The interplay between substance and abuse in EU Tax law after NEO Group: when operational substance seems not enough

This is a publication that is part of RSM's Voice of SCM. On a monthly basis, RSM issues the Voice of Supply Chain Management (SCM). Our consultants follow global developments and translate their impact into practical considerations for internationally active companies.

Operational substance does not rule out abuse, as an entity may conduct genuine activities while still forming part of an abusive arrangement given its purpose and overall structure. The NEO Group judgment confirms this by denying the withholding tax exemption to an operational parent company if it takes part in an underlying chain of non-genuine transactions. Following the OECD/G20 Base Erosion and Profit Shifting (“BEPS”) Project, substance planning became an important feature of international tax practice, as multinational enterprises faced heightened scrutiny over profit shifting and base erosion. Business substance generally refers to whether an enterprise maintains genuine operational activities and decision-making capacity in the jurisdiction in which it claims tax benefits.

This article was written by Rafi Mardroos (rmardroos@rsmnl.nl) and Wogan Chang (wchang@rsmnl.nl). Rafi and Wogan are tax consultants with RSM Netherlands with a focus on ESG and supply chain management.

What happened in NEO Group and which rule applied? 

The case concerned NEO Group UAB (‘NEO’), a Lithuanian company wholly owned by Retal Industries Limited (‘Retal’), a company resident in Cyprus. In 2016 and 2017, NEO and a second Lithuanian subsidiary of Retal paid dividends to Retal without Lithuanian withholding tax, relying on the exemption in Article 5 of the EU Parent-Subsidiary Directive (PSD). The Lithuanian tax authority did not dispute that Retal carried on genuine economic activities or that it was the beneficial owner of the dividends, even though more than 90 per cent of its income consisted of dividends.

The authority looked instead at the transactions above Retal. A Belizean shareholder had sold all shares in Retal to PPH, a newly incorporated Cypriot company, for approximately EUR 310 million, with payment deferred until 2027. The resulting receivable was assigned to a Cypriot-resident individual who already controlled both the seller and the buyer. Retal then paid dividends to PPH in amounts similar to those it had received from Lithuania, and PPH used funds derived from those dividends to settle its debt to the individual. The authority concluded that the individual, not Retal, was the ultimate beneficiary and assessed approximately EUR 2.25 million of tax plus interest and penalties. The Lithuanian Tax Disputes Commission referred questions to the Court of Justice of the European Union (CJEU), which ruled on 15 October 2026 in Case C-203/25.

Article 1(2) of the PSD, in the version applicable since 2015, requires Member States to deny the benefits of the directive to an arrangement, or a series of arrangements, that meets two cumulative conditions. First, it was put into place for the main purpose, or one of the main purposes, of obtaining a tax advantage that defeats the object or purpose of the PSD. Second, it is not genuine, having regard to all relevant facts and circumstances. Article 1(3) specifies that an arrangement is non-genuine to the extent that it is not put into place for valid commercial reasons that reflect economic reality, and Article 1(2) confirms that an arrangement may comprise more than one step or part. The burden of proof rests on the Member State that refuses the exemption.

What did the CJEU decide in NEO Group on anti-abuse rules under the PSD?

Under the general anti-abuse rule of the PSD, the CJEU’s judgment in NEO Group provides a clear example that substance and abuse are not mutually exclusive. In the first set of questions, the CJEU held (Judgment of the Court of Justice of 15 October 2026, NEO Group, C-203/25 (provisional text; ECLI to be added on publication) that even where the dividend-receiving parent company conducts genuine economic activities in another EU Member State, is not a conduit company and is the beneficial owner of the dividends, the source Member State may still deny the withholding tax exemption if the parent company participates in a wholly or partly non-genuine transaction chain designed to obtain a tax advantage contrary to the purpose of the PSD. The assessment must consider the arrangement as a whole and whether each step reflects economic reality and has valid commercial reasons. Accordingly, genuine economic activity and substance of the immediate parent company do not necessarily exclude abuse, and the relevant unit of analysis is the entire arrangement rather than the immediate parent company alone.

In the third and fourth set of questions, the CJEU further clarified that the dividend-paying Member State may consider transactions occurring outside its territory and deny the exemption where this is necessary to identify and counter the abusive arrangement. Such an approach is, in principle, proportionate, provided that the measures are appropriate and do not go beyond what is necessary to prevent abuse. In addition, the CJEU confirmed that the tax benefit under the PSD does not necessarily need to be obtained by the subsidiary that initially distributes the dividends.

In the sixth set of questions, the CJEU added that a non-genuine arrangement alone is insufficient to establish abuse. There must also be an intention to obtain a tax advantage by artificially creating the conditions for it. However, the tax authority need not prove that the dividend-paying subsidiary knew or should have known of the abuse. It is sufficient that such knowledge existed at the level of another group company in the transaction chain or the person benefiting from the tax advantage.

For example, where an EU parent entity has employees, premises and substantial economic activities, as well as a genuine operational connection with its subsidiary, its ownership of the subsidiary may therefore be supported by valid commercial reasons.  

Nevertheless, if dividends received by the EU parent subsequently reach the ultimate non-EU shareholder through capital reductions or other financial arrangements that lack valid commercial reasons and are principally intended to obtain a tax advantage, those arrangements, viewed as part of the wider transaction chain, may be regarded as non-genuine. In such circumstances, the relevant abuse would arise not from the parent’s ordinary business activities or its position in the ownership structure, but from the artificial financial arrangements through which the funds are transferred. As a result, the fact that the direct recipient is a genuine operating company rather than a conduit would not, in itself, preclude the application of the anti-abuse rule.

How has the definition of abuse under the PSD evolved?

The Danish cases of 2019 (T Danmark and Y Denmark, joined cases C-116/16 and C-117/16) focused primarily on conduit structures in which an interposed company passed dividends on to the beneficial owner. Nordcurrent group (C-228/24, 3 April 2025) clarified that conduit companies are merely one example of abuse and that all relevant facts and circumstances, including those preceding and following the dividend distribution, must be assessed. Building on that approach, the Dutch Supreme Court decided on 18 July 2025 (ECLI:NL:HR:2025:1162 and ECLI:NL:HR:2025:1163) that the existence of genuine activities at the level of an intermediate parent is not sufficient. The Dutch Supreme Court indicated that participation in the Dutch BV should be functionally attributed to the shareholder's substantive business, provided the shareholder undertakes a certain level of management activity (active involvement) concerning the distribution entity. NEO Group subsequently extended this arrangement-wide analysis by confirming that even a parent carrying on genuine activities and beneficially owning the dividends does not provide a safe harbour where that parent participates in a broader chain containing non-genuine steps.  

The case law has therefore moved from identifying substance-poor conduits, through a comprehensive and dynamic assessment, to examining the functional connection and actual involvement of the parent, and ultimately to scrutinising the entire transaction chain beyond the immediate dividend recipient.

How should multinational groups deal with operational substance and abuse after NEO Group?

From a practical perspective, the judgment confirms that the assessment of abuse is not confined to the direct recipient of the dividends but may encompass the entire transaction chain. Groups will therefore need to “follow the money” by tracing the flow and ultimate use of funds throughout the structure to assess potential exposure to an abuse challenge.

Multinational groups should also maintain documentation demonstrating the economic substance and valid commercial rationale of each relevant step in the broader arrangement. However, the burden remains on the tax authorities to establish the constituent elements of abuse, providing an important safeguard against presumptive or unsupported findings.

Four points follow from the judgment for groups active in international trade that rely on the PSD exemption. The first is mapping: a group can trace dividends upward and identify every shareholder-level transaction that is funded by, or follows, those dividends, such as share sales with deferred consideration, shareholder loans, loan assignments and capital reductions. The second is evidence: the commercial reasons for each step are best captured at the time of the transaction, for example in board minutes, financing agreements and valuation reports, because an authority may later test every step.  

The third is timing: because abuse can emerge over a longer period, holding and financing structures benefit from a periodic review, after acquisitions, disposals and refinancings. The fourth is contractual: a subsidiary can face withholding tax because of steps taken above it that it did not know about, which makes information rights, indemnities and conduct-of-claims provisions in shareholder agreements and acquisition documents relevant, particularly in joint ventures.

What are the takeaways for now after NEO Group?

Our view is that NEO Group moves the central question from where the substance sits to why each step in the chain exists. Substance remains necessary because it removes the conduit argument, but it no longer closes the discussion. The same logic already underlies the principal purpose test in tax treaties, in which purpose and the overall arrangement matter more than the legal form of any single entity. Groups that document the commercial logic of their holding, financing and distribution steps will be better placed in a dispute than groups that rely on substance at the level of the direct parent alone.

Two practical takeaways stand out:

• First and foremost: 'substance planning', whereby existing operational companies are interposed in legal structures or companies are 'dressed up' to become operational companies, is no longer a safeguard to achieve tax benefits.
• The question is what the judgment of 15 October 2026 will do to current practice in EU Member States. Dutch parliamentary history and the practice of the Dutch tax authorities, for instance, state that the look-through approach under the 'avoidance test' may cease at the level of operational companies. Or that no ‘artificial arrangement’ should be present where the direct parent company recipient has a material enterprise. These approaches may have become too lenient after the NEO Group decision of 15 October 2026.  

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