The ECJ and Corporate Tax: Recent Developments

1. The ECJ and Corporate Tax:Recent Developments Malcolm Gammie Q.C. One Essex Court

2. The Community Law principles • Direct tax systems must be compatible with Community law “It must be borne in mind that, according to settled case-law, although direct taxation is a matter within the competence of the Member States, they must none the less exercise that competence in a manner consistent with Community law (see, inter alia, Marks & Spencer, paragraph 29; Case C-374/04 Test Claimants in Class IV of the ACT Group Litigation [2006] ECR I-11673, paragraph 36; and Case C-182/08 Glaxo Wellcome [2009] ECR I-0000, paragraph 34).” Case C-337/08 X Holding BV paragraph 16

3. The Community Law Principles • Two basic principles: • Market access, i.e. a measure must not impede or restrict or render less attractive access to the single market (see e.g. Case C-55/94 Gebhard) • Non-discrimination, i.e. a measure must not discriminate on grounds of nationality • Applied from the perspective of the origin/host State, not by comparison with other Member States

4. Market Access • The issue is whether the effect of the measure is to restrict access • Discrimination is not a necessary feature of market access (although it is usually the difference in treatment between domestic and cross-border tax rules that identifies the issue) • “Quasi-restrictions” do not breach Treaty

5. Dassonville & Keck • The Dassonville formulation is: “All trading rules enacted by Member States which are capable of hindering, directly or indirectly, actually or potentially, intra-Community trade are to be considered as measures having an effect equivalent to quantitative restrictions” • Restricted by Keck in the case of “national provisions restricting or prohibiting certain selling arrangements”

6. Domestic & International Rules • Direct taxes have to draw lines between national and international and differentiate the two • It seems clear that any such line is liable to represent a prima facie breach, see Manninen and Marks & Spencer • The issue is then what amounts to “equal treatment” (see Bouanich) and what can be justified subject to proportionality (see Marks & Spencer)

7. Non-discrimination • This principally concerns domestic (“certain selling arrangements”) rather than cross-border rules • The analysis in the tax field, however, is made more difficult because States exercise extra-territorial taxing rights • Comparison is fundamental to nationality discrimination • Equal treatment here usually means the same treatment

8. Non-discrimination • Case C-253/03 CLT-UFA • Luxembourg company with German branch • Branch profits tax but at higher rate than if equivalent distribution of subsidiary profits • Advocate General: • “this violation of EC law stems from the fact that the Member State treats the non-resident company as a national company to establish the tax basis and then excludes it from the advantages linked with this taxation” (§ 68) • ECJ: • § 30 : “German subsidiaries and branches of companies having their seat in Luxembourg are in a situation in which they can be compared objectively”.

9. Differences in Treatment • Case C-471/04 Keller Holdings • Financing costs incurred by German parent company relating to subsidiaries are • not deductible if they relate to dividends paid by an indirect subsidiary established e.g. in Austria • deductible if they relate to dividends paid by an indirect subsidiary established in Germany. • ECJ • “in both cases, the dividends received … are … exempt from tax. Accordingly, a restriction on the deductibility of a parent company’s financing costs – as a corollary of the non-taxation of dividends – which affects solely dividends from abroad does not reflect a difference in the situation of parent companies according to whether the indirect subsidiary owned by the latter has its registered office in Germany or in another Member State”. (§ 37)

10. Host and Origin State Perspectives • Case C-374/04 Test Claimants in Class IV ACT GLO: • UK denial of imputation tax credit to non-resident investors • MFN and LoB issues • Case C-446/04 Test Claimants in the FII GLO: • Exemption of domestic dividends and taxation of foreign dividends with credit • Case C-201/05 Test Claimants in CFC and Dividend GLO (Order of 23 April 2008)

11. Another Dividend Case • Case C-170/05 Denkavit • 25% WHT on dividends to non-resident parent compared to 95% exemption of dividends paid to resident parent • Resident and non-resident parents in comparable position because France taxes both and objective of domestic rule is to eliminate multiple taxation • Dividend WHT reduced to 5% under FR/NE Treaty with credit in Netherlands, but • France cannot justify its discriminatory measure by reference to Dutch taxation of the dividend or its Treaty with the Netherlands

12. Juridical Double Taxation • Case C-513/04 Kerckhaert Morres • French dividend (with avoir fiscal less 15% WHT) • Belgium taxed domestic and foreign dividends at 25% but previously under BE/FR Treaty had allowed a fixed %age relief (withdrawn) • No breach of Article 56 EC Treaty by Belgium as failure to relieve French WHT an example of juridical double taxation • Belgium did not seek to relieve economic double taxation domestically and not bound to do so internationally

13. Justifications • Loss of tax revenue: completely unacceptable • Territoriality of tax: but does not mean you can treat it differently if you do not tax it – may be subject to tax elsewhere • Other compensating tax benefits: unacceptable • Effective fiscal supervision: acceptable in theory and accepted but mutual assistance is possible • Need to fight tax evasion or fraud: acceptable in theory • Cohesion: acceptable in theory • Allocation of taxing jurisdiction: the new cohesion?

14. Justifications – Tax Avoidance • In principle, a justification but limited to cases of wholly artificial arrangements to circumvent national tax provisions • Centros: • “the fact that the company was formed in a particular Member State for the sole purpose of enjoying the benefit of more favourable legislation does not constitute abuse even if that company conducts its activities entirely or mainly in that second State”. • A ‘blanket’ avoidance provision will not be accepted – ICI; Lankhorst; de Lasteyrie • BUT anti-‘double dipping’ can be justified – M&S

15. Justifications – Tax Avoidance • Case C-105/07 NV Lammers & Van Cleef “A national measure restricting freedom of establishment may be justified where it specifically targets wholly artificial arrangements designed to circumvent the legislation of the MS concerned” “… the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on the national territory”

16. Justifications – Tax Avoidance • Case C-201/05 Test Claimants in the CFC and Dividend GLO “[CFC rules] not permitted unless inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable … must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives, that CFC is actually established in the host MS and carries on genuine economic activities there” • But MS may impose compliance requirements to verify existence of establishment and genuine activities

17. Justifications – ‘Cohesion’ • Accepted once in Bachmann • Always argued; never accepted:- • One taxpayer, same tax; direct link between taxation and relief • But see now Case C-418/07 Papillon • Bachmann can be seen as a case of ‘equal treatment’ • “new cohesion justification” is to look at the aim of the legislative measure – Manninen; M&S

18. New cohesion – Aim of the tax rule • Objective of the legislation: • to avoid double taxation of the same profits (Manninen) • to ensure fiscal neutrality within group of companies (M&S) • the legislation at issue: • does not avoid the double taxation of profits distributed by a Swedish company (Manninen) • refusing systematically any transfer of losses of foreign subsidiaries does not ensure neutrality (M&S) • If the MS says that it cannot tax the profits of the Swedish company or of the foreign subsidiaries? • this objective (to avoid a reduction of tax revenues) is not admissible (Manninen) • the State would then have objectives (protection of the revenue or favouring groups only active on its territory) contrary to EC law (M&S)

19. Case C-231/05 Oy AA • Finnish subvention payment regime allowing a tax deductible intra-group financial transfer on the basis that it is taxable for the transferor • Oy AA sought to make payment to AA Ltd (UK) • Breach of EC law in particular— • Immaterial that Finland cannot tax AA Ltd but may make deduction conditional on taxation in other MS • Cannot make deduction conditional upon AA Ltd having a Finnish branch • Immaterial that AA Ltd can offset its losses in future periods against UK profits

20. Case C-231/05 Oy AA • Can Finland justify the breach? • MS deploy the three M&S justifications— • Finnish restriction ensures the coherence of its tax system and the balanced allocation of taxation powers between MS • Without the restriction there is a risk of “double dipping” • Without the restriction there is a risk of avoidance in allowing groups to transfer profits to MS where they are taxed at the lowest rate or exempt

21. Case C-231/05 Oy AA • As regards the need for balanced allocation— 53.  it should be pointed out that that need cannot justify a Member State systematically refusing to grant a tax advantage to a resident subsidiary, on the ground that the income of the parent company, having its establishment in another Member State, is not capable of being taxed in the first Member State (see, to that effect, Rewe Zentralfinanz, paragraph 43). 54. That element of justification may be allowed, however, where the system in question is designed to prevent conduct capable of jeopardising the right of the Member States to exercise their taxing powers in relation to activities carried on in their territory (Rewe Zentralfinanz, paragraph 42).

22. Case C-231/05 Oy AA 56. Similarly, to accept that an intra-group cross-border transfer, such as that at issue in the main proceedings, may be deducted from the taxable income of the transferor would result in allowing groups of companies to choose freely the Member State in which the profits of the subsidiary are to be taxed, by removing them from the basis of assessment of the latter and, where that transfer is regarded as taxable income in the Member State of the parent company transferee, incorporating them in the basis of assessment of the parent company. That would undermine the system of the allocation of the power to tax between Member States because, according to the choice made by the group of companies, the Member State of the subsidiary would be forced to renounce its right, in its capacity as the State of residence of that subsidiary, to tax the profits of that subsidiary in favour, possibly, of the Member State in which the parent company has its establishment (see also Test Claimants in Class IV of the ACT Group Litigation, paragraph 59).

23. Case C-231/05 • As regards the other justifications— 57. Concerning, secondly, the risk that losses might be used twice, it is sufficient to point out that the Finnish system of intra-group financial transfers does not concern the deductibility of losses. 58. Concerning, finally, the prevention of tax avoidance, it must be acknowledged that the possibility of transferring the taxable income of a subsidiary to a parent company with its establishment in another Member State carries the risk that, by means of purely artificial arrangements, income transfers may be organised within a group of companies towards companies established in Member States applying the lowest rates of taxation or in Member States in which such income is not taxed. That possibility is reinforced by the fact that the Finnish system of intra-group financial transfers does not require the transferee to have suffered losses.

24. Case C-231/05 Oy AA • Is a blanket restriction a proportionate response— 65. That detriment cannot be prevented by imposing conditions concerning the treatment of the income arising from the intra-group financial transfer in the Member State of the transferee, or concerning the existence of losses made by the transferee. To allow deduction of the intra-group financial transfer where it constitutes taxable income of the transferee company, or where the opportunities for the transferee company to transfer its losses to another company are limited, or to allow deduction of an intra-group financial transfer in favour of a company whose establishment is in a Member State applying a lower rate of tax than that applied by the Member State of the transferor only where that intra-group financial transfer is specifically justified by the economic situation of the transferee, as Oy AA has proposed, would nevertheless mean that, in the final analysis, the choice of the Member State of taxation would be a matter for the group of companies, which would have a wide discretion in that regard.

25. Case C-293/06 Deutsche Shell • DS set up Italian PE and supplied start-up capital • PE eventually incorporated and sold with resulting capital being repatriated to Germany • FOREX loss arose due to depreciation of Italian Lire • DS sought to deduct the FOREX loss in its German corporation tax computation

26. Case C-293/06 Deutsche Shell • According to settled case-law, all measures which prohibit, impede or render less attractive the exercise of [the freedom of establishment] must be regarded as obstacles • The Court has held in particular that such restrictive effects may arise specifically where, on account of a tax law, a company may be deterred from setting up subsidiary bodies such as PEs in other MS and from carrying on its activities through such bodies

27. Case 293/06 Deutsche Shell • Three justifications argued: • Taking account of the loss lead to a ‘non-coherent’ tax system since any equivalent FOREX gain would not be taxed: REJECTED - No direct relationship between the FOREX loss and any FOREX gain • The GE/IT Treaty allocated the taxing right over the PE to Italy and exempt it in Germany: REJECTED – FOREX loss could only arise in Germany and be relieved there • Effectively loss taken into account twice because deducted as operating expenditure but operating profit of PE not taxed: REJECTED – Germany unable to tax PE profit because it waived its taxing power under the GE/IT Treaty

28. Case C-414/06 Lidl (AG) • Lidl incurred a loss in its PE in Luxembourg and sought to deduct the loss in Germany • GE/LUX Treaty exempted PE profits in Germany and Germany claimed this meant losses were not deductible • That argument was lost in M&S but could the denial of a deduction be justified?

29. Case C-414/06 Lidl (AG) • M&S justified the UK restriction on the grounds of: • Preserving the allocation of taxing power • Preventing ‘double-dipping’ • Preventing tax avoidance • Any justification must also be proportionate in addressing the relevant issues and not going further than is needed to do so • Do the same justifications apply to a PE?

30. Case C-414/06 Lidl (AG) • Allocation of taxing powers • A PE differs from a subsidiary because State asserts taxing right over resident company but not non-resident subsidiary. Nevertheless, GE/LUX Treaty allocated taxing right to Luxembourg • Scope for double deduction of losses is the same • But PEs do not offer scope for ‘jurisdiction shopping’ to get relief at highest tax rate

31. Case C-414/06 Lidl (AG) • Sufficient that one or more of M&S justifications present; no need for all three • Is an outright prohibition on loss relief ‘proportionate’? i.e. “appropriate for securing attainment of the objectives it pursues and not go beyond what is necessary to attain those objectives? • Clearly attains the objective but goes further than necessary because relief and recapture is less restrictive while attaining the objective.

32. Case C-414/06 Lidl (ECJ) • A tax regime that denies relief for losses incurred by a foreign PE is a disadvantage that involves a restriction on the freedom of establishment • Under the Lux/Ge DTC the income of the Luxembourg PE is not taxed in Germany. The restriction on loss relief is therefore capable of preserving the balanced allocation of taxation powers • There would also be the possibility of losses being used twice • No need to show tax avoidance justification – M&S justifications are not cumulative • Furthermore proportionate because Luxembourg allowed carry forward of losses (which had been used)

33. Case C-418/07 Papillon • French fiscal consolidation scheme allows grouping of French subsidiaries and sub-subsidiaries of a French parent company but does not allow grouping of a French sub-subsidiary held via a non-resident subsidiary • Held: breach of EC law that could not be justified on grounds of allocation of taxing powers or “double dipping” – the issue related to a French sub-subsidiary not to the inclusion of a foreign subsidiary in the fiscal consolidation

34. Case C-418/07 Papillon • But could the breach be justified on the basis of maintaining the coherence of the French fiscal regime, i.e. Bachmann grounds? Is there a direct link between the tax advantage and the offsetting of the advantage by a particular tax levy? • French Government argues that— • Loss derived from depreciation of holding in sub-subsidiary cannot be ‘neutralised’ because immediate parent is not a French company within the fiscal consolidation regime • Too difficult to ascertain whether losses used twice on this basis

35. Case C-418/07 Papillon • The breach cannot be justified on these grounds because not a proportionate response— • Practical difficulties cannot of themselves justify breach • The mutual assistance directive can be invoked • Or the French parent company can be required to demonstrate whether the sub-subsidiary losses are taken into account in assessing its share values • As none of that is provided for as part of the French regime, it follows that the breach cannot be justified on these grounds because less restrictive measures (than a blanket prohibition) are available.

36. Case C-337/08 X Holding BV • Dutch Fiscal Unity regime— • Dutch parent company may elect to establish a consolidated entity with a Dutch subsidiary but not with a foreign subsidiary • X Holding applied to establish a consolidated entity with a Belgian subsidiary • ECJ reasoning— • Is there a breach? • Is there a justification? • Is it proportionate?

37. Case C-337/08 X Holding BV • Does the Dutch fiscal unity regime breach Community Law? 18. In that regard, the possibility granted by Netherlands law to resident parent companies and their resident subsidiaries to be taxed as if they formed a single tax entity, that is to say, to be subject to a tax integration scheme, constitutes an advantage for the companies concerned. That scheme allows, in particular, for the profits and losses of the companies constituting the tax entity to be consolidated at the level of the parent company and for the transactions carried out within the group to remain neutral for tax purposes. 19. The exclusion of such an advantage for a parent company which owns a subsidiary established in another Member State is liable to render less attractive the exercise by that parent company of its freedom of establishment by deterring it from setting up subsidiaries in other Member States. 20. In order for such a difference in treatment to be compatible with the provisions of the EC Treaty on the freedom of establishment, it must relate to situations which are not objectively comparable or be justified by an overriding reason in the general interest (see, to that effect, Case C-446/04 Test Claimants in the FII Group Litigation [2006] ECR I-11753, paragraph 167).

38. Case C-337/08 X Holding BV • Does the Dutch fiscal unity regime breach Community law? 24. However, the situation of a resident parent company wishing to form a single tax entity with a resident subsidiary and the situation of a resident parent company wishing to form a single tax entity with a non-resident subsidiary are objectively comparable with regard to the objective of a tax scheme such as that at issue in the main proceedingsin so far as each seeks to benefit from the advantages of that scheme, which, in particular, allows the profits and losses of the companies constituting the single tax entity to be consolidated at the level of the parent company and the transactions carried out within the group to remain neutral for tax purposes.

39. Case C-337/08 X Holding BV • Can the Dutch fiscal unity regime be justified? 26. In order to be so justified, such a difference must be appropriate for ensuring attainment of the objective pursued and must not go beyond what is necessary to achieve that objective (see, to that effect, Case C-250/95 Futura Participations and Singer [1997] ECR I-2471, paragraph 26, Case C-9/02 de Lasteyrie du Saillant [2004] ECR I-2409, paragraph 49, and Marks & Spencer, paragraph 35). 28. In that regard, it should be noted that the preservation of the allocation of the power to impose taxes between Member States may make it necessary to apply to the economic activities of companies established in one of those States only the tax rules of that State in respect of both profits and losses (see Marks & Spencer, paragraph 45, and Case C-414/06 Lidl Belgium [2008] ECR I-3601, paragraph 31).

40. Case C-337/08 X Holding BV • Can the Dutch fiscal unity regime be justified? 31. Since the parent company is at liberty to decide to form a tax entity with its subsidiary and, with equal liberty, to dissolve such an entity from one year to the next, the possibility of including a non-resident subsidiary in the single tax entity would be tantamount to granting the parent company the freedom to choose the tax scheme applicable to the losses of that subsidiary and the place where those losses are taken into account. 32. Since the dimensions of the tax entity can therefore be altered, acceptance of the possibility of including a non-resident subsidiary in such an entity would have the consequence of allowing the parent company to choose freely the Member State in which the losses of that subsidiary are to be taken into account (see, to that effect, Oy AA, paragraph 56, and Lidl Belgium, paragraph 34). 33. A tax scheme such as that at issue in the main proceedings is, for that reason, justified in view of the need to safeguard the allocation of the power to impose taxes between the Member States.

41. Case C-337/08 X Holding BV • But is there a less restriction answer? 35. X Holding and the Commission of the European Communities submit, in that regard, that the formation of a single tax entity in national territory means that resident subsidiaries are treated for tax purposes in the same way as permanent establishments. They argue that, by way of analogy, non-resident subsidiaries could, in the context of a cross-border tax entity, be treated in the same way as foreign permanent establishments. In their view, however, the losses incurred by a foreign permanent establishment can be temporarily offset against the profits of the parent company under a provision for temporary transfer of losses linked to a recovery arrangement in subsequent financial years. The application of that arrangement to non-resident subsidiaries might constitute a less onerous means to achieve the relevant objective than prohibiting a resident parent company from forming a single tax entity with a non-resident subsidiary.

42. Case C-337/08 X Holding BV • Is the Dutch response proportionate? 38. Permanent establishments situated in another Member State and non-resident subsidiaries are not in a comparable situation with regard to the allocation of the power of taxation as provided for in an agreement such as the Double Taxation Agreement, and in particular in Articles 7(1) and 23(2) thereof. Whereas a subsidiary, as an independent legal person, is subject to unlimited tax liability in the State party to such an agreement in which that subsidiary is established, the same does not apply in the case of a permanent establishment situated in another Member State, which remains in principle and in part subject to the fiscal jurisdiction of the Member State of origin.

43. Case C-337/08 X Holding BV • Is the Dutch response proportionate? 39. It is, admittedly, true that the Court has held in other cases that the second sentence of the first paragraph of Article 43 EC leaves traders free to choose the appropriate legal form in which to pursue their activities in another Member State and that freedom of choice must not be limited by discriminatory tax provisions (see, to that effect, Commission v France, paragraph 22; Oy AA, paragraph 40; and Case C-253/03 CLT-UFA [2006] ECR I-1831, paragraph 14). 40. However, the Member State of origin remains at liberty to determine the conditions and level of taxation for different types of establishments chosen by national companies operating abroad, on condition that those companies are not treated in a manner that is discriminatory in comparison with comparable national establishments (Case C-298/05 Columbus Container Services [2007] ECR I-10451, paragraphs 51 and 53). As permanent establishments situated in another Member State and non-resident subsidiaries are not, as has been stated in paragraph 38 of the present judgment, in a comparable situation with regard to the allocation of the power of taxation, the Member State of origin is not obliged to apply the same tax scheme to non-resident subsidiaries as that which it applies to foreign permanent establishments.

44. Marks & Spencer v Halsey [2003] STC (SCD 70 42. The corollary of this is that if the United Kingdom subsidiary chooses to establish a French subsidiary rather than a French branch, the parent company cannot complain of discrimination on the grounds that its French subsidiary is taxed less favourably in France than its United Kingdom subsidiary would have been had it established a French branch. This is in conformity with the principle that the application of different conditions for pursuing economic activities in different member states does not amount to discrimination. Such differences may preserve national boundaries and inhibit the exercise of the relevant freedoms but (in the absence of Community harmonisation legislation) a member state is entitled to impose stricter requirements on its nationals than are found elsewhere in the Community provided the exercise of a relevant Community right is not involved. 43. The United Kingdom parent company or the French subsidiary would be entitled to complain if the French subsidiary were subject to less favourable treatment as compared to other French companies because it was owned by a United Kingdom company rather than by French nationals: Metallgesellschaft Ltd v IRC; Hoechst AG v IRC (Joined cases C-397/98 and C-410/98) [2001] STC 452, [2001] Ch 620; X and Y v Riksskatteverket (Case C-436/00) (2002) 5 ITLR 433). Provided the French subsidiary is subject to no less favourable rules than comparable French companies, however, the more favourable treatment of a French branch is a purely internal French matter not involving any exercise by the French subsidiary of its Community rights. 44. In our view, therefore, it is clear that art 43 EC inures for the benefit of the United Kingdom subsidiary vis-à-vis France as the host state in its choice of a branch but cannot be relied upon by its French subsidiary as a French national against a French rule generally applicable to French companies. If, for example, France exempted particular profits arising to a French branch of the United Kingdom subsidiary, when the same profits would be taxed in the hands of a French subsidiary, the United Kingdom subsidiary could not complain that this infringed its freedom to establish in France indirectly through a subsidiary rather than directly through a branch. The exemption may exist as a matter of French domestic provision or it may be agreed through the bilateral double taxation treaty that is entered into between France and the United Kingdom. The most obvious example is the limitation under a treaty of a branch’s tax liability to tax on the profits attributable to the branch.