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’shea@qmul.ac.uk

ECTRegulationsDirectivesDecisionsInternational Agreements (EEA)“Soft Law”

Double Tax Conventions(A) MS-MS(B) MS-TC(C) Prior

Origin State rules Host State rules

Purely domestic rules (ECT not engaged)

National Tax Laws of the EU Member States

International Law

ECHRCommunity

Law

The EU Regulatory Framework for Tax

CompetenceCompliance

DTC

DiscriminationRestriction

ComparabilityJustification

ProportionalityHost

OriginThird Country

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.

Cross Border Loss Relief

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

Dividend +tax credit

FINLAND

Dividend but no tax creditIs granted in Finland

Company paysFinland CT

Company paysSwedish CT

Manninen

FINLAND SWEDEN

Dividend

Dividend

Taxation

No taxation

Taxation

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

Cross-border Mergers

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

GERMANY

DTC

The Netherlands-Belgium DTC is more favourable than the Germany- Netherlands 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.”

D case paragraph 61 (Two non-residents in a different situation

depending on the DTC)

C-374/04 ACT IV LoB Issue (Two Dutch companies in a different

situation depending on DTC)

UK

NL NL

NL GER

UK company paying a dividend

UK tax jurisdiction extendsto the non-resident DutchCompany with Dutch parent

Dividend + tax Credit under DTCbut taxed at 5%

Dividend exempted under DTC – no tax credit + no economic DT + no extension of UK taxsystem

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

ACT IV GLO paragraph 70

“If the Member State of residence of the company making distributable profits decides to exercise its taxing powers not only in relation to profits made in that State but also in relation to income arising in that State and paid to non‑resident companies receiving dividends, it is solely because of the exercise by that State of its taxing powers that, irrespective of any taxation in another Member State, a risk of

a series of charges to tax may arise.”

C-170/05 Denkavit Internationaal

NLFr

FRANCE Netherlands

Dividend paid to Dutch parent

WHT 25%

FR

Fr Dividend paid to a French parent

95%exempt

EXEMPTION MUST BEEXTENDED CROSS-BORDER

FrenchTax jurisdictionextended

Denkavit Internationaal paragraph 37

“the exemption in respect of dividends received by resident parent companies is designed to avoid the imposition of a series of charges to tax on the profits of subsidiaries which are distributed by way of dividend to the parent companies of those subsidiaries…

since the French Republic has chosen to relieve its residents of such a liability to tax, it must extend that relief to non-residents to the extent to which an imposition of that kind on those non-residents results from the exercise of its tax jurisdiction over them”

C-379/05 Amurta

PT

NL

NL

Dividend +25% WHT

Dividend NO WHT

Retailbox

AMURTAPortugueseResident s/h

Dutch resident s/h

5%s/

holding

C-379/05 Amurta – DTC Issue

PT

NL

NL

Dividend +25% WHT

Dividend NO WHT

Retailbox

AMURTA

DTC provided for a creditbut Portugal exemptedthe dividend income

C-265/04 Bouanich

FRANCE

SWEDEN

French resident s/hSwedishResident s/h

Swedishcompany

Bouanich : Different Tax Treatment of

Resident and Non-resident Shareholders

Company repurchasing its own shares Resident taxpayers – treated as a

capital gain and the s/h is allowed to deduct the costs of acquisition

Non-residents – treated as a dividend distribution with no right to deduct the cost of shares under domestic rules and taxed at 30%

Bouanich : Comparability

There is a restriction on the free movement of capital only if the non-resident shareholders are treated less favourably than the resident shareholders – that is a matter for the national court to determine

“the cost of acquisition is directly linked to the payment made on the occasion of a share repurchase so that, in this regard, residents and non-residents are in a comparable situation”. (Comparability)

C-101/05 Skatteverket v A (“A Case”)

(Different treatment depending on a provision in a DTC)

Third Country A(resident receives atax advantage)

Third Country B (resident denied a tax advantage)

EU Member State

DTC with an exchange of information provision

DTC with no exchange of information provision

The “A case”

Swedish tax rules provided for an exemption from income tax in respect of dividends distributed in the form of shares in a subsidiary when the distributing company was established in an EEA State or in a State with which Sweden had concluded a double taxation convention (DTC) containing an exchange of information provision.

The “A case”: Need to ensure effectiveness of fiscal

supervision

although the taxpayer could provide the relevant information “the onus still remains on the tax authorities to assess the value of the evidence provided, which would be impossible if those authorities did not have the power to seek cooperation from the competent authorities of the State of establishment of the distributing company”.

The “A case”: Need to ensure effectiveness of fiscal

supervision

Different legal context The Court noted that mutual assistance within the

Community operated on the basis of a different legal framework from third country situations.

Directive 77/799/EEC Community legislation relating to company

accounts allowed taxpayers “to produce reliable and verifiable evidence on the structure or activities of a company established in another Member State” but not in relation to third countries which were not “required to apply those Community measures”.

The “A case”: The Court’s conclusion

where taxpayer compliance can be verified only by obtaining information from the competent authority of a third country “it is, in principle, legitimate for that Member State to refuse to grant that advantage if, in particular, because that third country is not under any contractual obligation to provide information, it proves impossible to obtain such information from that country”.

This was a matter for the Swedish referring court to verify.

The “A case”DTCs with different provisions

The significance of DTCs should not go unnoticed.

If a DTC is in place between a Member State and a third country in circumstances like the A case, with an exchange of information provision on the lines of the OECD Model, then a resident of that Member State may be treated differently under that State’s tax system than a similar resident with an investment in a third country where no such DTC is in place with such an exchange of information provision.

National level (Portugal) - ECJ

Cases involving Portuguese tax rules where the rules are challenged (benefit EU persons exercising freedoms in Portugal)

Hollmann C-443/06 Commission v Portugal C-345/05 Cases involving rules of other Member

States which are challenged (benefit Portuguese nationals / residents exercising freedoms)

Amurta C-379/05 Centro Equestre C-345/04

Host v Origin Rules

ORIGIN STATE RULE

HOST STATERULE

A

B

D

C

Exercising a fundamental freedom => entitled to“NOT LESS FAVOURABLE TREATMENT” if comparable

C-385/00 De Groot paragraph 94“National Treatment” Test

“as far as the exercise of the power of taxation so allocated is concerned, the Member States must comply with the Community rules and, more particularly,

respect the principle of national treatment of nationals of other Member States and of their own nationals who exercise the freedoms guaranteed by the Treaty.”

“Migrant/Non-migrant test”

C-443/06 Hollmann

Hollmann resident in Germany

sells immovable property

in PortugalHollmann taxed on 100%of the gain at flat 25%

Residents taxed on 50%of the gain at progressiverates up to 42%

C-443/06 Hollmann

Assume a gain of €10,000 Resident is taxed on €5,000 42% maximum rate = €2,100 Non-resident on the same gain pays tax of

25% of €10,000 = €2,500 Non-resident always pays more tax on a

similar capital gain under the Portuguese capital gains tax regime

Less favourable treatment of non-resident who is in a comparable situation

C-443/06 Hollmann paragraph 37

the basis of assessment for capital gains realised is not the same for residents and non-residents.

Thus, for the sale of the same immovable property situated in Portugal non-residents are, in relation to the realisation of capital gains, subject to a tax which is higher than that applied to residents and are consequently in a less favourable position than the latter.

C-443/06 Hollmann paragraph 39

the effect of national legislation such as that in dispute in the case in the main proceedings is to make the transfer of capital less attractive for non-residents by deterring them from making investments in immovable property in Portugal and, and a result, from carrying out transactions related to those investments such as selling immovable property.

C-443/06 Hollmann paragraph 51

the taking into account of only half of the basis of capital gains realised by a resident, together with the fact that the tax levied on that resident’s income is subject to a progressive rate, the highest step of which is 42%, results, in the same taxable circumstances for a non-resident, in heavier taxation of the latter.

C-443/06 Hollmann paragraph 53

objectively speaking, there is no difference in situation capable of justifying the unequal tax treatment in respect of the taxation of capital gains between two categories of taxable persons.

Consequently, Mrs Hollmann’s situation is comparable to that of a resident.

C-345/05 Commission v Portugal

Sale of residence – exemption fromCGT provided new residence was situated in Portuguese territory

No exemption if new residence was situated abroad

C-345/05 Commission v Portugal paragraph 20

Even if Article 10(5) of the CIRS does not prevent a person liable to income tax in Portugal from pursuing employment in another Member State or generally exercising his right of establishment,

that provision is none the less likely to restrict the exercise of those rights by having, at the very least, a deterrent effect on taxable persons wishing to sell their real property in order to settle in a Member State other than the Portuguese Republic.

C-345/05 Commission v Portugal paragraph 21

a taxable person who decides to sell property that he owns in Portugal and uses as his own residence in order to transfer his residence to another Member State and to purchase a new property there for the purposes of his accommodation is, in the context of the exercise of the rights conferred by Articles 39 EC and 43 EC, subject to more unfavourable tax treatment than that enjoyed by a person who maintains his residence in Portugal.

C-345/04 Centro Equestre

German WHT +deduction of

related expenses limited for

non-residents

Centro Equestre provided equestrian services in Germany

Centro EquestreResident in Portugal

Thanks very much everyone !

OBRIGADO