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The Twin Engines of the EU Back  
The first half of 2006 has seen significant action by two of the EU institutions, in the area of tax. The European Court of Justice (ECJ) has given a number of landmark judgements which generally favour tax competition amongst Member States. In contrast, the EU Commission is working away on a number of projects aimed at the harmonisation of tax rules within the community, and the consequent reduction in tax competition.
The ECJ
Cases heard by the ECJ go through a two-part process. The first stage after the hearing is the publication of a draft judgement called the Advocate General's Opinion. This is usually, but not invariably, followed in a subsequent judgement given by the Court. The first half of 2006 has seen a number of important tax cases reaching the stage of the publication of either an opinion, or a final judgement. This represents the end of a process that probably began years ago in the case of each individual case. It is probably something of a coincidence that so many major tax cases have appeared in the first six months.
Brian Daly


Many commentators have detected in recent opinions and judgements, an increasing reluctance on the part of the Court to interfere with national sovergnity in the matter of taxation. However, the Court is constrained by its constitutional obligations to enforce the EU treaties. These treaties generally outlaw aspects of national tax systems which are discriminatory or protectionist in their nature. The Court, therefore, has little or no discretion but to strike down such measures.
However, the language it has used in recent cases - in particular in the Marks & Spencer case regarding cross-border losses, and in the Cadbury/Schweppes case dealing with controlled foreign company legislation - has shown an attempt by the Court to minimise the impact of the decision on national tax systems. As a result, some of these judgements have avoided fully exploring the issues and may have to be revisited by the Courts.

Cross-Border Losses
Marks & Spencer claimed group relief in the UK in respect of losses of a French resident subsidiary, which was outside the UK tax net. The domestic law of the UK, as is the case with Ireland, would not have allowed such relief. The Court upheld the taxpayer's contention that such a denial of relief interfered with its freedom of establishment, i.e. its freedom to choose to conduct its business in France through a subsidiary rather than through a branch. However, the ruling of the Court limited the entitlement to relief by the parent company and made no reference to relief being available to fellow subsidiaries. That aspect has been left ambiguous, and possibly requiring a further case to clarify it. Furthermore, the Court held that relief had to be provided in the UK only when it could be demonstrated that relief in any other EU Member State was no longer possible. It did not clarify whether that meant legally impossible, or merely practically impossible. Neither did it clarify whether the normal domestic rules in relation to claiming loss relief - which generally speaking, requires a claim within two years of the end of the year in which the loss is incurred - could be used to defeat a claim, where the impossibility of getting relief abroad became apparent only after that time period of two years had elapsed. Because of the many ambiguities in the judgement, it is of marginal importance only in increasing the relief actually available to tax payers.

Control Foreign Company Legislation
The Advocate General Opinion in the Cadbury/Schweppes held that controlled foreign company legislation was compatible with EU law provided it had application only to artificial arrangements which involved either the foreign company not carrying on real economic activity in the country in which it was located, or in charging its fellow group members for alleged services that were in reality of no economic significance to those members. Since that clearly is not what controlled foreign company legislation is aimed at in the UK, the practical effect of the judgement is to largely render UK CFC legislation illegal (and to have been so at all times). Because of the contrived manner in which the opinion arrived at the conclusion - stating that CFC legislation was compliant with the EU law in unrealistic circumstances - it offers the UK the temptation to take minimal action to reform its legislation. It would not be surprising to find that further cases on CFC legislation will be needed to clarify the legitimate limits to such legislation.

The opinion held that where an overseas subsidiary had the premises, plant and staff commensurate with the extent and complexity of the services it purported to offer, it could be regarded as carrying on bona fide commercial activity in the overseas State, and accordingly (provided the services it provided the group members were of real economic significance to them) to be outside the scope of CFC legislation. But the case left undecided the position of an overseas subsidiary which outsourced its activities. Each subsidiary has a choice of carrying on its activities through staff employed by it or through agents. The judgment focused only on the situation of the company with staff. If member states attempt to continue to apply CFC legislation to agency situations or to companies which resort to subcontracting , it may be necessary to resort again to the ECJ.

Exit Charges
A recent judgement in the case of a Netherlands individual who emigrated to the UK reinforced the message of a previous ECJ judgement in the de Lasteyrie case which held that many exit charges ' charges to CGT imposed on a taxpayer when leaving the tax net of a Member State and moving to another Member State - were contrary to EU law as interfering with freedom of movement of persons, freedom of establishment, and freedom of movement of capital. The most recent judgment suggests, however, that an exit charge which is confined to a charge on the part of the gain that has arisen during a person's period of residence in a Member State may be lawful in some circumstances. Ireland imposes exit charges on individuals, companies, and on trusts. The charge in Ireland is not on the gain that arises during residency in Ireland but rather on the gain that has arisen up to the point of departure, even if part of that gain arose prior to a person becoming resident in Ireland.

Foreign Dividends
A number of UK companies challenged the UK 'Franked Investment Income' regime which is similar to the Irish tax treatment of domestic and foreign dividends. Under this regime, dividends from one Irish company to another are tax exempt (apart from surcharge) whereas foreign dividends are fully taxable albeit with credit in some cases for foreign taxes. The opinion given has held, not surprisingly, that the discriminatory treatment is contrary to EU law. This may open up the prospect of a claim for refund of tax by companies who have suffered tax in Ireland on foreign dividends.

In a separate case concerning cross border dividends (Denkavit) the advocate general has cast doubt on the legality of withholding taxes within the EU on dividend payments , especially where the dividend is tax exempt in the country in which it is received , as it would seem dividends received by a corporate in Ireland from another EU state should be.

Reclaiming Tax
The many tax cases that appear before the ECJ are not taken by taxpayers out of concern for the public good. They are taken to defend themselves against an immediate tax charge, or to seek refund of taxes paid in the past, possibly illegally. All of the cases described above raise the potential, not only in the UK and elsewhere, but also in Ireland, for claims for refund of tax. Even the CFC case has such an implication in Ireland, notwithstanding that we have no formal CFC legislation. We do, however, have legislation that can attribute to individuals, the income of companies or trusts resident abroad, including in the EU. Aspects of that legislation may, by implication, be unlawful.

However, the ability to claim refunds of tax is not without limits. In a recent case involving an Italian local authority tax, the Court noted that if all of the tax that had been levied in Italy had to be refunded, the impact on Italian national finances would be catastrophic. It also noted that the tax was of such importance that it was essential that Italy be able to put a replacement tax (meeting EU treaty requirements) in place before the existing tax could cease to operate. For all of these reasons, it was proposed that Italy would be allowed until the end of 2006 to come up with a replacement tax, and in the meantime could continue with the illegal tax. It is also proposed that only those who had claimed refunds up to the date of the issue of the Advocate General's opinion should be entitled to a refund. This was an attempt to balance the need to give taxpayers an incentive to challenge illegal taxes, while ensuring that the result is not to bankrupt the Member States.

This rule is not applied in every case and will be applied only in respect of a tax that was levied in good faith (i.e. without reasonable knowledge that it was illegal) and where the consequences of refunds would seriously undermine the finances of the State. Nonetheless, it emphasises the importance of acting early and putting in protective claims for repayment of tax, where a taxpayer believes that a domestic tax (whether in this State or in another EU Member State where the taxpayer is exposed to tax) is illegal. Generally, the prospect of getting a refund will be maximised if the claim is made prior to the issue of the Advocate General opinion. This does not necessarily mean that the taxpayer has to be the first one to claim the refund, and has to be the one who takes the case before the ECJ. If taxpayers take heed of the issues being appealed at the ECJ, there is usually plenty of time in which to put in a protective claim for a refund if a similar issue arises in Ireland.

The Commission
The Commission is acting on a number of fronts to promote tax harmonisation. Its flagship project is the CCCTB ' the Common Consolidated Corporate Tax Base. This is an attempt to produce a single set of rules for determining taxable profits for a trading company, regardless of where in Europe it carries on its activities. The idea is that a company would file in one location only, pay its tax there, and that the revenues would be shared out amongst the States in which it generates profits, under some pre-determined criteria.

Ireland is opposed to this proposal, which would undermine its tax competitiveness, not least because the criteria for revenue sharing would be likely to favour other Member States, in cases where multinationals are located in Ireland. The Commission realise that there is little or no prospect of it becoming a mandatory tax system across Europe but are hoping that it will be adopted, on a voluntary basis, by a significant number of Member States.

As Paul McGowan, Tax Partner in KPMG, pointed out in an article in Finance Dublin, the project faces mammoth technical difficulties and an early resolution is not to be expected. The approach being adopted is to draft tax rules from scratch, rather than identifying what is common to the tax systems of the 25 Member States, and using that as a starting point.

The EU are re-examining rules relating to 'place of supply' and are attempting to devise a 'one-stop shop' proposal which would enable the taxpayer making supplies in many Member States to meet all VAT applications in one Member State only. This has echoes of the CCCTB Project in corporation tax. Since VAT compliance obligations are more burdensome than corporation tax obligations, it makes a bit more sense in the area of VAT. However, the need of Member States to protect their domestic source of finance will, in this case, again prove an obstacle to reaching agreement.

The Commission are also resurrecting a study of VAT as it applies to financial services. VAT can represent a major cost to financial service companies, and can be an obstacle to outsourcing and to the rational development of their businesses. The obstacle to the application of VAT in a straightforward way to financial services and insurance is primarily the definition of 'turnover'. Even if the Commission come up with a solution that would make sense to the financial services industry, it will have to come up also with a solution which does not involve significant loss of tax revenues to Member States. It may prove very difficult to satisfy the needs not only of the financial services industries but also of the Member States' tax needs. The financial services industry will need to watch these developments very carefully.

The EU is pursuing a coordinated European approach for the design, the implementation, and the evaluation of research and development tax incentives. This does not appear to be an attempt to impose a 'one size fits all' model for R&D tax incentives. Instead, the Commission are proposing to produce a document setting out the constraints of community law in terms of State aids, and to identify the best practices at present in use amongst Member States in promoting research and development.

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