DIRECT TAXATION AND EUROPEAN LAW (the recent case law of the ECJ) Melchior WATHELET Professor of European Law at the Universities of Louvain-La-Neuve and Liège Guest Professor at the Universities of Luxembourg and Lyon Honorary Judge at the ECJ Of Counsel CMS - Bureau Francis Lefebvre (Paris)
DIRECT TAXATIONFALLS WITHIN THE COMPETENCE OF THE MEMBER STATES BUT THE MEMBER STATES MUST EXERCISE THAT COMPETENCE CONSISTENTLY WITH COMMUNITY LAW
DIRECT TAXATIONFALLS WITHIN THE COMPETENCE OF THE MEMBER STATES Tax scales, taxation methods, taxable incomes are to be decided by the Member States
THE MEMBER STATES MUST EXERCISE THAT COMPETENCE CONSISTENTLY WITH COMMUNITY LAW
The ECJ (GILLY 1998) has distinguished :the exercise of the taxing power (coupled with the obligation to be consistent with EU Law) andthe allocation of the taxing power among the Member States (which has to be decided before exercising this power)
« If the Member States are free to define the criteria for allocation their powers of taxation as between themselves, » (by double taxation conventions) GILLY (1998) the simple existence of a double taxation convention does not exempt them from complying with EC law (single market + primacy) SAINT GOBAIN (1999) DE GROOT (2002)
With consistency, the ECJ case-law has defined : the obligation to exercise the fiscal competence consistently with EC-Lawas the prohibition in the fields offree movement of - persons (workers or citizens) - services - capitalfreedom of establishmentof ANY DISCRIMINATION OR RESTRICTION (BARRIER) except if they are justified.
Cases decided : 1957-1985 0 1986-1994 5 1995-2006 more than 55 ________ over 80 (90 % of which declare the national tax system inconsistent with EC-law) and only 5 infringement procedures Pending cases more than 60
Germany 19 Netherlands 11 Belgium 9 Great Britain 9 Sweden 7 Finland 6 France 5 Luxembourg 5 Denmark 2 Greece 2 Portugal 1 Austria 1 Italy 0 Ireland 0 Spain 0
Most favoured nation clause Refusal for some non-residents of tax advantages granted to residents and some other non-residents (in application of a double tax convention) • CFC rules Taxation in the head of a resident parent company of profits realized (even not distributed) by a subsidiary resident in a country with a lower tax rate • D (2005) • Bujara (2005) • ACT Group Litigation (2006) • Cadbury Schweppes (2006) • NL • NL • UK • UK Some pending (or pending again or recent) cases
Thin capitalization rules • UK • DE • Thin Cap Group Litigation(2007) • Lankhorst-Hohorst(2002)
Single market restrictions • Different tax treatment according to whether an insurance contract is signed with (or capital is invested in or transferred to) (or dividends are paid to) a resident or non-resident company or shareholder. • SE • BE • ES • BE • DK • Safir (1998) • Skandia (2003) • Bachmann (1992) • Comm vs Spain(pending) • Comm vs Belgium(2006) • Comm vs Danemark(2007)[“new BACHMANN”]
Withholding taxes • for foreign artists • on payment to foreign service providers • on pension income of non- residents • on outbound dividends • DE • BE • Fin • FR • Scorpio(2006)(cfr Gerritse 2003) • Commvs Belgium(2006) • Turpeinen(2006) • Denkavit(2006)(cfr Fokus Bank – EFTA Court)
Free movement of capital with third States A vs SKATTEVERKET : • Is it consistent with EC law that dividends paid to A be taxed because they are paid by a company not established in a Member State (or a State having with Sweden an agreement of exchange of information) ? A-B vs SKATTEVERKET : • Same question when the tax treatment of the dividends is less favourable because the subsidiary of the company paying them, has an activity in Russia and not in Sweden. • Article III, 157 of the Constitutional Treaty • FIDIUM FINANZ(2006) : if the freedom of establishment is essentially at stake, the free movement of capital is not taken into consideration. • FII GROUP LITIGATION(2006) : to check whether tax has been paid abroad can be more difficult in the third countries.
To date, ECJ case law has • found a high level of breaches in terms of discrimination or obstacles • been very strict in accepting reasons put forward to justify these breaches
High level of breaches found • Residents and non residents are in theory in comparable situations and accordingly cannot be discriminated against where the applicable tax rule is not in any way related to residence
Rules of fiscal procedure : BIEHL (1990), SCHUMACKER (1995) • Rule of progressive scales : ASSCHER (1996) • Tax advantages deriving from a double taxation convention : ST GOBAIN (1999) • Deductibility of business expenses – Tax ScalesGERRITSE (2003) • Tax credit on inbound dividendsLENZ (2004) – MANNINEN (2004)
A double taxation convention may help to establish the comparability of the situations “[in the DTC between Greece and the UK],… a branch in Greece of a Bank having its seat in the United Kingdom constitutes in Greece a permanent establishment treated for tax purposes as a resident company, so that, in that respect, it is accepted in a formal convention that it is in a situation objectively comparable to that of a Greek company” Royal Bank of Scotland (1999)
SCHUMACKER (1995) If it is logical that according a DTC, the State of residence has to take into account the personal and family situation of a taxpayer, this DTC becomes inconsistent with EU Law if the taxpayer does not have any income in his State of residence, with the consequence that his personal and family situation is no where taken into fiscal consideration.
New cases : APPLICATION • RITTER COULAIS (2006): • German national, resident in France; all incomes in Germany • Negative incomes in France not taken into account in Germany because not located in Germany • Advocate General (01/03/2005) • Discrimination because residents and non-residents are in comparable situations (as the State of residence cannot take these negative incomes into account in the absence of any income) • ECJ (21/02/2006) • Infringement of 48 EC because less favourable treatment of non-resident workers.
BLANCKAERT (2005): • Non resident in the NL • Refusal of the NL to grant him some tax deductions • Court • No infringement : not comparable situations • This tax deduction only granted when social security contributions are not sufficient to offset social security deductions • Therefore, this tax deduction is limited to people affiliated to the NL social security (not the case of Mr BLANCKAERT)
CONIJN (2006): • Non resident in Germany, incomes in Germany • Refusal by Germany law to grant him deduction of tax consultation expenses (granted to residents) • Advocate General • Infringement of 43 EC : indirect discrimination based on nationality. • ECJ (06/07/2006) • Infringement of 43 EC : comparable situations and restriction (not justified).
CLT-UFA (2006) : • Company, resident in the Grand Duchy of Luxembourg, has a branch in Germany. • The tax rate on the profits of the branch is higher than if the same profits had been distributed by a subsidiary in Germany. • Advocate General (14/04/2005) • “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 (23/02/2006) • § 30 : “German subsidiaries and branches of companies having their seat in Luxembourg are in a situation in which they can be compared objectively”.
KELLER HOLDING (2006) : • In German Law, financing costs incurred by a parent company and relating to shareholdings are • not deductible if they relate to dividends paid by an indirect subsidiary established 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)
FII GROUP LITIGATION (2006)(“Inbound” dividends) : • Advocate General • “Insofar as it chooses to relieve economic double taxation on its residents’ dividends, a home State must provide the same relief for incoming foreign-source dividends as for domestic dividends and must take foreign corporation tax paid into account for this purpose”. (§ 75) • ECJ • “… where a Member State has a system for preventing or mitigating the imposition of a series of charges to tax or economic double taxation as regards dividends paid to residents by resident companies, it must treat dividends paid to residents by non-resident companies in the same way” (§ 72).
DENKAVIT (2006)(“Outbound” dividends) : • To impose “a heavier tax burden on dividends paid by resident subsidiaries to Netherlands parent companies than that imposed on dividends paid to French parent companies” … “amounts to a discriminatory measure which is incompatible with the Treaty” (§ 39), • even under the only form of a witholding tax • even if a double taxation convention with another member State, provides for an imputation hich appears to be impossible.
REWE (2007) : • In German law, losses stemming from write-downs to the book value of subsidiaries are deductible without conditions by parent companies only for their domestic subsidiaries • The situations are comparable as the profits of subsidiaries (even German) are never taxable in the head of the parent company.
NEW CASES : EVOLUTION ? • Comparable situation for residents and non residents
D (1) (judgment of July 5th, 2005): • Dutch wealth tax. Deduction only for residents • D is German resident and has immovable property in the NL • Advocate General (26/10/2004) • Residents and non residents are in comparable situations • Same tax base • 100 % of D’s tax base is also liable for wealth tax in the Netherlands • Germany is unable to grant deduction as wealth tax does not exist in Germany • Court (05/07/2005) • Residents and non residents are NOT in comparable situations • Only a small portion of D’s income is taxable in the Netherlands • Germany was unable to grant D a tax benefit • not because there was no taxable income in Germany (as Mr Schumacker in Belgium) • but because wealth tax does not exist in Germany
D (2) : • Dutch wealth tax. Tax deduction only applies to some non-residents (double tax treaty with Belgium) • Equal treatment of non-residents and residents ? • Advocate General (26/10/2004) • YES (but it is not necessary to reply to this question). • ECJ (5/07/2005) • NO : German and Belgian non-residents are not in the same situation • The general balance of the double tax treaty must be observed (in spite of the same tax base, the same proportion of income in the Netherlands and the non-existence of wealth tax in Belgium and Germany)
ACT GROUP LITIGATION (2006) : in UK law • partial tax credit on dividends paid to Companies resident in a country only when it is so provided for in the DTC signed by the UK and this country.AG : “ each DTC contains a specific allocation of tax jurisdiction and priority of taxation between the Contracting States” (§ 95). • partial tax credit denied to Netherlands-resident Companies if controlled by a resident of a Member State, when no provision for this tax credit in the DTC signed by the UK and this Member StateAG : “ the distinction in a DTC between non- residents on the basis of the country of residence (and thus applicable DTC) of their controlling shareholder, forms a part of the equilibrium of jurisdiction and priority reached by the Contracting States” (§ 101).
ECJ“… the grant of a tax credit to a non-resident company … as provided for under a number of DTCs concluded by the UK, cannot be regarded as a benefit separable from the remainder of those DTCs, but is an integral part of them and contributes to their overall balance” (§ 88).Thus, “a company resident in a Member State which has concluded a DTC with the UK which does not provide for such a tax credit is not in the same situation as a company resident in a Member State which has concluded a DTC which does provide for one” (§ 91).
Does the judgement “D” question the Saint Gobain (double taxation convention) or Gottardo case law (social security convention) ? • In Saint Gobain, the branch of the French company asked in Germany to be considered as a German company • In Gottardo, a French asked to be considered in Italy as an Italian citizen. • In “D”, a German resident asked to the Netherlands, to be treated as a Belgian.
Any restriction to trans-national operations is in principle inconsistent with the Treaty.
A. • different taxation of dividends or interests coming from abroad (Verkooijen (1999) – Lenz (2004) – Manninen (2004) – Comm./France (2004) – FII Group Litigation (2006)) • different taxation of insurance contracts according to whether they are signed with resident or non resident companies (Safir (1998) – Skandia (2003)) • different taxation of a subsidiary or a parent Company according to whether the parent company or the subsidiary is established abroad or not (ICI (1998), Metallgesellschaft (2001), St Gobain (1999))
thin capitalization rules different according to whether the lending shareholder of the subsidiary is established abroad or not…(Lankhorst – Hohorst (2002)) • withholding tax (withheld by the customer of a non-resident artist(SCORPIO – 2006), or of a non-resident service provider (Comm. v. Belgium – 2006) • deductibility of losses from write-downs to the book value of subsidiaries less favourable if the subsidiary is established abroad.(REWE 2007) • deferral of taxation on capital gains arising from the sale of a residence conditioned on the purchase of a new residence on Swedish territory (Comm. v. Sweden (2007))
Illustration • Exit tax to be paid in case of transfer of domicile is illegal (HUGHES DE LASTEYRIE DU SAILLANT 2004)BUT NOT IF • tax is assessed on profits from a shareholding when residence is moved to another Member State • if the tax is differed until the shares are disposed of without any further conditions (for ex. : security) • If the tax finally levied is not higher than the tax which would have been levied on disposal within the territory (N – 07/09/2006).
MARKS & SPENCER (transfer of losses) • Advocate General • General rule : “prevent Member States from creating or maintaining in force measures promoting internal trade to the detriment of intra-Community trade” (§ 39) • In this case : “the refusal at issue in the present case constitutes an “exit restriction” which is characterised by unfavourable treatment of companies wishing to establish subsidiaries in other Member States”.
Judgement of 13/12/2005 • « It (the exclusion of group relief) thus constitutes a restriction on freedom of establishment within the meaning of articles 43 EC and 48 EC, in that it applies different treatment for tax purposes to losses incurred by a resident subsidiary and losses incurred by a non resident subsidiary » (§ 34)
TEST CLAIMANTS THIN CAP GROUP (2007) • Thin capitalisation rules create an obstacle as resident subsidiaries are disadvantaged when their parent company is not resident (it is less attractive to create or acquire a subsidiary in this country).
Can national law decide that an individual is still resident despite having moved ? VAN HILTEN (2006): • Mrs. VAN HILTEN, a Dutch citizen, left the Netherlands in 1988 and dies abroad in 1997 • According to Dutch law, she is presumed to have maintained tax residency in the Netherlands (10 years); • Advocate General (July 2005) • No breach of EU law • ECJ (23/02/2006) • Transfer of residence does not involve financial transactions or transfers of property : therefore, nothing to restrict
Preliminary question • before deciding whether the exercise of the fiscal competence restricts transnational operations, • is there a fiscal competence at all ? • does the different or even disadvantageous treatment result from the application of a given national tax system or simply from disparities or allocation of the taxing power between different national tax systems ?
ACT GROUP LITIGATION(2006) Should, on dividends paid by UK subsidiaries, individual shareholders of a non-UK-resident parent company be entitled to the same tax credit as the individual shareholders of a UK-resident parent company ? NO as on outgoing dividends, no UK income is levied. There is therefore no UK income tax liability to extinguish with an imputation credit. YES if for example under a DTC (or even unilaterally), the UK has or has kept the right to subject these dividends to UK income tax.
“Insofar as a Member State does not exercise tax jurisdiction over a non-resident tax payer, then it does not have to give loss relief.” How to reconcile this with : • Marks & Spencer ? • Bosal Holding ? • REWE ?
KERCKHAERT-MORRES (2006) • Belgium law applies 25 % tax rate to all dividends received by Belgian residents, whatever their source but refuses to take into account the 15 % withholding tax levied on dividends in the Source State, France. • Advocate General : no restriction or indirect discrimination because the effect of the combination of the avoir fiscal and the withholding tax in France is that Belgian resident shareholders finally keep more of a French-source dividend than from a dividend paid by a Belgian company BUT ANYWAY
even if it was not the case the disadvantage would not result from any breach of EC law by Belgium which does not“oblige home States to relieve juridical double taxation resulting from the dislocation of tax base between two Member-States” (§ 30) SO PLAIN DOUBLE TAXATION WOULD BE LEGAL !
ECJ (November 2006) • Belgian law is perfectly consistent with Community law when it applies the same tax rate to all the dividends received by Belgian residents, whatever is their origin. • Belgian law is not due to take into consideration the prior foreign taxations; the juridical double taxation is then legal in Community law. • The Court did not even take into account that, in this particular case, the taxpayer had been granted a tax credit in France. • “… the adverse consequences… result from the exercise in parallel by two Member States of their fiscal sovereignty” (§ 20)