On 3 April 2025, the Court of Justice of the European Union delivered its decision (Case C‑228/24). The case centered on whether a Lithuanian tax authority could deny the participation exemption for dividends received from a UK subsidiary that lacked substance (e.g., no premises or staff), even though the subsidiary generated profits in its own right. The Lithuanian tax authorities classified the subsidiary as ‘artificial’ on the grounds that it had no employees, assets, or premises, and that its sole director simultaneously managed several other companies. Notably, however, the subsidiary was not a mere dividend conduit, as it distributed dividends from its own profits. In this context meaning that it wasn’t just set up to pass along dividends or passing income through to the parent – it actually generated its own revenues. Despite this, the dividends received were taxed, resulting in nearly EUR 4 million in additional taxes and penalties.
Dividends from an “artificial” company
Under Article 35(2) of the Lithuanian Corporate Income Tax Act, dividends received by a Lithuanian entity from a subsidiary established in a European Economic Area state that pays corporate tax are tax-exempt. This is known as participation exemption. However, Article 32(6) of the same law provides that this exemption does not apply where the subsidiary is deemed “artificial,” and its main purpose or one of the main purposes is obtaining a tax advantage.
The CJEU clarified that under Directive 2011/96/EU, Member States are entitled to deny the dividend tax exemption to a parent company – even where the subsidiary is not a conduit entity – if an abuse scheme is identified. However, the Court emphasized that simply classifying a company as “artificial” is not sufficient. It must be proven that the main purpose of its establishment or maintenance was linked to abusive features and tax benefits. The mere fact that a company displays some “artificial” features is not enough.
Importantly, when assessing a foreign subsidiary’s activity, authorities cannot limit their review solely to the moment when dividends were distributed. If the subsidiary was initially established for genuine business reasons and carried out commercial activities for some time, those facts must also be taken into account.
Key clarifications:
- Member States may refuse to grant a dividend tax exemption to a parent company if the subsidiary (even if not a conduit) is deemed “artificial,” provided that indicators of abuse are present.
- Determining whether a company is “artificial” requires assessment of the entire factual situation – not only at the moment of dividend distribution, but also the company’s prior business activity.
- Merely classifying a subsidiary as “artificial” does not automatically mean the parent company has gained an unlawful tax advantage. It must be shown that the main or one of the main purposes of its existence was to obtain tax benefits.
Practical advice for companies
Facts and indicators that may be assessed in favor of the company include:
- Business necessity – whether the subsidiary genuinely contributed to operations (e.g., acting as an intermediary with game distribution platforms).
- Economic rationale – whether the activity was needed due to market conditions, technological or business barriers, or contractual reasons (e.g., foreign jurisdiction rules more favorable for managing operational risks).
- Tax rates – if the foreign corporate tax rate is even higher than Lithuania’s, it is hard to argue that the purpose was tax avoidance.
- Business history – even if the subsidiary has few employees or uses a virtual office, it may still perform real functions such as entering into contracts, managing client relations, and assuming financial risks. It is important to demonstrate that the company engaged in genuine commercial activity over time, even if later its operations decreased.
This judgment is significant not only for Lithuanian companies but also for businesses across the EU – it makes clear that tax authorities cannot rely solely on the formal “artificiality” label of a subsidiary. They must prove the existence of a genuine abuse scheme and a tax avoidance purpose.
Jaroslavas Lukoševičius
Attorney
Creada
