Saturday, July 15, 2006

ECJ Annual report 2005 made available

The 2005 Annual Report of the ECJ can already be downloaded here. The document titled “The Court of Justice in 2005: changes and proceedings”, prepared by Vassilios Skouris (President of the Court of Justice) mentions 3 tax cases amongst the most relevant cases of 2005. The referred cases are the unavoidable Marks & Spencer (UK), the non-less controversial D case (Netherlands) and the less-known Schemp case (Germany). This reference to 3 cases dealing with tax matters demonstrates ultimatly the impact of these 3 tax cases on the overall “development” of the jurisprudence of the ECJ.

Not a while ago, the whispers in the corridors of conferences was that ECJ jurisprudence was leading to some sort of tax harmonization through the backdoor, by forcing member states to adjust their direct tax systems. But these rumours have recently vanished and were even substituted with claims of a “change of hart” by the ECJ on direct tax issues. These claims are apparently supported by recent victories of tax authorities on landmark cases such as Marks & Spencer and the D case. No wonder that the joke is “please remain seated until this area of turbulence has passed”!

The choice of those 3 cases to appear in the Annual Report does not seem to be coincidence. If the denial of the MFN concept in the "D case" took some tax advisors by surprise, the outcome of the Marks & Spencer case can be said to lay a shadow on future cases. The significance of Marks & Spencer case is said to rest on the use of a new justification, which apparently is already being used by Member States to defend other infringements of EU Law. Below I summarize very briefly the cases mentioned by the ECJ report.

Case C-446/03 Marks & Spencer
In the Marks & Spencer case the ECJ had to deal with a claim by M&S to the UK tax authorities for group tax relief in respect of the losses incurred by its German, Belgian and French subsidiaries. The problem lied in the fact that UK tax legislation, which allowed, under certain circumstances, the parent company of a group to effectively offset profits and losses incurred by its subsidiaries, denied that same group relief to subsidiaries not resident or trading in the UK (foreign subsidiaries). The ECJ surprisingly held that the UK legislation constitutes a restriction on freedom of establishment since it applied a different treatment for tax purposes to losses incurred by a resident subsidiary and losses incurred by a non-resident subsidiary. Nevertheless, the story was far from the end and the ECJ acknowledged that such a restriction may be justified. In that regard, the Court set out objective criteria that demonstrate that such legislation pursues legitimate objectives that are compatible with the EC Treaty. The ECJ considered that the fact that the UK legislation (I) protects the balanced allocation of the power to impose taxation between the various Member States; (ii) provides for avoidance of the risk of double use of losses; and (iii) limits the risk of tax avoidance, results in such legislation being compatible with the EC Treaty. But the ECJ was still not truly satisfied in complicating the mater (with the above 3 justifications) and further added that UK legislation did not comply with the principle of proportionality if there would be no more possibility for the foreign subsidiary’s losses to be taken into account in its State of residence. This means that only if M&S would demonstrate to the UK tax authorities that all possibilities to take into account the losses in Germany, Belgium and France were exhausted then the loss would be taken into account! But this, as you imagine, is very difficult to prove… In my humble opinion this mess could have been simply avoided by saying that since UK does not tax the non-resident company such losses should not be taken into account by the parent company (i.e. there is no difference in treatment or restriction if the first place).

Case C-376/03 D case
In the D case the ECJ scrutinized the Dutch wealth-tax regime, which only granted an allowance to non-residents if at least 90% of the non-residents wealth was in the Netherlands. But the central issue in this case was not the domestic rule but a provision in the tax treaty between the Netherlands and Belgium, which extended to Belgian nationals the said allowance, whatever the proportion of their net assets located in the Netherlands. The ECJ was called to answer whether the difference in treatment created between Belgian nationals and nationals of other Member States (arising from the said allowance included in a tax treaty) was consistent with Articles 56 and 58 of the EC Treaty. This was basically the Most Favored Nation (MFN) argument in EC Law. Again in a controversial decision, the ECJ simply preferred to refer that Member States are at liberty, in the framework of tax treaties, to determine the connecting factors for the purposes of allocating powers of taxation and that it has accepted that a difference in treatment between nationals of the two contracting States that results from that allocation cannot constitute discrimination contrary to Article 39 EC. The ECJ hided behind the reciprocity element of tax treaties to state that the fact that reciprocal rights and obligations laid down by the Tax Treaty apply only to persons resident in one of the two contracting Member States is specifically an inherent consequence of tax treaties. I found particularly unsatisfactory the fact that this allowance (included in the tax treaty) can be said to be ultimately an incentive to invest in the Netherlands given to Belgium nationals and the fact that such provision, instead of being placed in the domestic tax code, is agreed in the framework of tax treaties “cures” this evident difference in treatment!

Case C-403/03 Schempp
In the Schempp case the issue in question concerned the deductibility for tax purposes of maintenance paid to a recipient resident in another Member State. In Germany, income tax legislation provides that maintenance payments to a divorced spouse are deductible but in case of non-resident recipients the deductibility is linked to the effective taxation of the recipient’s maintenance payments in the other Member State, proved by a certificate from the foreign tax authorities. In this case, since the former spouse was resident in Austria (where such maintenance payments are exempt at the level of the recipient) the German national was refused the deduction of its maintenance payments. In this case the ECJ observed that the unfavorable treatment simply derived from the difference between the German and Austrian tax systems with regard to the taxing of maintenance payments. The ECJ Court that the ECJ treaty offers no guarantee to a citizen of the Union that transferring his activities (or the transfer of his former spouse’s residence) to a Member State other than that in which he previously resided will be neutral as regards taxation.

Although this was not a case on one of the fundamental freedoms, it cannot be minimized the effect that the Court considered that the EC treaty does not guarantee a EU-citizen that a transfer of his activity to a Member State other than the one in which previously resided will be neutral for tax purposes.


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