The EU Regulatory Framework for Tax Tom O’Shea MA LLM (Tax) Centre for Commercial Law Studies, Queen Mary, University of London Email: t.o’firstname.lastname@example.org
The EU Regulatory Framework for Tax ECT Regulations Directives Decisions International Agreements (EEA) “Soft Law” Competence ComplianceDTC Community Law ECHR Discrimination Restriction Comparability Justification Proportionality Host Origin Third Country Double Tax Conventions (A) MS-MS (B) MS-TC (C) Prior International Law National Tax Laws of the EU Member States Origin State rules Host State rules Purely domestic rules (ECT not engaged)
The EU Tax Regulatory Framework • Direct taxation is regulated at three different levels: • National level • DTC/International law level • Community level • For EU Member States the overarching rule is that national tax rules and DTC rules must comply with Community Law
The EU Tax Regulatory Framework • when giving effect to commitments assumed under international agreements, be it an agreement between Member States or an agreement between a Member State and one or more non-member countries, Member States are required, subject to the provisions of Article 307 EC, to comply with the obligations that Community law imposes on them. The fact that non-member countries, for their part, are not obliged to comply with any Community-law obligation is of no relevance in this respect. C-55/00 Gottardo paragraph 33.
Marks and Spencer • Marks and Spencer plc decided to open establishments in France, Germany and Belgium • They chose to establish subsidiaries rather than branches • These subsidiaries incurred losses – so operations were terminated (in France, the subsidiary was sold to a third party)
UK Group relief • Had Marks and Spencer plc established foreign branches – they would have qualified for group relief – • Equally if they had established UK subsidiaries with branches abroad, they would have qualified for group relief • Even if they established foreign subs with UK branches – they would have qualified for a certain amount of group relief
No taxation of profits…. • But ….because M+S established subsidiaries – residents of other States – no group relief was available under UK rules because - as the UK argued - the UK did not tax the profits of the subsidiaries therefore it should not have to give relief for the losses of the subsidiaries.
Two basic arguments…. • Whether a branch and a subsidiary have to be treated in the same way – if you give group relief to the branch do you have to give group relief to the subsidiary also? • Avoir Fiscal and host States? • What about Origin States?
UK-UK and UK- cross-border • If you give group relief in a UK – UK situation – do you have to give it n a UK- cross-border situation – when, for example, a sub is established in France, or Germany • Is that a restriction on the freedom of establishment of M+S? • Are there any justifications?
The ECJ • Group relief such as that at issue in the main proceedings constitutes a tax advantage for the companies concerned. By speeding up the relief of the losses of the loss-making companies by allowing them to be set off immediately against the profits of other group companies, such relief confers a cash advantage on the group.
The ECJ • Such a restriction is permissible only if it pursues a legitimate objective compatible with the Treaty and is justified by imperative reasons in the public interest. It is further necessary, in such a case, that its application be appropriate to ensuring the attainment of the objective thus pursued and not go beyond what is necessary to attain it
The ECJ • residence is not always a proper factor for distinction. In effect, acceptance of the proposition that the Member State in which a company seeks to establish itself may freely apply to it a different treatment solely by reason of the fact that its registered office is situated in another Member State would deprive Article 43 EC of all meaning [citing Avoir Fiscal]
The ECJ • In order to ascertain whether such a restriction is justified, it is necessary to consider what the consequences would be if an advantage such as that at issue in the main proceedings were to be extended unconditionally.
Justification 1: Balanced allocation of the power to tax • profits and losses are two sides of the same coin and must be treated symmetrically in the same tax system in order to protect a balanced allocation of the power to impose taxes between the different Member States • ECJ: to give companies the option to have their losses taken into account in the Member State in which they are established or in another Member State would significantly jeopardise a balanced allocation of the power to impose taxes between Member States
Justification 2: “Double-dipping” • relating to the danger that losses would be used twice, it must be accepted that Member States must be able to prevent that from occurring.
Justification 3: Tax Avoidance through Loss Tax Planning • relating to the risk of tax avoidance, it must be accepted that the possibility of transferring the losses incurred by a non-resident company to a resident company entails the risk that within a group of companies losses will be transferred to companies established in the Member States which apply the highest rates of taxation and in which the tax value of the losses is therefore the highest.
Court finds justification • restrictive provisions such as those at issue in the main proceedings pursue legitimate objectives which are compatible with the Treaty and constitute overriding reasons in the public interest and that they are apt to ensure the attainment of those objectives.
Proportionality? • measures less restrictive than a general exclusion from group relief might be envisaged. • the possibility of making relief conditional upon the foreign subsidiary’s having taken full advantage of the possibilities available in its Member State of residence of having the losses taken into account. • possibility that group relief might be made conditional on the subsequent profits of the non-resident subsidiary being incorporated in the taxable profits of the company which benefited from group relief up to an amount equal to the losses previously set off.
Court finds breach if…. • the restrictive measure at issue in the main proceedings goes beyond what is necessary to attain the essential part of the objectives pursued where: • – the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring those losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods, and
And if …… • there is no possibility for the foreign subsidiary’s losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.
The ECJ • Where, in one Member State, the resident parent company demonstrates to the tax authorities that those conditions are fulfilled, it is contrary to Articles 43 EC and 48 EC to preclude the possibility for the parent company to deduct from its taxable profits in that Member State the losses incurred by its non-resident subsidiary
The ECJ – concluding remark • Member States are free to adopt or to maintain in force rules having the specific purpose of precluding from a tax benefit wholly artificial arrangements whose purpose is to circumvent or escape national tax law
M+S win? • it is contrary to Articles 43 EC and 48 EC to prevent the resident parent company from [deducting losses of its subs resident in other Member States] where the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods and where there are no possibilities for those losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.
M+S Outcome – New Rules • Measures to deny loss relief where there are “arrangements” which either • result in losses becoming unrelievable outside the UK that were otherwise relievable • Give rise to unrelievable losses which would not have arisen but for the availability of the relief in the UK • If the purpose or one of the main purposes of those arrangements is to obtain UK relief
Migrant – Non-Migrant Test : Origin & Host State • De Groot (Workers) C-385/00 • Eurowings (Services) C-294/97 • Manninen (Capital) C-319/02 • Marks and Spencer (Establishment)
De Groot C-385/00 • due to the application of the proportionality factor, a portion of the personal tax relief to which Mr de Groot was entitled did not give rise to an actual tax reduction in the Netherlands. He therefore suffered a real disadvantage as a result of the application of the proportionality factor since he derived from his maintenance payments and from the tax-free allowance a lesser tax advantage than he would have received had he received his entire income for 1994 in the Netherlands. (para 83)
De Groot • That disadvantage caused by the application by the Member State of residence of its rules on the avoidance of double taxation is liable to discourage a national of that State from leaving it in order to take up paid employment, within the meaning of the Treaty, in the territory of another Member State. (para 84)
Eurowings C-294/97 • The national court (…) notes that lessees receive more favourable treatment for tax purposes if they lease goods from a lessor established in Germany than if they lease from a lessor established in another Member State (para 19)
Eurowings • Any legislation of a Member State which (…) reserves a fiscal advantage to the majority of undertakings which lease goods from lessors established in that State whilst depriving those leasing from lessors established in another Member State of such an advantage gives rise to a difference of treatment based on the place of establishment of the provider of the services, which is prohibited by Article 59 of the Treaty. (para 40).
Eurowings • Contrary to what was argued (…) that difference in treatment can also not be justified by the fact that the lessor established in another Member State is there subject to lower taxation (para 43)
Eurowings • Any tax advantage resulting for providers of services from the low taxation to which they are subject in the Member State in which they are established cannot be used by another Member State to justify less favourable treatment in tax matters given to recipients of services established in the latter Member State (para 44)
Manninen C-319/02 • the tax credit under Finnish tax legislation is designed to prevent the double taxation of company profits distributed to shareholders by setting off the corporation tax due from the company distributing dividends against the tax due from the shareholder by way of income tax on revenue from capital. The end result of such a system is that dividends are no longer taxed in the hands of the shareholder. Since the tax credit applies solely in favour of dividends paid by companies established in Finland, that legislation disadvantages fully taxable persons in Finland who receive dividends from companies established in other Member States, who, for their part, are taxed at the rate of 29% by way of income tax on revenue from capital. (para 20)
Manninen Company pays Swedish CT Company pays Finland CT Dividend but no tax credit Is granted in Finland Dividend +tax credit FINLAND
Manninen Taxation Taxation Dividend Dividend Notaxation SWEDEN FINLAND Look at the “purpose” of the Finland rule
Manninen • Having regard to the objective pursued by the Finnish tax legislation, the cohesion of that tax system is assured as long as the correlation between the tax advantage granted in favour of the shareholder and the tax due by way of corporation tax is maintained. Therefore, in a case such as that at issue in the main proceedings, the granting to a shareholder who is fully taxable in Finland and who holds shares in a company established in Sweden of a tax credit calculated by reference to the corporation tax owed by that company in Sweden would not threaten the cohesion of the Finnish tax system and would constitute a measure less restrictive of the free movement of capital than that laid down by the Finnish tax legislation. (para 46)
Manninen • the calculation of a tax credit granted to a shareholder fully taxable in Finland, who has received dividends from a company established in Sweden, must take account of the tax actually paid by the company established in that other Member State, as such tax arises from the general rules on calculating the basis of assessment and from the rate of corporation tax in that latter Member State. (para 54)
Manninen • It is true that, in relation to such legislation, the situation of persons fully taxable in Finland might differ according to the place where they invested their capital. That would be the case in particular where the tax legislation of the Member State in which the investments were made already eliminated the risk of double taxation of company profits distributed in the form of dividends, by, for example, subjecting to corporation tax only such profits by the company concerned as were not distributed. (para 34)
Manninen & M+S • Thus, the Finnish tax credit does not have to be granted cross-border always • Similarly, the UK Group relief advantages do not have to be granted across border always • But each time a Member State has a particular tax rule which reserves a tax advantage for its own residents who operate in that Member State • A similar resident operating cross-border / exercising Community freedoms must have the tax treatment in the establishment State taken into consideration also in the light of the objectives of the Origin State’s tax rule
SEVIC • involved a merger between a German company and a Luxembourg company. German law provided for the registration of mergers between German resident companies only: cross-border mergers were not recognised. • The Court found that such rules were contrary to the freedom of establishment provisions contained in the Treaty.
SEVIC • Freedom of Establishment includes • “the formation and management of those companies under the conditions defined by the legislation of the State of establishment for its own companies”
SEVIC • This covers all measures • “which permit or even merely facilitate access to another Member State and the pursuit of an economic activity in that State by allowing the persons concerned to participate in the economic life of the country effectively and under the same conditions as national operators”.
SEVIC • The Court sees a cross-border merger as a one way of exercising the freedom of establishment: the merger operation allows a company without dissolution to transform itself, thus providing a way, within a single operation, to pursue an activity in a new company format without interruption; saving time, costs, and the complications associated with a dissolution or liquidation and a new company formation.
SEVIC • as the German rules treated internal German mergers more favourably than cross-border mergers this constituted a restriction of the freedom of establishment which required justification.
SEVIC • German justifications – protection of employees, shareholders, creditors, and effectiveness of fiscal supervision • refusing to register all cross-border mergers even in situations where these interests were not threatened would go beyond what was necessary to protect those interests.
C-376/03 D case : “MFN issue” • NETHERLANDS BELGIUM DTC DTC The Netherlands-Belgium DTC is more favourable than the Germany- Netherlands DTC GERMANY
D case paragraph 61 (Two non-residents in a different situation depending on the DTC) • “The fact that those reciprocal rights and obligations apply only to persons resident in one of the two Contracting Member States is an inherent consequence of bilateral double taxation conventions. • It follows that a taxable person resident in Belgium is not in the same situation as a taxable person resident outside Belgium so far as concerns wealth tax on real property situated in the Netherlands.”
C-374/04 ACT IV LoB Issue(Two Dutch companies in a different situation depending on DTC) NL GER Dividend + tax Credit under DTC but taxed at 5% NL NL Dividend exempted under DTC – no tax credit + no economic DT + no extension of UK tax system UK UK company paying a dividend UK tax jurisdiction extends to the non-resident Dutch Company with Dutch parent
ACT IV GLO • Similar treatment of domestic and foreign dividends in the recipient’s Member State where the foreign dividends are taxed in the recipient’s Member State => comparability of the dividend streams • Inbound and outbound dividends can be treated differently – because in one situation the UK is acting as a residence State and in the other the UK is acting as a source State only – limited and unlimited tax liability