This case concerns the UK’s legislation on Controlled Foreign Corporations or CFCs.  This legislation provides that, under certain conditions, a resident company can be taxed on the profits of a foreign subsidiary as they arise. The conditions are: -    the CFC is a foreign company in which the resident company owns a holding of more than 50%; -    the CFC is subject, in the State in which it is established, to a level of taxation that is less than three quarters of the amount of tax which would have been paid in the UK.

The profits of the CFC are taxed in the hands of the UK parent, and a tax credit is granted for the tax that the CFC has paid in the State in which it is established. If the CFC distributes dividends, and those dividends are taxed at source, the UK also grants an additional tax credit for that source taxation.

The CFC legislation provides a number of exceptions, i.e. the taxation does not apply in the following cases: -    the CFC adopts an ‘acceptable distribution policy’, which means that a specified percentage (90% in 1996) of its profits are distributed within 18 months of their arising and taxed in the hands of a resident company; -    the CFC is engaged in ‘exempt activities’ within the meaning of that legislation, such as certain trading activities carried out from a business establishment; -    the CFC is quoted in a recognised stock exchange; -    the CFC’s chargeable profits do not exceed an amount set at UK £50 000 (€ 75.000).

The taxation provided for by the legislation on CFCs is also excluded when ‘the motive test’ is satisfied. The latter involves two cumulative conditions: -    First, the resident company must show that a reduction of UK tax was not the main purpose, or one of the main purposes, of the activities of the CFC; -    Secondly, the resident company must show that it was not the main reason, or one of the main reasons, for the foreign subsidiary’s existence in the accounting period concerned to achieve a reduction in United Kingdom tax by means of the diversion of profits. According to that legislation, there is a diversion of profits if it is reasonable to suppose that, had the foreign subsidiary or any related company established outside the United Kingdom not existed, the receipts would have been received by, and been taxable in the hands of, a United Kingdom resident.

The case at hand concerns two Irish subsidiaries of the Cadbury-Schweppes group that were established in the advantageous IFSC regime. According to the decision making the reference, it is established that the two subsidiaries were established in Ireland solely in order that the profits related to the internal financing activities of the Cadbury Schweppes group could benefit from the tax regime of the IFSC.

Judgment of the Court

The ECJ swiftly moves to the conclusion that the UK’s CFC legislation constitutes an infringement of the freedom of establishment enshrined in Art. 43 and 48 EC Treaty. The Court then applies the rule-of-reason test, if, in other words, an overriding reason of public interest could justify this infringement, and whether the infringement is proportionate in light of the public interest pursued.

The Court emphasizes that the mere fact that a resident company establishes a subsidiary, in another Member State with a lower level of taxation cannot set up a general presumption of tax evasion which justifies a restricting measure. Only when a national measure specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned, the measure can be seen as justified.

The Court states that the aforementioned exceptions to the CFC legislation largely allow subsidiaries in another Member State, with real economic activities, to exercise their freedom of establishment freely. If none of these exceptions are present, the taxation mentioned in the CFC legislation will not apply if the establishment and activities of the CFC pass the “motive test”. The Court doubts, however, if the motive test only targets wholly artificial arrangements. The Commission and the Belgian Government remark that the sole fact that diversion of profits is (one of) the main aim(s) of incorporating a foreign subsidiary, does not automatically lead to a wholly artificial establishment of that foreign subsidiary.

As the applicants, the Belgian Government and the Commission state, it is not sufficient that none of the exceptions to the CFC legislation apply and that the intention of obtaining a tax advantage was the motive for the establishment and activities of a foreign subsidiary to conclude that a wholly artificial arrangement has been set up with the sole aim of tax evasion. Such a presumption should be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment. The resident company must be given an opportunity to produce evidence that the CFC is actually established and that its activities are genuine. In this light, the UK authorities have the opportunity, for the purposes of obtaining the necessary information on the CFC’s real situation, of resorting to the procedures for collaboration and exchange of information between national tax administrations introduced by Council Directive concerning mutual assistance (77/799/EEC).

To conclude, the ECJ leaves it to the referring UK court to determine whether the motive test only targets wholly artificial arrangements or whether foreign subsidiaries with real economic activity are also targeted by the CFC legislation. This referral of the final decision to a national court is quite remarkable because it appears clearly from the detailed analysis the Court performed that the economic reality test is not the core of the motive test. In light of the aim of legal security, it would have been more diligent, if the ECJ had made the final decision by itself.

Mr. N., sole shareholder of three Dutch ltd.’s, moves from the Netherlands to the United Kingdom in the course of 1997. Pursuant to Dutch income tax regulations, Mr. N. has by that action disposed of his participations and will be taxed on the gains. Mr. N., though, uses the possibility to get a suspension of payment of tax due, for 10 years, by offering sufficient guarantees. In this case, Mr. N. has given in pledge part of the shares at issue. Mr. N. starts a procedure in front of the ECJ to have the gains tax on substantial shareholdings, as well as the pledge, declared incompatible with EC Law.

The first question that arises is whether Mr. N.’s claim should be based on an infringement of the freedom of establishment (Art. 43 EC Treaty) or whether Art.18 EC Treaty, concerning EU citizens’ freedom of movement and residence, applies. The ECJ judges that having a shareholding of 100% in another Member State than the Member State of residence, falls within the scope of the freedom of establishment.

The remainder of the dispute is very similar to the one at issue in the de Lasteyrie du Saillant case (ECJ, 14th of March 2004, C-9/02). The ECJ judges that (i) the immediate taxation of the gains, (ii) the alternative offered to the taxpayer by means of a pledge, (iii) the fact that later depreciations cannot be offset against the amount due, all lead to an infringement of the freedom of establishment.

The Court then applies the rule-of-reason test and states that the need of preservation of allocation of taxation powers between the different Member States is a legitimate aim (making reference to the Marks & Spencer case, 13th of December 2005, C-446/03). Nevertheless, the Dutch substantial shareholding gains tax is not proportionate in light of this aim.

First of all, there are other less restrictive methods available. Council Directive 77/799/EEC of 19 December 1977 concerning mutual assistance allows the authorities of the Member States to request all information necessary, and pursuant to Council Directive 76/308/EEC of 15 March 1976 on mutual assistance for the recovery of claims a Member State may request the assistance of another Member State in the recovery of debts relating to certain taxes, including those on income and capital.

Secondly, depreciations that arise after the transfer of residence must be taken into account, except when these depreciations are already taken into account in the Member State of residence. A system of capital gains tax on substantial shareholdings can only be compatible with EC Law if these two conditions are met.

Within the Finnish group relief system, it’s possible, under certain conditions, to make financial transfers within a group that are tax deductible for the distributor and taxable income for the recipient. This way, losses can be offset against profits within the same group of corporations. Transfers are possible in all directions, from parent company to (sub-)subsidiary and vice versa, as well as between sister companies.

However, one of the conditions for this advantageous regime to apply gave rise to a dispute which will be judged by the ECJ. For the transfer to be tax deductible by the distributor, the recipient has to be a Finnish company.

This dispute is very similar to the one judged in the Marks & Spencer Case of the 13th of December 2005 (Case C-446/03). In general, Advocate-General Kokott seems to follow the decision of the ECJ in that case. Restricting the group relief system to domestic companies constitutes a restriction to the right of establishment. However, such a restriction can be justified by the need for preservation of allocation of taxing powers between the different Member States.

The Oy AA case differs from the M&S case to the extent that in Marks and Spencer, the losses of foreign subsidiaries of M&S could not be offset with UK profits because of the liquidation of these subsidiaries. Thus, the ECJ considered the British group relief system disproportionate, as far as the impossibility to repatriate foreign losses is concerned.

In this case, however, Advocate-General Kokott clearly states that such facts are not present in the Oy AA case and that the ECJ needn’t decide about such exceptional situations.

The autonomous region of Azores is part of Portugal’s overseas territories where EC Law in principle applies, even though Art. 299 (2) EC Treaty permits taking into account factors like remoteness, insularity or dependence on a few products. As all these factors apply in the case of the Azores, jeopardizing the development of the local economy, the autonomous region at issues grants a reduction of 20% on Portuguese personal income tax and 30% on Portuguese corporate income tax, and this to all taxpayers established in its territory.

In its decision 2003/442/EC of the 11th of December 2002 the Commission analyzes these reductions. The reductions are considered as state aid in the sense of Art. 87 (1) EC Treaty, especially due to the selectivity of the measure. Taxpayers established in the Azores are taxed at a lower rate than taxpayers in other parts of Portugal. The state aid at issue could be compatible with EC Law if its established in view of promoting the development of economically disadvantaged regions (Art. 87 (3) EC Treaty).

The Commission accepts that the lower tax rate in the Azores could be justified, as long as those advantages are limited to companies contributing to the local development. This, however, is not the case for companies active in financial services or companies that deliver intra-group services. On these grounds, the Commission decided that the reductions of the Portuguese income taxes are illegal state aid when they apply to such companies.

Portugal, backed by the United Kingdom, argues that the Commission jumps to conclusions concerning the selectivity criterion. The context should be the autonomous region of Azores, where all companies are subject to the same regime, and not the whole of Portugal. Completely in line with the Opinion of Advocate-General Geelhoet of the 20th of October 2005, the ECJ states that only when an infra-State body is sufficiently autonomous in relation to the central government of a Member State, the legal framework appropriate to determine the selectivity of a tax measure might be limited to the geographical area concerned where the infra-State body, in particular on account of its status and powers, occupied a fundamental role in the definition of the political and economic environment in which the undertakings present on the territory within its competence operated. In the case of the Azores, the two aspects of the fiscal policy of the regional government, namely the decision to reduce the regional tax burden by exercising its power to reduce tax rates on revenue and the fulfillment of its task of correcting inequalities deriving from insularity, were inextricably linked and depended, from the financial point of view, on budgetary transfers managed by the central government. This implies, says the ECJ, that the correct context in which to see the measure at issue, is the complete territory of Portugal and the reduction in the Azores then constitutes a selective measure.

Finally the ECJ also confirms that companies that deliver financial or intra-group services do not sufficiently contribute to local development to enjoy the special regime of Art. 87 (3) EC Treaty. Therefore, the reduction, so far as it applies to these companies, amounts to illegal state aid.

An Italian charitable non-profit foundation (Stauffer) is the proprietor of commercial premises in Munich, but pursues no other activities in Germany. The services ancillary to the rental of that commercial property are provided by a German property management agent.

A foundation with the same characteristics as the Stauffer foundation would normally be exempt from corporation tax in Germany. However, Stauffer’s seat and management are located in Italy, which under German law makes the foundation liable to tax on rental income.

First of all, the ECJ decides that an investment in real estate, without active management, falls within the scope of Art. 56 EC Treaty (free movement of capital) and not within the scope of Art. 43 EC Treaty (freedom of establishment).

Granting an exemption of corporation tax solely to foundations established in Germany constitutes a restriction to the free movement of capital. Subsequently, the Court examines whether there could be a ground of justification for this restriction. Art. 58 EC Treaty cannot be interpreted as meaning that any tax legislation making a distinction between taxpayers by reference to their place of residence or the Member State in which their capital is invested is automatically compatible with the Treaty.

Only a difference in treatment that is justified by overriding reasons in the general interest, and that does not constitute a means of arbitrary discrimination or a disguised restriction, could be deemed compatible. The ECJ then applies the traditional “rule of reason” test to examine whether the restricting national regulation is relevant and proportional in light of the pursued aim of general interest.

Even though Art. 58 EC Treaty only applies to free movement of capital, and the EC Treaty articles concerning the other freedoms do not contain an equivalent article, the ECJ nevertheless applies the rule-of-reason test to all four Treaty freedoms. This again confirms the view that the ECJ considers Art. 58 EC Treaty as a codification of the rule-of-reason test.

All traditional grounds of justification mentioned by the German tax authorities, i.e. the effectiveness of fiscal supervision, the cohesion of the national tax system and the need to protect the basis of tax revenue, are rejected by the ECJ. A new argument advanced by the German tax authorities was that it cannot be ruled out that criminal and terrorist organizations operate under the guise of a charitable foundation, with the aim of money laundering and illegal transfer of funds between different EC Member States. But this ground of justification was also rejected by the ECJ, which pointed out that a presumption of criminal activity cannot be based solely on the observation that a foundation is established in a different Member State.

The ECJ concludes that refusing an exemption of tax on rental income of charitable foundations, purely because that foundation is established in a different Member State, constitutes an unjustified restriction to the freedom of capital movement.

Opinion of Advocate General, 3 October 2006, Case C-522/04, Commission of the European Communities v. Kingdom of Belgium

In his opinion of today, Advocate General STIX-HACKL has concluded that a number of Belgian tax provisions relating to life insurance contracts are contrary to EC law. The Belgian tax provisions include:

• Article 59 of the BITC (Belgian Income Tax Code) which makes the deductibility of employers’ supplementary pension and life assurance contributions subject to the condition that the contributions be paid to an insurance undertaking or mutual fund established in Belgium.
• Articles 145/1 and 145/3 BITC subjects the tax reduction for long-term savings granted for personal supplementary pension and life assurance contributions in the form of deductions made by the employer from the employee’s remuneration to the condition that the contributions be paid to an insurance undertaking or mutual fund established in Belgium. The Advocate General provided that Articles 59, 145/1 and 145/3 BITC constituted a restriction on the freedom to provide services for life insurance companies established in another Member State and also restricts the free movement of workers and the right of establishment.
• Article 364a BITC provides that when capital, surrender values and savings referred to in Article 34 of the BITC are paid or allocated to a taxpayer who has previously transferred his residence or the primary location of his assets abroad, the payment or allocation is deemed to have taken place on the day preceding that transfer.
• Article 364b BITC that taxes transfers of capital or of surrender values built up by means of employers’ contributions or personal contributions for supplementary retirement benefits to another pension fund or insurance institution established outside Belgium, while such a transfer does not constitute a taxable transaction if the capital or surrender values are transferred to another pension fund or insurance institution established in Belgium. According to the Advocate General, Articles 364a and 364b BITC are contrary to Directive 2002/83 concerning life assurance and constitute a discriminatory restriction on the free movement of capital.
• Article 224/2a of the General regulation on taxes assimilated to stamp duty that requires foreign insurers who have no place of business in Belgium to obtain authorisation, before providing their services in Belgium, of a representative residing in Belgium, who personally assumes, in writing, responsibility towards the State for paying the annual tax on insurance contracts, interest and fines which may be due in respect of contracts relating to risks situated in Belgium. The Advocate General considers that this obligation has been introduced in order to guarantee payment of the stamp duty and to combat tax evasion, which are objectives of public interest. However, such objectives can be effectively pursued by means of the Mutual Assistance Directive (77/799/EEC) recently amended by Council Directive 2003/93/EC. Hence, according to the Advocate General, the obligation to appoint a tax representative also constitutes an unjustifiable obstacle to freedom to provide services.

It should be noted that the Belgian Government did not dispute the Commission’s arguments in relation to the provisions of the BITC. The Belgian government only defended the compatibility with EC law of the obligation to appoint a tax representative pursuant to Article 224/2a of the General regulation on taxes. Therefore, it can be reasonably expected that the European Court of Justice will, as a minimum, find the Belgian income tax measures contrary to EC law.

Author: Mathieu Isenbaert

The European Commission has recently sent four (4!) formal requests to the Belgian government in order to end various kinds of discriminatory tax treatment.

Flemish Registration Duties

The first request relates to Article 61/3 of the Flemish Registration Duties Code, according to which a certain amount of the registration duties paid previously on the purchase of a house is deductible from the registration duties on the purchase of a new house. Such feature was designed to stimulate geographical mobility within the Flemish region. It is therefore provided that only Flemish registration duties previously paid can be credited. As a result, citizens moving house from another Member State to Flanders cannot get a credit for the registration duties that they have paid on the purchase of a house in their Member State of origin.

The European Commission considers that the refusal to give credits for foreign registration duties restricts citizens from moving to Flanders and from acquiring properties there. Therefore, the Commission deems the Flemish rule to be an infraction of the right of every citizen of the European Union to move and reside freely within the territory of the Union (Article 18 EC Treaty), as well as of the freedom of establishment (Article 43 EC Treaty) and of the free movement of capital (Article 56 EC Treaty). This case also illustrates the fact that the regional authorities of the Member States are bound by the EC Treaty in the same way as the central government.

Personal tax deductions

Secondly, the European Commission has requested Belgium to end discrimination on personal tax deductions for residents with foreign source income. The Belgian legislation at issue discriminates Belgian residents who enjoy both Belgian and foreign income by not granting such residents a full deduction for personal and family allowances. When a double tax convention is applicable, Belgium applies the so-called exemption with progression method by calculating the normal tax due on the gross overall income and subsequently granting a foreign tax credit that equals the overall tax due multiplied with a proportionality factor. The numerator of that proportionality factor is the foreign source income and the denominator thereof is the overall income, in which the personal and family allowances are not taken into account. As a result, only a portion of the amount of the personal and family allowances result in an effective reduction of the Belgian tax payable.

The Commission considers that this limited deduction of personal allowances is contrary to the EC Treaty. The European Court of Justice has already ruled on a very similar issue in a case concerning the Netherlands (Case C-385/00 “De Groot”). The Commission considers that the unavailability of full personal deductions contravenes the free movement of workers and self-employed persons guaranteed by Articles 39 and 43 of the EC Treaty and the corresponding provisions of the EEA Agreement and the right of every citizen of the Union to move and reside freely within the territory of each Member State of Article 18 of the EC Treaty.

Inbound dividends

The third Commission request relates to the discriminatory taxation of dividends paid by foreign companies to Belgian private investors. Belgian private investors receiving domestic dividends either pay a final tax withheld by the company or they are taxed at a special income tax rate of, in principle, 25%. Inbound dividends from other Member States are usually subject to a withholding tax of up to 15% in the source State on the basis of the double taxation agreement between Belgium and that State. Additionally, such dividends are taxed in Belgium at the special income tax rate of 25%. The result is that inbound dividends are taxed more heavily than domestic dividends.

The Commission has stated in its Dividend Taxation Communication of 19 December 2003 (IP/04/25) that a higher tax burden on inbound dividends constitutes a restriction within the meaning of Article 56 of the EC Treaty on individual taxpayers to invest in foreign shares. The European Court of Justice has interpreted the EC Treaty accordingly in the Manninen case (case C-319/02). In so far as the shareholding gives the shareholder control over the company it is also a restriction of the freedom of establishment of Article 43 of the EC Treaty. The same is true for the corresponding Articles of the EEA Agreement.

The subject matter of this complaint is also comparable to that of a request for a preliminary ruling, still pending before the European Court of Justice (case C-513/04 - Kerckhaert-Morres). That case is different, however, in so far that it concerns French dividends that entitled Belgian investors to a credit for French corporation tax, thus reducing the ultimate tax burden for Belgian investors when investing in France.

Outbound dividends

Finally, Belgium, together with Spain, Italy, Luxembourg, the Netherlands and Portugal, has received a formal request to amend its tax legislation concerning outbound dividend payments to companies. All six Member States tax dividend payments to foreign companies more heavily than dividend payments to domestic ones. Their national legislation provides for no or for only a very low taxation of domestic dividends while outbound dividends are subject to withholding taxes ranging from 5 to 25%.

The Commission’s legal analysis in these cases follows the one put forward in the aforementioned Commission’s Communication of 19 December 2003 (IP/04/25).

***

These four requests from the Commission are in the form of “reasoned opinions” under Article 226 of the EC Treaty. If Belgium does not reply satisfactorily to the reasoned opinions within two months, the Commission may refer the matters to the European Court of Justice.

The online press releases of the Commission can be found here:

Flemish registration duties
Personal tax deductions
Inbound dividends
Outbound dividends

European governments have earned 57.5 billion euro on the production and sale of beer. That is more than total annual government expenses in Poland or Finland.

This can be read in the report ‘The contribution made by beer to the European Economy’, researched by Ernst & Young. European consumers paid an estimated 19 billion in VAT for their beer consumption.

Excises contributed 10.5 billion to national treasuries. Top ranked countries for excises are Norway, Sweden, Finland, United Kingdom and Ireland.

Germany is the leading country in the production and consumption of beer. And it tops the list of exporting countries, followed closely by the Netherlands. Total tax revenues from beer are 7.5 billion in Germany.

Ernst & Young did the research by order of the Brewers of Europe.

The main conclusions of the report

The full report with country chapters 

A reference for a preliminary ruling to the ECJ by the Hasselt Court of First Instance concerning the Flemish exemption from succession duties for family-owned businesses has recently been published (Geurts and Vogten case, O.J., C-74/3, Case C-464/05). Article 60bis, §5 of the Flemish Code for Succession Duties provides for such an exemption on the condition that (i) at least five workers have been employed in the Flemish Region prior to the decease of the family-owner and (ii) the same rate of employment is maintained during the first five years following such decease. The deceased was a Dutch national who resided in Belgium but whose family business was established exclusively in the Netherlands. The Hasselt Court refers to the ECJ the question whether such conditions are compatible with the right of establishment and the free movement of capital. In light of the heirs of Barbier case (C-364/01), a finding by the ECJ in favour of the taxpayer, necessitating a change in the Flemish succession duties legislation, cannot be excluded.

The ECJ has recently declared the Belgium mobility law to breach the EC-freedoms.

Often countries’legislation is found by the European Court of Justice (ECJ) to be in breach of one or more of the EC-freedoms.

All that being great, but what is the impact of this on a nation’s policy in this respect.

Martin Banks did a small research on this and put his findings in an article for Expatica.com on April 19, 2006(link below).

http://www.expatica.com/source/site_article.asp?subchannel_id=41&story_id=29389&name=Defending+EU+worker+mobility

In his opinion of May 2, 2006 on the Cadbury Schweppes case (C-196/04), Advocate General Léger advised against the compatibility of British Controlled Foreign Company (CFC) legislation with the right of establishment of Article 43 EC Treaty.

CFC legislation applies when the profits made by a foreign group company controlled by a resident company are subject to substantially lower taxation than the tax rate in effect in the home State. Unless specified exceptions can be relied upon, CFC legislation will include the profits of such foreign controlled companies, as they arise, in the tax base of the parent company. CFC rules therefore are an exception to the general rule that only profits distributed in the form of dividends can be added to the tax base of the parent company.

The “lower level of taxation” triggering the application of UK CFC legislation at the time of the facts of the case, was set at three-quarters of the amount of tax which would have been due if the profits of the subsidiary had been taxed in the United Kingdom. A tax credit for the (lower) host State taxation and subsequent dividend taxation, if any, is granted to the UK resident company. CFC legislation also provides for a set of five exceptions, including a so-called “motive test” in which the taxpayer is allowed to show that a reduction in the UK tax base was not the main purpose, or one of the main purposes, of setting up the foreign company and of conducting business therewith.

Two Irish subsidiaries of Cadbury Schweppes enjoyed a tax rate of 10% under the (now abolished) IFSC regime and, hence, were hit by the UK CFC legislation. The non-tax motives submitted by Cadbury Schweppes did not satisfy the UK tax authorities, nor did they convince the referring judge, as the main purpose for establishing the Irish subsidiaries. Advocate General (AG) Léger, therefore, implicitly assumes that the main purpose for establishing the Irish subsidiaries was of a fiscal nature. Nevertheless, AG Léger finds that the level of taxation is a factor which a company may legitimately take into account in exercising its right of establishment of Article 43 EC and that the UK CFC legislation constitutes a restriction of that right. The AG goes on to examine whether the counteraction of tax avoidance may be a justification for such a restriction.

The UK tax authorities argued that its CFC legislation was adopted to counter the artificial diversion of profits from a resident company to a foreign subsidiary established in a low-tax country and carrying out intra-group transactions. However, referring to the ICI, X and Y,  Lankhorst-Hohorst, and De Lasteyrie du Saillant cases, the AG reminds of the fact that only legislation aimed at countering wholly artificial arrangements can justify a hindrance to a freedom guaranteed by the Treaty. The quintessential criterion, according to the AG, is whether the foreign subsidiaries are engaged in the actual pursuit of economic activity in the host State. As long as the foreign subsidiary performs genuine services from the host State to the parent company, such a situation cannot be considered as tax avoidance, even if the establishment of the foreign subsidiary had the reduction of the tax burden as its main purpose.

It is not clear to the AG whether the “motive test”, which provides for an exception to the CFC legislation, enables the taxpayer to redeem himself by providing proof of the substance of the foreign establishment in the host State and of the reality of the services rendered thereby. Only under such circumstances would the CFC legislation apply to wholly artificial situations and, therefore, be justified and proportionate. Based on the ambiguity of the “motive test”, the AG has recommended the remittal of the case to the referring national Court in order to determine whether the UK CFC rules only apply to wholly artificial situations within the abovementioned meaning.

If the ECJ’s grand chamber follows AG Léger’s opinion, it appears that the UK CFC legislation will be found to operate disproportionately restrictive whenever foreign subsidiaries with economic substance are targeted. It is to be expected that UK legislation and similar legislation in other Member States will have to be amended. A final ruling by the ECJ in support of Cadbury Schweppes will encourage investments in those Member States with low general rates of taxation or with favourable tax regimes such as the Belgian notional interest deduction.

Het Hof van Justitie heeft in haar arrest van 15 december 2005 een ingewikkelde regelgeving van België veroordeeld wegens schending van artikel 43 E.G.-verdrag.

De ingewikkelde regelgeving kwam erop neer dat een in België wonende zelfstandige werd verplicht tot inschrijven in België van een bedrijfsvoertuig dat aan hem ter beschikking was gesteld door een in een andere lidstaat gevestigde vennootschap (in casu Luxemburg) die hem tewerkstelde, terwijl dit bedrijfsvoertuig niet hoofdzakelijk bestemd was voor duurzaam gebruik in België en werd daar ook niet duurzaam gebruikt.

Dit werd dus veroordeeld.

Voor de volledige tekst van het arrest

The Court of Justice decided on 23 March 2006 over the supply of services from a company towards a fixed establishment of that company in another Member State but which forms no legal entity distinct from the company. These services are, except for the exceptions in the Sixth VAT Directive, not subject to VAT. Since the fixed establishment forms part of the same legal entity as the main company, the fixed company can not be considered as a separate taxable person.

Full text of the judgment.

In case C-253/03 CLT-UFA delivered on 23 February 2006 the ECJ stated that German provisions stipulating for different tax rates for branches and subsidiaries were contrary to the EC Treaty. 

Up until 2000 German tax provisions stipulated that domestic subsidiaries could benefit from a reduced tax rate of 30% provided that the profits were distributed. If the profits were retained, a general tax rate of 45% would apply. The reduced tax rate of 30% was however not applicable to branches of non-resident companies, instead the profits were subject t corporate tax of 42%. Hence, there was an obvious difference in tax treatment depending on whether the foreign company chose to operate in Germany through a subsidiary or a branch. 

CLT-UFA SA, a Luxemburg company with a permanent establishment in Germany, brought an action against German tax authorities claiming that the application of different tax rates was in breach with the freedom of establishment in Article 43 of the EC Treaty. 

When examining the case the ECJ referred to cases Commission v France and Saint Gobain. The court stressed that the freedom of establishment includes the freedom to choose the appropriate legal form in which to pursue activities in another Member State and cannot be limited by discriminatory tax provisions. The court found that branches and subsidiaries were in comparable situation for corporate tax purposes. The application of different conditions was therefore discriminatory. The court ruled finally that the difference in treatment could not be justified, and consequently a breach of EC Law was at hand. Read the case. 

The ECJ has delivered its judgment in case C-152/03 Ritter Coulais, concluding that German tax legislation may not hinder taxpayers who are subject to unlimited tax liability in Germany from taking into account rental losses realized abroad.

The case deals with a German couple who earned income in Germany from employment as school teachers but lived in a private family house in France. They requested that negavite income deriving from the property in France would be taken into account in Germany when determining their income tax rate.

According to the German-French tax treaty the income deriving from an immovable property was only taxable in the state where the property was situaded, France. The tax treaty provided, however, that this did not limit the right of Germany to take into account such income when determining the rate applicable to German income taxes. Accordingly, foreign income could be taken into account in Germany for the purposes of determining the rate of taxation. No account would however be taken to foreign losses. Yet this would be the case in a purely domestic situation.

The ECJ conluded that the application of different rules to non-residents infringed the free movement of workers. Read the full text.

The ECJ has delivered its decision in case C-265/04 Bouanich. The ruling is a legal precedent in all EU member states.

Mrs Bouanich, a French resident, held shares in a Swedish company. When the company repurchased shares from its shareholders Sweden withdrew a withholding tax of 30% on the amount paid to non-residents. In case of Mrs Bouanich the tax rate was reduced to 15% according to provisions in the Swedish-French tax treaty.

According to Swedish rules repurchase of shares constitutes a taxable event whereon the Swedish residents are taxed for capital gain after deduction for costs and expenses whereas the same amount paid out to non-residents is treated as dividends, with no right to costs deductions.

The question referred to the ECJ was whether this differential tax treatment of resident and non-resident shareholders, resulting partly from Swedish domestic law and partly from the application of the double tax treaty between France and Sweden, was compatible with the provisions of the EC Treaty.

The ECJ argued that the right to deduct the acquisition costs of shares constitutes a tax advantage, which is preserved solely to resident shareholders. In court’s view the effect of Swedish rules is that it is less attractive for investors to make cross-border transfers of capital such as buying shares in companies resident in Sweden. Consequently, the opportunities available to Swedish companies to raise capital from non-resident investors are restricted.

The ECJ found therefore that the differential treatment of non-resident and resident shareholders in the case of a repurchase of shares constitutes a restriction on the movement of capital within the meaning of Article 56 EC Treaty.

As to the possible grounds of justification, the ECJ found that, as the cost of acquisition of the shares is directly linked to the payments made in respect of their repurchase, there is no objective difference between the situations of resident and non-resident taxpayers when receiving such income. Consequently, the court found that the Swedish legislation was discriminatory to non-resident shareholders in as far as it imposed a higher tax burden compared to resident shareholders.

The ECJ examined also whether the tax treaty should be considered when examining the domestic legislation. The ECJ made the general statement that the tax treaty must be taken into account when interpreting Community Law since the tax treaty forms part of the legal background in the main proceedings. The court argued that the national legislation which derives from a tax treaty would only be compatible with the free movement of capital if the treatment of the non-resident shareholder as set out by the treaty is not less favourable than the treatment of a resident shareholder. The determination of whether the non-residents shareholders benefit from an equal treatment or suffer a disadvantage is the task of the national court. In so far the tax treaty does not result in an equal treatment it shall be set aside. Read full text.

One of the changes in the field of VAT the Program Bill of 27 December 2005 brought along is the rewriting of article 45 § 2 of the Belgian VAT Code, which deals with the deduction limitations in connection to cars. One of the changes carried out in this article relates to the fact that full deductibility of VAT relating to the letting or selling of cars will be restricted.

From now on the full deductibility of input VAT is only possible for ‘the letting of vehicles by a taxpayer who has an economic activity in letting vehicles to whosoever’ or for ‘the selling of vehicles by a taxpayer who has an economic activity in selling vehicles to whosoever’. As a consequence it will for instance no longer be possible for a car dealer to fully deduct the input VAT on the letting of cars because of the sole fact that a car dealer mainly sells cars and does not let cars to wohsoever. Only clients can benefit from the latter service.

One can question the conformity of the abovementiond provisions with the standstill clause as incorporated in the Sixth VAT Directive (art. 17.6). In principle the Member States can only preserve the exclusions from from the right to fully deduct input VAT that existed allready on the moment the Sixth VAT Directive came into effect. Thus it is not allowed for Member State to introduce new exclusions nor to enlarge the the scope of existing exclusions from the right to fully deduct input VAT.

In this case, the new provisions of article 45 § 2 can only be interpreted as the enlargment of the scope of an existing exclusions. As a result thereof we have to conclude that the Sixth VAT Directive violated.

On 24 January 2006 an agreement has been reached by the 22 Member State concerning reduced VAT rates for labour- intensive services. The agreement provides for the extension of the reduced VAT rates on labour-intensive services until 31 december 2010. Read the full statement.

Assume buying a residence in Portugal. To finance your acquisition you can either take up a loan from a Portuguese bank or any other bank resident in other EU Member States. Interest paid to Portuguese banks will not be subject to a 20 % withholding tax, this will however be the case once the interests are paid to a non-Portuguese financial institution.

According to the Commission, the application of withholding taxes on outbound interest results in a higher tax burden for foreign banks, which in turn, restricts the freedom to provide services and the free movement of capital. The Commission has therefore sent Portugal a formal request to amend its tax legislation. The request is so far in the form of a reasoned opinion, which the Portuguese government has to answer within two months. If Portugal does not reply satisfactorily, the Commission may refer the matter to the ECJ.
Read the press release.

Capital gains of non-residents

Spanish law provides for different tax treatment of capital gains depending on whether the taxpayer is resident or non-resident in Spain. According to rules which are available only to individuals resident in Spain, capital gains on assets derived from immovable property are subject to progressive taxation if the assets remain within the possession of the taxpayer for less than one year, and to a flat rate of 15% when the assets are realised after one year of possession.

Similar capital gains of non-resident individuals are on the contrary always taxed at a flat rate of 35%. The legislation entails therefore a higher tax burden for non-residents, a fact which the Commission finds discriminatory.

Spain has not changed its legislation despite the Commission’s formal request of July 2005. The Commission decided therefore to refer Spain to the ECJ.

Employment income of non-residents

The ECJ will also examine Spanish rules on taxation of employment related income. Non-resident individuals are generally subject to a final withholding tax at a rate of 25%, whereas resident individuals are taxed according to a progressive scale. In the latter case, individuals resident in Spain can benefit from a more advantageous tax rates ranging from 15% to 45%. The difference in treatment is most evident in cases when the resident taxpayers receive a comparatively low income, as the income is in such cases subject to the lowest tax rate. This application of different rules for residents and non-residents is therefore considered to be in breach with Article 39 of the EC Treaty.

Read the press release.