Belgian cayman tax 2.1 partially overturned by the Constitutional Court: key takeaways

Pro memoria: the principles of cayman tax 2.1

The reform of the caiman tax 2.1 introduced several highly controversial provisions, including:

• The introduction of a rebuttable presumption of ‘founder status’ for every person listed in a UBO register;
• A stricter definition of the so-called substance exclusion (and thus the concept of 'genuine economic activity');
• The introduction of the 'intermediate structure' regime;
• The classification as a legal construct of "fonds dédiés" that are held for more than 50% by one person or by several interrelated persons;
• The introduction of an exit tax upon emigration of a founder outside Belgium;
• The taxation of the distribution of previously exempt capital gains on shares by a legal construct, through the abolition of the 'exemption vaut impôt' principle.
• The extension of the reporting obligation and mandatory filing of annex 276 CJC.

It was precisely these provisions that were challenged before the Constitutional Court. Below, we discuss the provisions that were effectively annulled by the Court.

1. The tightened substance exclusion is reversed

The Programme Law of 22 December 2023 had tightened the so-called substance exclusion. This amendment applied to income earned as from 1 January 2024. The application of the substance exclusion required the following three conditions to be met:

• The legal construct is established in a State as referred to in Article 5/1, §2, paragraph 2 of the Belgian Income Tax Code (‘BITC’), i.e. a State with which Belgium has concluded a double taxation treaty or with which it exchanges tax information;
• The income of the legal construct is, in principle, derived from the exercise of one or more genuine economic activities;
• This genuine activity is not aimed at managing the founder’s private wealth.

The law further defined the concept of economic activity as 'the offering of goods or services on a particular market' and specifies that these activities cannot therefore relate solely to the management of the founder’s private wealth.

The Constitutional Court has now rightly ruled that restricting the concept of 'economic activity' to merely the 'offering of goods or services on a specific market' is not acceptable in the context of cayman tax. The Court considers that the fact that the legal construct merely manages assets or that the income of that structure derives solely from that asset management is not in itself sufficient to demonstrate that the structure is entirely artificial and has no connection with economic reality (B.12.3).

The taxpayer must be given the opportunity to demonstrate to the tax authorities, under the supervision of the competent judge, that the legal construct is not a wholly artificial structure without any connection to economic reality (B.12.3).

The Court therefore annuls Article 5/1, §3, second paragraph BITC.

2. Limitation of the exit tax to the Belgian period and clarification 

An exit tax was introduced in Article 18, paragraph 1, 3°/1 BITC for the following cases:
(i) transfer of the founder's tax residence abroad;
(ii) transfer of the statutory seat of a legal construct abroad, other than to Belgium;
(iii) contribution of economic rights, shares/participations or assets of the legal construct to another legal construct or legal entity, or the transfer to another State or jurisdiction, other than Belgium.

The scope of this exit tax was not limited to the 'Belgian period' and applied to 'undistributed profits'.

During the legislative process, the Minister clarified that this new Article 18, paragraph 1, 3°/1 of the BITC qualifies as a dividend: "any reserve that has increased the capital of the legal construct, beyond the founder’s contributed capital" (B.21), meaning not only realised profits but also latent capital gains, which was debatable in light of the statutory wording.

The Constitutional Court provided a highly useful clarification.

On the one hand, the Court states that the term "undistributed profit" refers to the reserves of the legal construct exceeding the founder’s contributed capital. The Court emphasised that the concepts of "profit" and "reserve" presuppose income that the legal construct has realised, for example through the sale of assets, and which has not been distributed. The term therefore does not cover latent capital gains on assets (B.21). On the other hand, the Court confirmed that Belgium’s taxing power is limited to the “Belgian period”. It follows that the Court annulled Article 18(1)(3)(1) BITC, insofar as it entailed the taxation of undistributed profit realised by a legal construct at a time when the natural or legal person who founded that legal construct did not yet have, as the case may be, his or her residence, seat of fortune, establishment, or place of management or control in Belgium (B.40).

3. CFC rules and the cayman tax: the winning combination

It is possible for a natural person to indirectly hold a legal construct through a regularly taxed company. Under the CFC (“controlled foreign company”) rules, the income of the legal construct in question can be attributed to the regularly taxed company. In effect, this income is therefore effectively taxed.

Since the entry into force of the cayman tax 2.1 – which introduced the concept of 'intermediate structures' – the application of the CFC rules has been crucial. Article 5/1, §3, first subparagraph, c) BITC provided for an exemption from look-through taxation when, under the CFC rules, the income of the legal construct is attributed to a Belgian domestic company and thus subject to regular taxation.

The Constitutional Court has now held that limiting this exemption to situations where the income is taxed exclusively at the level of a Belgian company is not reasonably justified. The exemption should also apply when the income is taxed at the level of a non-domestic company under CFC rules analogous to those under Belgian law.

The Court therefore annulled Article 5/1, §3, first subparagraph, c) BITC insofar as it did not allow the founder to demonstrate that the income of the legal construct was taxed in the hands of a non-domestic company under CFC rules analogous to those in Article 185/2 BITC, and consequently to obtain the exemption (B.68).

4. More flexibility for "Fonds dédiés"

The “fonds dédiés” were particularly affected by the reform of the cayman tax 2.1. Initially, they were exempt provided they were not wholly (i.e. 100%) held by a single person or by several interrelated persons. As from 1 January 2024, this exemption was significantly restricted, since it only applied where the fund was not more than 50% held by a single person or by several interrelated persons.

For the record: persons are deemed interrelated if:

• one or more natural or legal persons exercise control over other legal persons within the meaning of Article 1:14 of the Companies and Associations Code; or
• these persons are relatives by blood or marriage up to the fourth degree; or
• these persons are married, legally cohabiting, or have established their residence or seat of fortune at the same address.

The Constitutional Court ruled that the 50% participation threshold for collective investment funds (CIFs) is disproportionate.

Taxpayers must have the opportunity to demonstrate that third-party participation in a CIF of less than 50% is not driven by purely tax motives, and that the CIF should therefore not qualify as a legal construct or intermediary structure.

Article 2, §1, 13/1, second paragraph BITC is therefore annulled insofar as it does not allow the taxpayers concerned to prove that a third party’s participation of less than 50% in a CIF was not driven solely by tax motives, and that the CIF in question was therefore not a legal construct or intermediary structure (B.96).

Conclusion

The aforementioned judgment by the Constitutional Court marks a turning point in the evolution of  cayman tax and opens up new perspectives.

Furthermore, it should be emphasized that the annulment of the provisions in question has retroactive effect. It is, of course, impossible to predict when and how the legislator will respond to the aforementioned judgment.

We will, of course, continue to monitor this closely for you and keep you informed of any new developments in this regard. In the meantime, we strongly recommend that you have your tax position reviewed in light of this new judgment by the Constitutional Court. Our team of specialists is at your disposal to assist you in this matter.

Furthermore, it should be emphasized that the annulment of the provisions in question has retroactive effect. It is, of course, impossible to predict when and how the legislator will respond to the aforementioned judgment.