third party beneficiaries.” A “founder” is defined as any of the following:
- Any individual or Belgian not-for-profit entity who has set up the legal arrangement or has settled assets and rights therein
- Upon decease of the aforementioned individual founders, their direct or indirect heirs or the individuals who will directly or indirectly inherit from the latter, unless they or their heirs can demonstrate that they will never obtain any benefit from the legal arrangement
A third-party beneficiary is any Belgian resident individual or not-for-profit entity that receives, at any time or in any way, a financial benefit or a benefit in kind from a legal arrangement. An individual can qualify both as a founder and as a third-party beneficiary.
Tax transparency in respect of income received by legal arrangements
The Bill provides for a tax fiction pursuant to which Belgian resident founders of legal arrangements will be deemed, for Belgian tax purposes, the beneficiaries of the income received by such legal arrangements and therefore, will become taxable thereon. Founders will not be taxable based on the income of their legal arrangements if they can prove that such income has been paid to a third-party beneficiary that is resident in a country that, pursuant to a tax treaty, agreement or other bilateral or multilateral legal instrument, can exchange with Belgium information relating to tax matters. Individuals(other than the initial founder)who can demonstrate that they will never obtain any benefit from the legal arrangement will not be deemed as founders. According to the explanatory statement on the Bill, individuals can prove this by (i) renouncing any benefit from a legal arrangement to which they may be entitled; and (ii) providing a letter from the relevant body of the legal arrangement that confirms that the individual can never obtain any benefit from such legal arrangement.
Tax treatment of income distributed by legal arrangements (other than upon liquidation)
The Cayman Tax also provides for a tax fiction at the level of a third-party beneficiary who is resident in Belgium. When income received by a legal arrangement is distributed in the same year to said third-party beneficiary, the latter will be deemed the beneficiary of such income for Belgian tax purposes and will become taxable thereon. On the basis of the explanatory statement to the Bill, the following distinction can be made with respect to distributions by legal arrangements to third party beneficiaries resident in Belgium: (i) Distributions by foreign companies (other than upon liquidation) Dividend distributions by foreign companies are currently already taxable at the level of Belgian shareholders at 25% (normally 27% as of 1 January 2017). Under the Cayman Tax, dividend distributions from current year earnings and from earnings accumulated during prior years to third party beneficiaries would remain taxable at the level of third party beneficiaries, unless the income that is distributed has already been subject to the application of the tax transparency regime in Belgium. (ii) Distributions by trusts (other than upon liquidation) Under the new tax fiction, distributions by a trust would only be taxable at the level of third party beneficiaries, to the extent they relate to income which the trust has received in the same year. Distributions of earnings accumulated during prior years to third party beneficiaries would not be taxable on the basis of the explanatory statement to the Bill. (iii) Distributions by foundations (other than upon liquidation) The same tax treatment applicable to distributions by trusts should arguably apply to distributions by foundations, as the latter are not companies and can in principle not distribute dividends. However, the Bill and its explanatory statement are not clear in this respect.
Liquidation of legal arrangements
Distributions made by a foreign legal entity that qualifies as a legal arrangement as a result of its liquidation or the total or partial transfer of its assets for which no equivalent consideration is received will be considered a taxable dividend for the part that exceeds the amount of contributed assets that have been subject to their tax regime in Belgium. The exact meaning of “having been subject to their tax regime Belgium” is not yet entirely clear. According to the explanatory statement on the Bill, the abovementioned taxation would also apply in case of a transfer of seat of a legal entity. However, there seems to be no legal basis for such taxation in the law, as the relevant holder does not receive any payment and he continues to hold the rights in the entity whose legal seat has been transferred. On the basis of the explanatory statement to the Bill, the following distinction can be made with respect to distributions by legal arrangements upon liquidation to third party beneficiaries resident in Belgium: (i) Distributions by foreign companies and foundations upon liquidation Currently, the liquidation bonus (i.e. the liquidation proceeds exceeding the paid-up capital) distributed by foreign companies is already taxable at the level of Belgian shareholders at 25% (normally 27% as of 1 January 2017). Under the Cayman Tax, distributions from earnings accumulated during prior years (prior to the entry into force of the Cayman Tax) will remain subject to tax upon liquidation. Note that this tax will apply not only in case of liquidation of foreign companies but also in case of liquidation of foreign foundations. (ii) Distributions by trusts upon liquidation Surprisingly, distributions made by a trust upon its liquidation would not be considered taxable. In other words, trusts would be able to distribute their income accumulated prior to the entry into force of the Cayman Tax without taxation. Accordingly, the main difference between a trust and a foreign legal entity (companies and foundations) qualifying as a legal arrangement is that upon liquidation of the latter, the distribution of income accumulated in the years prior to the entry into force of the Cayman Tax is taxable, whereas upon liquidation of a trust, the distribution of such income seems not to be taxable according to the Bill and the examples provided in the explanatory statement thereto. Often a trust will hold its assets through another company, which may also qualify as a legal arrangement for purposes for the Cayman Tax. The distribution of the shares of such underlying company should not be a taxable event under the Cayman Tax. However, the subsequent liquidation of the underlying company and the distribution of its liquidation proceeds will normally be taxable at the level of a Belgian shareholder (whether or not the underling company qualifies as a legal arrangement).
Anti-abuse provisions and entry into force
The Bill provides for a specific anti-abuse provision pursuant to which tax authorities would be entitled to disregard legal acts of foreign legal entities qualifying as legal arrangements, which are aimed at circumventing the Cayman Tax. Moreover, it is provided that any change to the deed of incorporation of a foreign legal entity (legal arrangement) in order to convert it into a trust to escape the taxation upon liquidation of the latter is not binding upon the tax authorities. In the absence of any possibility for taxpayers to provide counterproof that the transaction is driven by a valid economic or other motive (other than avoiding the application of the Cayman Tax), the legal validity of this specific anti-abuse provision seems disputable. The Bill also provides that any changes to the deed of incorporation of a trust in order to convert it into a legal entity (legal arrangement) as of 9 October 2014 is not binding upon the tax authorities.
As of 1st January 2015, Belgian residents that can be considered founders of foreign trusts, foundations and tax haven companies will become subject to a tax transparency regime. This means that, as of 1st January 2015, they will be considered the direct beneficiaries of income received by such legal arrangements for Belgian tax purposes and thus will become taxable thereon, even if such income is not distributed by the legal arrangement to the beneficiary. Many legal arrangements, such as trusts and foundations, hold their investments through underlying companies. If these underlying companies could also be considered as legal arrangements, the Belgian resident founders could be considered the owners of the investments held by the underlying companies and thus could be taxed on the income received thereon, irrespective of whether they would receive such income from the legal arrangement or not.
Different scenarios could be considered to alleviate the tax burden that Belgian resident founders may encounter as a result of the proposed tax transparency rules. For instance, one could consider having legal arrangements holding types of investments whose income is typically exempt from Belgian income tax under certain conditions (e.g., capital gains realized on shares or on certain accumulation UCITS investing not more than 25 percent in debt instruments) instead of investments whose income is taxable according to Belgian law. In such case, the tax transparency regime would not have adverse tax consequences for Belgian resident founders. Moreover, liquidation of trusts with Belgian resident founders or beneficiaries may also be considered, as its accumulated income seems not to be taxable in Belgium upon distribution to such Belgian residents under the Bill and its explanatory statement. In this respect, it should also be taken into account whether the trust holds any companies and what the impact would be of the Cayman Tax on the distribution thereof. More generally, tax payers are recommended to evaluate the use of foreign structures qualifying as legal arrangements in light of this change in tax treatment.