Note: The following is an adapted and expanded report based on the written testimony of Martha Caziero, Head of Policy at Tax Foundation Europe, submitted to the European Commission.
Tax Foundation Europe’s core mission is to develop robust research and educate policymakers on critical tax matters that directly impact the growth and competitiveness of the European Union’s broader economy. As the European Commission advances its public consultations on the ambitious Tax Omnibus proposal, the organization has offered a targeted review of selected issues rather than a comprehensive critique. By focusing on provisions that actively shape regional growth and economic competitiveness, experts hope to contribute meaningfully to the ongoing discussions and negotiations currently taking place within the Council of the European Union.
Among the primary issues under evaluation are the proposed elimination of holding requirements from the Parent-Subsidiary and Interest and Royalty directives to ease withholding tax exemptions on dividend, interest, and royalty payments. Additionally, the debate centers on the legal nature of the Anti-Tax Avoidance Directive, specifically whether it should function strictly as a minimum standard for protecting Member States’ tax bases or move toward broader minimum harmonization.
Reassessing Holding Requirements in the Parent-Subsidiary and Interest and Royalty Directives
The Parent-Subsidiary Directive (PSD) and the Interest and Royalty Directive (IRD) currently maintain distinct ownership thresholds for equity, debt, and intellectual property rights holders seeking exemption from withholding taxes on cross-border payments. Under current rules, the PSD requires a parent company to hold at least 10 percent of a subsidiary’s shares, either directly or indirectly. Meanwhile, the IRD mandates that associated companies connect via a shareholding of at least 25 percent, held either directly or through a common parent company.
When shareholdings fall below these specific thresholds, Member States retain the sovereign freedom to levy withholding taxes on cross-border payments, subject to compliance with foundational EU Treaties. However, the newly introduced Tax Omnibus proposal seeks to abolish these established thresholds entirely. Under the proposed changes, Member States would no longer possess the legal freedom to levy withholding taxes on cross-border payments directed toward portfolio investments—meaning investments falling below the historical 10 percent and 25 percent markers.
This potential shift has generated considerable debate among Member States. Many governments argue that the amendment effectively transforms the PSD and IRD from mechanisms designed to facilitate the sensible grouping of corporate entities within the single market into instruments that reallocate taxing rights among Member States. Because this reallocation would impact national tax revenues in markedly different ways, critics warn that the proposal could produce asymmetrical fiscal effects across the bloc.
To better understand these dynamics, policy analysts examine the changing nature of both directives and question whether the core objective of avoiding double taxation is equally valid for controlling investments and portfolio investments alike. Furthermore, experts are assessing the proposal’s potential fallout on national tax revenues, proposing alternative pathways that could alleviate budgetary concerns while safeguarding the overarching objective of economic competitiveness.
Addressing Definitive Double Taxation on Portfolio Investments
For shareholdings that fall outside the protective scope of the current directives, Member States remain fully empowered to levy withholding taxes on outbound payments of dividends, interest, and royalties. In the case of dividend income, this framework can inadvertently trigger a burdensome cycle of triple taxation.
The first layer of tax occurs when the distributing company’s profits are subjected to corporate income tax within its home state of residence. A second layer is introduced when the receiving company is taxed by the distributing company’s state on the exact amount of distributed dividends. Finally, a third layer arises when the receiving company faces corporate income tax in its own home state, as the incoming dividends are folded directly into its taxable corporate base.
For interest and royalty income, taxpayers frequently encounter juridical double taxation. Initially, the interest and royalties received by a company are taxed via a source-state withholding tax levied by the paying company’s jurisdiction. Subsequently, those same interest and royalty payments are taxed a second time when they enter the receiving company’s corporate tax base in its state of residence.
Although EU law imposes boundaries on this taxing power by requiring Member States to treat resident and non-resident taxpayers equally when they find themselves in comparable situations, these legal protections have distinct limits. For dividend payments, Member States are restricted from levying withholding taxes on all outbound payments while granting exemptions exclusively to domestic recipients. If a Member State exempts domestic dividends from corporate income tax, it cannot simultaneously penalize cross-border dividends with a withholding tax without violating fundamental freedoms.
For interest and royalties, however, the mandate of national treatment operates differently. Source Member States levying withholding taxes must typically account for expenses directly connected to that income, taxing the item on a net basis similarly to domestic transactions. Yet, because receiving states generally tax interest and royalties regardless of their geographic origin, equal treatment rules fail to resolve underlying double taxation outcomes. Consequently, EU fundamental freedoms constrain outbound withholding taxes far more strictly for dividends than they do for interest and royalties.
Bilateral double tax conventions (DTCs) negotiated among Member States also attempt to limit withholding taxes by capping source-state tax rates and obliging the residence state of the receiving company to grant a tax credit. Despite these overlapping layers of protection, definitive double taxation continues to occur within the internal market. Complex multi-country scenarios, triangular cases, and divergent interpretations of treaty terms by different national administrations often leave businesses exposed to unresolved double taxation.
Administrative Costs and the Impact on Free Movement
While empirical evidence does not definitively prove that the mere existence of withholding taxes directly dictates investment location decisions for portfolio investors, the administrative reality surrounding tax relief tells a different story. Exemptions derived from domestic laws, EU directives, or bilateral tax treaties almost always come paired with stringent administrative requirements.
In practice, Member States frequently levy their higher statutory withholding rates rather than lower treaty rates while pending the verification of these complex requirements. Recovering the difference through tax refunds involves notable time lags. Extensive administrative costs and prolonged delays have consistently proven to be negatively correlated with cross-border investment decisions. When the costs of recovering over-withheld taxes rise, investment activity within a given jurisdiction tends to decline, ultimately fragmenting the seamless functioning of the internal market.
Reevaluating the Limitation to Controlling Shareholdings
The historical restriction of withholding tax exemptions to direct shareholdings—specifically those exceeding 10 percent for dividends and 25 percent for royalties—has faced growing scrutiny. While a 25 percent threshold once loosely mirrored substantial minority rights under corporate law, a 10 percent requirement increasingly looks like an arbitrary line drawn to determine eligibility for double taxation relief.
The rationale traditionally offered by the OECD Model Convention for favoring direct holdings is the desire to prevent recurrent taxation and facilitate international investment. However, these justifications apply equally to portfolio investments. A dividend or interest payment suffers double taxation regardless of the underlying percentage of ownership.
A more persuasive argument supporting favorable treatment for direct holdings is the need to maintain neutrality between establishing a foreign subsidiary and operating through a permanent establishment abroad. Because a permanent establishment shares legal identity with its head office, transfers between them are not classified as dividend distributions and thus escape withholding taxes. Exempting direct holdings ensures businesses are not artificially steered toward one legal form for tax reasons. Nevertheless, extending this same exemption to portfolio investments would not undermine this principle; it would simply ensure that portfolio investors are similarly shielded from a double layer of taxation while preserving structural neutrality.
Asymmetrical Revenue Impacts and Potential Solutions
The fiscal consequences of the Tax Omnibus proposal would vary dramatically across Member States depending on their current statutory withholding practices. Capital-exporting nations generally provide foreign tax credits for taxes withheld at source, whereas capital-importing countries retain those source-tax revenues. Consequently, eliminating outbound withholding taxes benefits the former while negatively impacting the fiscal balance of the latter.
Statistical data highlights a distinct geographical divide. Net exporters of portfolio investments include nations such as Germany, Italy, Sweden, Denmark, Belgium, Greece, Portugal, Cyprus, Malta, Croatia, Bulgaria, Estonia, Lithuania, Slovakia, Slovenia, and Latvia. Conversely, net importers feature Luxembourg, France, the Netherlands, Ireland, Spain, Poland, Romania, Hungary, Austria, Finland, and Czechia.
This structural reality suggests the proposal could create revenue shortfalls for capital-importing nations that currently rely on withholding taxes. To address these legitimate budgetary concerns without abandoning the goal of market integration, policymakers have proposed implementing a statistical revenue-sharing mechanism or treating the corresponding funds as an EU own resource.
Inspired by historical precedents like the repealed Savings Directive, a revenue-sharing clause could require capital-exporting countries that experience financial gains from the proposal to transfer a portion of those gains to capital-importing countries facing revenue losses. Using a calculated statistical formula based on estimated returns on equity, debt, and intellectual property assets, contributions could be accurately scaled. For dividends, a baseline rate of 2.34 percent—derived from average domestic corporate tax burdens across the EU—could be applied, while a 6 percent rate could be utilized for interest and royalty yields.
Alternatively, treating these adjusted amounts as an EU own resource would finance common EU expenditures rather than bolstering individual national budgets. Capital-exporting countries would transfer amounts roughly corresponding to the foreign tax credits they currently grant, rendering the operation revenue-neutral for them while helping capital-importing countries indirectly through shared European funding.
Harmonization Challenges within the Anti-Tax Avoidance Directive
Beyond withholding taxes, the proposal introduces significant legal questions concerning the nature of the Anti-Tax Avoidance Directive (ATAD) as a minimum standard of protection. Article 3 of the ATAD establishes that Member States retain the freedom to adopt stricter domestic measures beyond the baseline directive, provided they comply with EU Treaties. However, specific provisions within the Tax Omnibus proposal introduce ambiguous wording that calls this minimum-standard framework into doubt.
Within the proposed rules governing controlled foreign companies (CFCs) and interest limitations, certain passages hint at restrictive harmonization without providing clear legal certainty. While some exclusions appear strictly mandatory, the lack of explicit prohibitions against national divergence creates conflicting signals for both Member States and corporate taxpayers. When directives mix mandatory language with ambiguous fallback protections, legal certainty suffers, undermining the very harmonization goals intended by the European legislature.
Similar tensions emerge around the newly introduced research and development (R&D) full expensing provision. Designed as a minimum harmonization measure, it allows Member States to maintain or introduce alternative domestic regimes provided they offer treatment at least as favorable as the proposal. However, defining legal equivalence across a diverse landscape of national R&D incentives has proven challenging for governments aiming to comply without running afoul of state aid prohibitions.
Because full expensing allows businesses to immediately deduct qualifying R&D capital expenditures rather than spreading deductions over years of depreciating asset life, it effectively neutralizes the erosive impact of inflation and the time value of money. Establishing clear equivalence criteria—such as evaluating whether a domestic rule preserves the net present value of capital deductions—will be essential to ensuring that these provisions genuinely streamline the internal market rather than adding layers of regulatory complexity.
Conclusion
Tax Foundation Europe views the Tax Omnibus proposal as a broadly constructive step toward optimizing the internal market, provided key legal and structural ambiguities are properly addressed. Eliminating holding thresholds for withholding tax exemptions promises to streamline cross-border activity, particularly if accompanied by simplified relief procedures. While the shifting of taxing rights requires careful fiscal balancing through statistical revenue-sharing mechanisms or own-resource structures, resolving double taxation remains critical for European competitiveness. At the same time, clarifying the boundaries of minimum harmonization within the ATAD and standardizing R&D expensing equivalents will ensure the legislative framework delivers genuine legal certainty and economic growth across the European Union.
