2. Paul Farmer Partner, Joseph Hage Aaronson
The Development of the Concept of Discrimination in EU and UK cases on direct taxation
Paul Farmer
Partner, Joseph Hage Aaronson M
280 High holborn
London, Wc1v 7ee, United Kingdom T

3. Joseph Hage Aaronson LLP
Outline
Trends in the general ECJ case law on restrictions on fundamental freedoms
Particular features of direct tax restrictions
ECJ’s approach to direct tax restrictions
Development of defences over last two decades
Illustrations
Thin Cap etc
Cross-border losses
Dividend taxation
07/02/2014
Joseph Hage Aaronson LLP

4. Sotgiu v Deutsche Bundespost (1974)
“It may therefore be that criteria such as place of origin or residence of a worker may, according to circumstances, be tantamount, as regards their practical effect, to discrimination on the grounds of nationality, such as is prohibited by the treaty and the regulation.
However, this would not be the case with a separation allowance the conditions of allotment and rules for the payment of which took account of objective differences which the situation of workers may involve according to whether their residence, at the time their taking up a given post, is within the territory of the state in question or abroad.”
07/02/2014
Joseph Hage Aaronson LLP

5. Joseph Hage Aaronson LLP
Cassis de Dijon (1979)
“Obstacles to movement within the Community resulting from disparities between the national laws relating to the marketing of the products in question must be accepted in so far as those provisions may be recognized as being necessary in order to satisfy mandatory requirements relating in particular to the effectiveness of fiscal supervision, the protection of public health, the fairness of commercial transactions and the defence of the consumer .”
07/02/2014
Joseph Hage Aaronson LLP

6. Joseph Hage Aaronson LLP
Gebhard (1995)
“It follows, however, from the Court's case-law that national measures liable to hinder or make less attractive the exercise of fundamental freedoms guaranteed by the Treaty must fulfil four conditions: they must be applied in a non-discriminatory manner; they must be justified by imperative requirements in the general interest; they must be suitable for securing the attainment of the objective which they pursue; and they must not go beyond what is necessary in order to attain it.”
07/02/2014
Joseph Hage Aaronson LLP

7. Joseph Hage Aaronson LLP
Bosman (1995)
“It is sufficient to note that, although the rules in issue in the main proceedings apply also to transfers between clubs belonging to different national associations within the same Member State and are similar to those governing transfers between clubs belonging to the same national association, they still directly affect players‘ access to the employment market in other Member States and are thus capable of impeding freedom of movement for workers. ... Consequently, the transfer rules constitute an obstacle to freedom of movement for workers prohibited in principle by Article 48 of the Treaty. It could only be otherwise if those rules pursued a legitimate aim compatible with the Treaty and were justified by pressing reasons of public interest. But even if that were so, application of those rules would still have to be such as to ensure achievement of the aim in question and not go beyond what is necessary for that purpose.”
07/02/2014
Joseph Hage Aaronson LLP

8. Particular features of tax restrictions
Unharmonised tax rules
Individual countries determine scope of their taxing rights, generally on basis of residence and source
Also define their tax systems (e.g. dividend taxation, group relief)
Some co-ordination through bilateral DTCs
Specific anti-avoidance rules (e.g. CFC rules)
More general rules to protect tax base (e.g. rules limiting scope of group relief, transfer pricing and allocation of profits, exit charges).
07/02/2014
Joseph Hage Aaronson LLP

9. Joseph Hage Aaronson LLP
ECJ’s approach
MS competent to define the extent of their taxing rights and tax systems
Obligation not to discriminate on grounds of nationality or, more broadly, against persons exercising fundamental freedoms (whether inbound or outbound) (see eg discussion by Maduro in Marks and Spencer (2005))
Obligation does not extend to eliminating:
double taxation arising from parallel exercise of fiscal sovereignty (e.g. Kerckhaert and Morres (2006), Haribo (2011) and Levy (2012)).
disadvantages arising from disparities between MS tax rules, although distinction often difficult (see cases such as Gilly 1998, Geschwind (1999) and Imfeld (2013).
Limiting benefits of a bilateral treaty to persons resident in the other contracting state is inherent in bilateral conventions so that persons resident in another state not in a comparable position (D (2005) and ACT Class IV (2006) but compare Saint Gobain (1999)).
07/02/2014
Joseph Hage Aaronson LLP

10. Joseph Hage Aaronson LLP
Justification
Non-comparability/objective justification
Cassis-style general interest justifications:
Fiscal supervision
Fiscal cohesion
Tax avoidance
Balanced allocation of taxing powers
07/02/2014
Joseph Hage Aaronson LLP

11. Joseph Hage Aaronson LLP
Justification
Despite occasional protests (eg AG Jacobs in Danner (2002) and Maduro in M&S (2005) language often mixed
Substantial overlap between defences because all tax-related
The question ultimately is whether the different treatment is sufficiently explained by a MS’s allocated taxing rights and its chosen tax systems
Contrast general case law where a range of general policy interests may be in issue (consumer protection, health, environment etc).
Contrast also fiscal state aid where there are two levels of justification: the logic of the tax system and compatibility with the common market on wider general interest grounds
07/02/2014
Joseph Hage Aaronson LLP

12. Development of Defences
Preserving fiscal coherence essentially about symmetry between taxing rights and deductions
Potentially good defence but applied rigidly and narrowly during nineties (although recent come-back)
Combatting tax avoidance or abuse limited to defence of rules combatting non- commercial arrangements (e.g. CFC rules)
Case law until around 2005 failed to recognise need for more general rules protecting the tax base.
Conflation of protecting tax base and (mere) loss of revenue
Following earlier glimpses emergence of balanced allocation in Marks & Spencer
Growing importance in recent case law of proportionality limb of test
07/02/2014
Joseph Hage Aaronson LLP

13. Thin Capitalisation Lankhorst Hohorst (2002)
A struggling German company replaced bank borrowings with a loan from its Netherlands parent reducing its interest payments. Tax authorities treated the interest as a disguised distribution on the basis that it would not have been able to obtain a similar loan from a third party.
07/02/2014
Joseph Hage Aaronson LLP

14. Lankhorst Hohorst (2002) (ECJ’s response)
Loss of tax revenue not an overriding general interest Not justified by preventing tax avoidance. Legislation does not have the specific purpose of preventing wholly artificial arrangements designed to circumvent German tax legislation but applies wherever the parent company is foreign. National court had found no abuse, the purpose of the loan being to reduce the subsidiary’s interest payments. Fiscal coherence argument based on internationally recognised arm's length principle rejected. No Bachmann-style link between the less favourable treatment and a countervailing advantage.
07/02/2014
Joseph Hage Aaronson LLP

15. Thin Cap Group litigation (2007)
Bachmann defence again rejected because no direct link
But arm’s length rule accepted as an appropriate means of combatting abusive practices “the sole purpose of which is to avoid the tax that would normally be payable on profits generated by activities undertaken in the national territory.”
Moving on to proportionality:
“National legislation which provides for a consideration of objective and verifiable elements in order to determine whether a transaction represents a purely artificial arrangement, entered into for tax reasons alone, is to be considered as not going beyond what is necessary to prevent abusive practices where, in the first place, on each occasion on which the existence of such an arrangement cannot be ruled out, the taxpayer is given an opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that arrangement.”
“it is for the national court to determine whether those provisions allow taxpayers, where the transaction does not satisfy the arm’s-length criterion, to produce evidence of the commercial justifications for that transaction”.
07/02/2014
Joseph Hage Aaronson LLP

16. Thin Cap (Court of Appeal)
Court of Appeal (Arden LJ dissenting) accepted HMRC’s argument that the ECJ’s judgment in Thin Cap merely required the UK to apply an arm’s length test and not an additional “commercial justification” test.
It overturned Henderson J who had concluded that HMRC’s case was “threadbare” because it contradicted the clear words of the ECJ’s judgment in Thin Cap.
07/02/2014
Joseph Hage Aaronson LLP

17. Joseph Hage Aaronson LLP
SGI (2010)
Greater emphasis on balanced allocation of taxing powers than in Thin Cap
Belgian rules held to be justified by a combination of preventing tax avoidance and preserving balanced allocation
But similar language used for the proportionality test.
07/02/2014
Joseph Hage Aaronson LLP

18. AG Kokott: relationship between balanced allocation and tax avoidance
“Such abusive arrangements therefore constitute simply a particular form of interference in the allocation of the power to tax between Member States. If artificial arrangements are adopted in order to remove income from the scope of taxation in one Member State and subject it to taxation in another State, that is quite simply interference in the balanced allocation of the power to tax. Accordingly, combating such practices does not, as a general rule, constitute an end in itself but pursues the broader objective of ensuring the right of a Member State to exercise its tax jurisdiction in relation to activities carried out on its territory.”
In other words, preventing tax avoidance is a sub-category of preserving the balanced allocation of taxing powers.
07/02/2014
Joseph Hage Aaronson LLP

19. Tax avoidance and balanced allocation
Providing the ultimate test is the commerciality of the arrangements, thin cap and transfer pricing cases can be dealt with using either or both concepts.
However, rules targeting entirely commercial, albeit not arm’s length, arrangements would not be proportionate to the aim of preventing tax avoidance or abusive practices. If the CA were correct and commercial arrangements could lawfully be overridden to impose an arm’s length standard, this would have to be on the basis of balanced allocation alone.
The cross-border losses and exit tax cases illustrate rules which do require a broader justification than preventing abusive practices.
07/02/2014
Joseph Hage Aaronson LLP

20. Joseph Hage Aaronson LLP
Marks and Spencer (2005)
The debate between the parties focused on whether the restriction on cross-border group relief was justified on grounds of non- comparability of situations and fiscal coherence. AG Maduro focused solely on fiscal coherence (protesting that non- comparability had no part in an outbound situation).
The ECJ re-characterised the UK’s argument as:
Need for symmetry in treatment of profits and losses in order to protect a balanced allocation of the power to impose taxes between Member States
Risk that the losses might be used twice
Tax avoidance in the form of jurisdiction shopping for losses.
07/02/2014
Joseph Hage Aaronson LLP

21. Joseph Hage Aaronson LLP
Marks & Spencer
The Court (finally) grasps the difference between (mere) loss of revenue and the need to protect the tax base
The ECJ repeats that loss of tax revenue is not a defence but adds: “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, as the taxable basis would be increased in the first State and reduced in the second to the extent of the losses transferred.”
07/02/2014
Joseph Hage Aaronson LLP

22. Joseph Hage Aaronson LLP
Marks and Spencer
What concerned the ECJ was not merely lack of symmetry but the freedom for a taxpayer to choose where to set off its losses.
That freedom was liable to undermine balanced allocation, allow double use of losses and open the door to jurisdiction-shopping.
Where there was no choice these issues did not arise.
Hence the ECJ’s conclusion that the restriction was disproportionate where the taxpayer had no choice because the losses cannot be used locally (and in M&S’s case the only other option was the UK).
07/02/2014
Joseph Hage Aaronson LLP

23. Later cases on cross-border losses
Since M&S there has been discussion of how many of the three justifications are required.
The key issue (as can be seen from e.g. Oy AA (2007), X Holding (2010) and A Oy (2013)) is whether the taxpayer can choose where to set off the losses.
In the UK proceedings HMRC have argued that the right to relief is lost where the taxpayer can take any step to make the losses unusable locally.
07/02/2014
Joseph Hage Aaronson LLP

24. Marks and Spencer in UK courts
Since returning to the UK courts M&S has been the subject of 7 hearings in the UK courts (including the CA twice):
What was meant by the no possibilities test?
At what point did it have to be met?
Where a taxpayer made an initial claim before it met the test could it make another one within the self-assessment time limits once it did?
Could M&S make later, out-of-time claims for the pay-and-file years where its initial claims did not meet the test?
How are the losses available for surrender to be calculated?
Some of the issues have been resolved and we expect the SC’s judgment on the remaining ones this month.
07/02/2014
Joseph Hage Aaronson LLP

25. Tax avoidance and balanced allocation
In M&S the tax avoidance defence was of no relevance as the group relief regime is designed to permit manipulation of results between group members.
Nor can it deal adequately with exit taxes etc as there is a need for general rules going beyond combatting non-commercial arrangements (e.g. National Grid Indus (2011) and DMC (2014).)
Hence the references to the broader defence of balanced allocation in those cases (although arguably fiscal cohesion would also have been an option).
07/02/2014
Joseph Hage Aaronson LLP

26. Hoechst/Metallgesellschaft (2001) (UK System)
ACT
surrender
Dividend paid
under GIE UK CT
07/02/2014
Joseph Hage Aaronson LLP

27. Hoechst (German Parent No GIE)
Dividend UK
ACT (set off
later against CT
07/02/2014
Joseph Hage Aaronson LLP

28. Hoechst/Metallgesellschaft (2001)
UK: if resident subsidiaries and their non-resident parent companies could exercise the GIE no ACT at all would be paid in the United Kingdom. The subsidiary would be exempt from payment of ACT when paying dividends to its parent company, but that exemption would not be offset by any subsequent payment of ACT by the non-resident parent company when it made distributions (because it is not subject to United Kingdom corporation tax or, therefore, to ACT)
07/02/2014
Joseph Hage Aaronson LLP

29. Hoechst: ECJ’s response
ACT is merely an advance payment of CT. So the German-parented subsidiary would not avoid paying any tax in the UK on profits distributed by way of dividends. No reason not to give it the same cash flow advantage enjoyed by domestically owned subsidiary.
The fact that the German parent is not subject to ACT when it pays on the dividend income is attributable to its not being liable to CT in the UK. It should not have to make an advance payment of a tax to which it will never be liable.
Loss of tax revenue is not a recognised overriding general interest (ICI ).
07/02/2014
Joseph Hage Aaronson LLP

30. Boake Allen (House of Lords 2007)
The refusal of the GIE to a US-parented UK subsidiary was not contrary to the non- discrimination article because the difference in treatment was not solely because the capital of the subsidiaries was controlled by a non-UK-resident.
The difference in treatment between the UK/UK case and the UK/US case arose because:
in the UK/UK case, the election shifted the ACT liability to the parent; and
in the UK/US case, the US parent was not liable to ACT and so an election could not be made as this would result in exemption.
In other words, the HL accepted the argument rejected by the ECJ in Hoechst.
Expressed in the language of EU law, the HL considered that the different treatment was not discriminatory because the situations were not comparable or was justified by the allocation of taxing powers between the UK and US.
07/02/2014
Joseph Hage Aaronson LLP

31. Joseph Hage Aaronson LLP
FCE Bank US UK UK
Surrender of loss
07/02/2014
Joseph Hage Aaronson LLP

32. FCE Bank (FTT, UT and CA 2010-2012)
Boake Allen distinguished.
In Boake Allen the relief was refused because the parent which sought to be a party to the group income election was not liable to ACT. By contrast in FCE Bank the parent was not a party to the claim for group relief and the claim was refused solely because of the US residency of the parent.
Expressed in the language of EU law, there was no objective tax justification for the different treatment.
See similarly Felixstowe Docks on consortium relief (FTT, 2011).
07/02/2014
Joseph Hage Aaronson LLP

33. Joseph Hage Aaronson LLP
ACT Class IV (2006)
ACT Class IV raised the question which the ECJ did not have to answer.
Must the non-resident parent be given a tax credit on the same terms as a resident parent or a parent covered by another DTC granting such a credit.
07/02/2014
Joseph Hage Aaronson LLP

34. Joseph Hage Aaronson LLP
ACT Class IV (2006)
To require the source Member State to ensure that profits distributed to a non- resident shareholder are not liable to economic double taxation would mean forcing it to abandon its right to tax a profit generated through an economic activity undertaken on its territory.
It is the Member State of residence that is best placed to determine the shareholder’s ability to pay tax (Schumacker and Parent Subsidiary Directive).
It is in its capacity as the State of residence of the shareholder that the UK grants the tax credit to resident shareholders.
The position of a Member State in which both the companies making the distribution and the ultimate shareholders are resident is thus not comparable to that of a Member State in which only the dividend-paying company is resident.
07/02/2014
Joseph Hage Aaronson LLP

35. Joseph Hage Aaronson LLP
Denkavit (2006)
However, as soon as a Member State taxes the dividend income of resident and non-resident shareholders paid by resident companies, their situations become comparable.
MS cannot impose discriminatory withholding taxes unless (actually) offset by relief in the other state under a DTC (e.g. Com v Italy 2009, Case 540/07).
07/02/2014
Joseph Hage Aaronson LLP

36. Joseph Hage Aaronson LLP
Withholding tax 
(MS B)
Dividend
WHT 15
MS C
CT 30
07/02/2014
Joseph Hage Aaronson LLP

37. Joseph Hage Aaronson LLP
Imputation system 
MS B
MS A
CT 45
(Tax credit 15 to resident shareholders only)
07/02/2014
Joseph Hage Aaronson LLP

38. FII Litigation Corporation tax on foreign dividendsUK UK
Exempt
CT with DTR UK EU CT CT
FII I – Exemption and tax credit methods equivalent
07/02/2014
Joseph Hage Aaronson LLP

39. FII Litigation Corporation tax on foreign dividends (FII 2)
Exempt UK UK
CT at 30% with DTR at
effective rate UK EU
Statutory rate: 30
Effective rate: 15
Nominal rate
CT: 30
Effective rate: 15
Total Burden 15
Total Burden 30
07/02/2014
Joseph Hage Aaronson LLP

40. Joseph Hage Aaronson LLP
FII (UK ACT system) 
Tax Credit
Dividend UK
ACT
Dividend paid
under GIE
surrender UK
Corporation Tax
07/02/2014
Joseph Hage Aaronson LLP

41. FII (Foreign dividends)
Tax Credit UK
ACT
Dividend paid
under GIE
No or limited
surrender possible UK
CT subject
to DTR
EU1
dividend
dividend
EU2 CT
07/02/2014
Joseph Hage Aaronson LLP

42. Joseph Hage Aaronson LLP
FIDS 
No tax credit
FID UK
ACT repayable UK
CT subject to DTR EU CT
07/02/2014
Joseph Hage Aaronson LLP

43. Joseph Hage Aaronson LLP
FII Litigation
FII returns to the High Court in May. Issues include:
interpretation of FII 2 and its relationship with FII 1;
whether the provisions should be given a conforming interpretation and, if so what;
how to quantify the claims;
whether HMRC can run a change of position defence.
See also High Court judgment in Prudential (2013) where FII 1 and 2 were considered.
07/02/2014
Joseph Hage Aaronson LLP