Non-discrimination: the turn of tax transparent funds

Case C-139/25 marks a new step taken by the European Court of Justice to shape the tax framework applicable to foreign investment funds operating in Spain.

While a solid doctrine validating the direct application of Article 63 TFEU to foreign funds has been established, it was not clear how this doctrine should be applied in practice to tax transparent funds whose Spanish-sourced income is directly allocated to the LPs of the fund.

The case concerns a US investment fund that obtained Spanish-sourced income which was subject to a 15% withholding tax in Spain. Pursuant to Article 63 TFEU, the US fund claimed the application of the reduced 1% taxation granted by Spanish legislation to comparable Spanish harmonised investment funds.

The US fund argued that, while it met all the relevant requirements to be considered a comparable collective investment undertaking to those regulated under Spanish tax law, the different tax treatment given in Spain (15% taxation versus the 1% tax granted to domestic investment funds) should be regarded as a discriminatory restriction contrary to Article 63 TFEU.

The particularity of this case was the tax status of the US fund. The fund opted to be treated as a tax-transparent entity for US tax purposes. This was optional, so instead of being taxed as a corporation in the US, the fund opted for a look-through system whereby the income was automatically allocated to the LPs.

This was the core of the dispute. The Spanish tax authorities argued that, under the look-through system, the investors obtained not only the Spanish-sourced income directly, but also the right to deduct any tax paid in Spain (the 'Double Tax Credit'). This Double Tax Credit derives from the application of the US–Spain Tax Treaty, which essentially allows US citizens and residents to deduct the income tax paid in Spain from their US tax (Article 24.2 of the Treaty).

Therefore, the Spanish tax authorities' argument is that any discrimination that could exist between this US fund and a Spanish harmonised investment fund is neutralised by the effects of the double tax treaty in practice. Any tax discrimination against the US fund, which is subject to a 15% tax on its Spanish-sourced income (compared to the 1% paid by a Spanish fund), is automatically neutralised by the tax treaty, as it enables the US investors to deduct any Spanish tax paid on this income from their personal US tax.

The dispute was then referred to the ECJ for a preliminary ruling. In this preliminary ruling, the ECJ ruled that

• (i) It is possible to consider that discrimination in the taxation of a foreign fund comparable to a Spanish collective investment undertaking is neutralised by the provisions of a double taxation treaty when a transparent investment fund transfers not only the income, but also the tax credit to its unit holders, allowing them to deduct the foreign tax (in this case, the Spanish tax) from their personal income tax

• (ii) In that case, the court (in this case, the Spanish court) must satisfy itself that these unit-holders can actually benefit from the application of the tax credit recognised under the tax treaty.

In our view, this ruling marks a relevant milestone for foreign investment funds. When it comes to tax-transparent funds, the tax authorities cannot simply claim that a treaty applies in order to assert that discrimination has been neutralised. They must instead prove that the ultimate recipients of this income are entitled to deduct the full amount of tax paid in Spain from their personal tax liability.

On a related note, while not a matter for the discussions in this case, we also believe that recognising the direct application of Article 63 TFEU to tax-transparent funds could strengthen these funds' arguments in discussions with the Spanish tax authorities regarding the application of the withholding tax exemption on dividends paid to EU recipients ultimately held by collective investment undertakings. If comparable evidence can be provided for both Spanish and foreign harmonised funds, Article 63 TFEU may apply even when the investment fund is transparent for tax purposes.