CFC Legislation and EC Law: Lessons from Sweden and UK
On 4 April 2005 the Council for Advance Tax Rulings (Skatterättsnämnden) held, in two different rulings, that:
– the CFC rules in the Swedish tax legislation are incompatible with Art. 43 EC Treaty regarding the freedom of establishment of companies within EU Member States;
– the CFC rules violate Art. 56 EC Treaty regarding the freedom of capital in a situation where a company subject to low taxation is established outside the EU; however, restrictions on the free movement of capital to and from states outside the EU may be justified to uphold the aim of tax avoidance rules; and
– the CFC rules do not violate the applicable tax treaties, i.e. respectively, Sweden's treaties with Luxembourg and Switzerland.
This ruling puts the spotlight on the compatibility of CFC regimes with the fundamental freedoms under EC Law. CFC rules primarily apply to domestic shareholders holding shares in a CFC, depending on the requirements set by domestic law. Such rules may fall under the principle of freedom of establishment conferred by Art. 43(1) (2) of the EC Treaty. In all other cases, the principle of freedom of establishment may be complemented by the freedom of movement of capital, conferred by Art. 56(1) of the EC Treaty. In the end the question lies in determining if CFC rules, which constitute a special regime for low-taxed CFCs with passive income abroad, are justifiable or not under European Community law. And this is for the ECJ to determine.
For the ones that are not aware, this issue will soon be tackled by the ECJ in the Cadbury Schweppes Case (Case C-196/04) referred to the ECJ by the UK Special Commissioners on 29 April 2004.
The facts are the following: Cadbury Schweppes pl is incorporated and resident in the United Kingdom. It is the parent company of a group of companies including two indirect 100 percent subsidiaries incorporated with unlimited liability in Ireland and agreed (for the purposes of this appeal only) to be resident in Ireland, Cadbury Schweppes Treasury Services (CSTS) and Cadbury Schweppes Treasury International (CSTI). CSTS and CSTI were subject to a tax rate of 10 percent within the International Financial Services Centre in Dublin. CSTS and CSTI raised finance and provided that finance to subsidiaries in the PLC worldwide group.
On August 18, 2000 the Inland Revenue assessed Cadbury Schweppes Overseas Limited (the first United Kingdom resident company in the chain of companies) to an amount equal to corporation tax of £8,638,633.54 (being tax at 33 percent on the profits of £34,684,038 equals £11,445,732.54 less credit for Irish tax of £2,807,099) in respect of the profits of CSTI for the period ended December 28, 1996 (CSTS made a loss in the same period that was surrendered for Irish tax purposes partly to CSTI and partly to another Irish company). The taxpayer appealed to the Special Commissioners on August 21, 2000.
The Special Commissioners determined that the reason for incorporating CSTI was to avoid the application to CSTS of certain foreign exchange provisions under United Kingdom tax law in the event that the controlled foreign companies' legislation in issue in this appeal was applied to CSTS. The Special Commissioners ultimately concluded that PLC established CSTS and CSTI as tax resident indirect subsidiaries in Ireland solely for the purpose of ensuring that the profits arising from their intra-group lending treasury activities could benefit from the International Financial Services Centre regime for group treasury companies in Ireland and would not be taxed in the United Kingdom. In view of this, it referred the following question to the European Court of Justice (ECJ) in a decision dated June 6, 2004.
Do Articles 43, 49 and 56 of the EC Treaty preclude national tax legislation, which provides, in specified circumstances, for the imposition of a charge upon a company resident in that Member State in respect of the profits of a subsidiary company resident in another Member State and subject to a lower level of taxation?
For me I have the feeling that the Court will restrict its judgment to the freedom of establishment issue and avoid the question of freedom of capital and its eventual extension to third countries. Let’s see.
– the CFC rules in the Swedish tax legislation are incompatible with Art. 43 EC Treaty regarding the freedom of establishment of companies within EU Member States;
– the CFC rules violate Art. 56 EC Treaty regarding the freedom of capital in a situation where a company subject to low taxation is established outside the EU; however, restrictions on the free movement of capital to and from states outside the EU may be justified to uphold the aim of tax avoidance rules; and
– the CFC rules do not violate the applicable tax treaties, i.e. respectively, Sweden's treaties with Luxembourg and Switzerland.
This ruling puts the spotlight on the compatibility of CFC regimes with the fundamental freedoms under EC Law. CFC rules primarily apply to domestic shareholders holding shares in a CFC, depending on the requirements set by domestic law. Such rules may fall under the principle of freedom of establishment conferred by Art. 43(1) (2) of the EC Treaty. In all other cases, the principle of freedom of establishment may be complemented by the freedom of movement of capital, conferred by Art. 56(1) of the EC Treaty. In the end the question lies in determining if CFC rules, which constitute a special regime for low-taxed CFCs with passive income abroad, are justifiable or not under European Community law. And this is for the ECJ to determine.
For the ones that are not aware, this issue will soon be tackled by the ECJ in the Cadbury Schweppes Case (Case C-196/04) referred to the ECJ by the UK Special Commissioners on 29 April 2004.
The facts are the following: Cadbury Schweppes pl is incorporated and resident in the United Kingdom. It is the parent company of a group of companies including two indirect 100 percent subsidiaries incorporated with unlimited liability in Ireland and agreed (for the purposes of this appeal only) to be resident in Ireland, Cadbury Schweppes Treasury Services (CSTS) and Cadbury Schweppes Treasury International (CSTI). CSTS and CSTI were subject to a tax rate of 10 percent within the International Financial Services Centre in Dublin. CSTS and CSTI raised finance and provided that finance to subsidiaries in the PLC worldwide group.
On August 18, 2000 the Inland Revenue assessed Cadbury Schweppes Overseas Limited (the first United Kingdom resident company in the chain of companies) to an amount equal to corporation tax of £8,638,633.54 (being tax at 33 percent on the profits of £34,684,038 equals £11,445,732.54 less credit for Irish tax of £2,807,099) in respect of the profits of CSTI for the period ended December 28, 1996 (CSTS made a loss in the same period that was surrendered for Irish tax purposes partly to CSTI and partly to another Irish company). The taxpayer appealed to the Special Commissioners on August 21, 2000.
The Special Commissioners determined that the reason for incorporating CSTI was to avoid the application to CSTS of certain foreign exchange provisions under United Kingdom tax law in the event that the controlled foreign companies' legislation in issue in this appeal was applied to CSTS. The Special Commissioners ultimately concluded that PLC established CSTS and CSTI as tax resident indirect subsidiaries in Ireland solely for the purpose of ensuring that the profits arising from their intra-group lending treasury activities could benefit from the International Financial Services Centre regime for group treasury companies in Ireland and would not be taxed in the United Kingdom. In view of this, it referred the following question to the European Court of Justice (ECJ) in a decision dated June 6, 2004.
Do Articles 43, 49 and 56 of the EC Treaty preclude national tax legislation, which provides, in specified circumstances, for the imposition of a charge upon a company resident in that Member State in respect of the profits of a subsidiary company resident in another Member State and subject to a lower level of taxation?
For me I have the feeling that the Court will restrict its judgment to the freedom of establishment issue and avoid the question of freedom of capital and its eventual extension to third countries. Let’s see.
posted by Talk Tax Blog at 4:48 pm
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