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The Development of the Concept of Discrimination in EU and UK cases on direct taxation Paul Farmer Partner, Joseph Hage Aaronson M +44.

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Presentation on theme: "The Development of the Concept of Discrimination in EU and UK cases on direct taxation Paul Farmer Partner, Joseph Hage Aaronson M +44."— Presentation transcript:


2 The Development of the Concept of Discrimination in EU and UK cases on direct taxation Paul Farmer Partner, Joseph Hage Aaronson PFARMER@JHA.COM M +44 20 7515 050982 280 HIGH HOLBORN LONDON, WC1V 7EE, UNITED KINGDOM T +44 20 7851 8888

3 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 Joseph Hage Aaronson LLP07/02/20141

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.” Joseph Hage Aaronson LLP07/02/20142

5 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.” Joseph Hage Aaronson LLP07/02/20143

6 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.” Joseph Hage Aaronson LLP07/02/20144

7 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.” Joseph Hage Aaronson LLP07/02/20145

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). Joseph Hage Aaronson LLP07/02/20146

9 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)). Joseph Hage Aaronson LLP07/02/20147

10 Justification Non-comparability/objective justification Cassis-style general interest justifications: – Fiscal supervision – Fiscal cohesion – Tax avoidance – Balanced allocation of taxing powers Joseph Hage Aaronson LLP07/02/20148

11 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 Joseph Hage Aaronson LLP07/02/20149

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 Joseph Hage Aaronson LLP07/02/201410

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. Joseph Hage Aaronson LLP07/02/201411

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. Joseph Hage Aaronson LLP07/02/201412

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”. Joseph Hage Aaronson LLP07/02/201413

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. Joseph Hage Aaronson LLP07/02/201414

17 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. Joseph Hage Aaronson LLP07/02/201415

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. Joseph Hage Aaronson LLP07/02/201416

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. Joseph Hage Aaronson LLP07/02/201417

20 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. Joseph Hage Aaronson LLP07/02/201418

21 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.” Joseph Hage Aaronson LLP07/02/201419

22 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). Joseph Hage Aaronson LLP07/02/201420

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. Joseph Hage Aaronson LLP07/02/201421

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. Joseph Hage Aaronson LLP07/02/201422

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). Joseph Hage Aaronson LLP07/02/201423

26 Dividend paid under GIE Hoechst/Metallgesellschaft (2001) (UK System) UK ACT CT surrender Joseph Hage Aaronson LLP07/02/201425

27 Hoechst ( German Parent No GIE ) German UK Dividend ACT (set off later against CT Joseph Hage Aaronson LLP07/02/201426

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) Joseph Hage Aaronson LLP07/02/201424

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 ). Joseph Hage Aaronson LLP07/02/201427

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. Joseph Hage Aaronson LLP07/02/201428

31 FCE Bank US UK Surrender of loss Joseph Hage Aaronson LLP07/02/201429

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). Joseph Hage Aaronson LLP07/02/201430

33 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. Joseph Hage Aaronson LLP07/02/201431

34 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. Joseph Hage Aaronson LLP07/02/201432

35 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). Joseph Hage Aaronson LLP07/02/201433

36 Withholding tax  (MS B) MS C Dividend WHT 15 CT 30 Joseph Hage Aaronson LLP07/02/201435

37 Imputation system  MS A CT 45 (Tax credit 15 to resident shareholders only) MS B Joseph Hage Aaronson LLP07/02/201434

38 FII Litigation Corporation tax on foreign dividends UK EU ExemptCT with DTR CT FII I – Exemption and tax credit methods equivalent Joseph Hage Aaronson LLP07/02/201436

39 FII Litigation Corporation tax on foreign dividends (FII 2) UK EU Exempt CT at 30% with DTR at effective rate Statutory rate: 30 Effective rate: 15 Nominal rate CT: 30 Effective rate: 15 Total Burden 30 Total Burden 15 Joseph Hage Aaronson LLP07/02/201437

40 FII ( UK ACT system )  UK Tax Credit Dividend Dividend paid under GIE ACT surrender Corporation Tax Joseph Hage Aaronson LLP07/02/201438

41 CT No or limited surrender possible ACT FII ( Foreign dividends )  UK EU1 EU2 Tax Credit dividend CT subject to DTR Dividend paid under GIE Joseph Hage Aaronson LLP07/02/201439

42 FIDS  No tax credit UK EU FID ACT repayable CT subject to DTR CT Joseph Hage Aaronson LLP07/02/201440

43 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. Joseph Hage Aaronson LLP07/02/201441

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