The Development of the Concept of Discrimination in EU and UK

The Development of the Concept
of Discrimination in EU and UK
cases on direct taxation
Paul Farmer
Partner, Joseph Hage Aaronson
[email protected]
M +44 20 7515 050982
T +44 20 7851 8888
• 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 LLP
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
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 .”
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 nondiscriminatory 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 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.”
Joseph Hage Aaronson LLP
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 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
Joseph Hage Aaronson LLP
• Non-comparability/objective justification
• Cassis-style general interest justifications:
– Fiscal supervision
– Fiscal cohesion
– Tax avoidance
– Balanced allocation of taxing powers
Joseph Hage Aaronson LLP
• 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 LLP
Development of Defences
Preserving fiscal coherence essentially about symmetry between taxing rights and
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 noncommercial 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 LLP
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 LLP
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 LLP
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 LLP
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”
• 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 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
• But similar language used for the proportionality
Joseph Hage Aaronson LLP
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 LLP
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 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 noncomparability of situations and fiscal coherence. AG Maduro
focused solely on fiscal coherence (protesting that noncomparability 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 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.”
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
• 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 LLP
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 LLP
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 LLP
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 LLP
Hoechst/Metallgesellschaft (2001)
(UK System)
Dividend paid
under GIE
Joseph Hage Aaronson LLP
Hoechst (German Parent No GIE)
ACT (set off
later against CT
Joseph Hage Aaronson LLP
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
Joseph Hage Aaronson LLP
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 LLP
Boake Allen (House of Lords 2007)
The refusal of the GIE to a US-parented UK subsidiary was not contrary to the nondiscrimination 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
– 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 LLP
FCE Bank
Surrender of loss
Joseph Hage Aaronson LLP
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 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.
Joseph Hage Aaronson LLP
ACT Class IV (2006)
To require the source Member State to ensure that profits distributed to a nonresident 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 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).
Joseph Hage Aaronson LLP
Withholding tax
(MS B)
WHT 15
CT 30
Joseph Hage Aaronson LLP
Imputation system
CT 45
(Tax credit 15 to resident shareholders only)
Joseph Hage Aaronson LLP
FII Litigation
Corporation tax on foreign dividends
CT with DTR
FII I – Exemption and tax credit methods equivalent
Joseph Hage Aaronson LLP
FII Litigation
Corporation tax on foreign dividends (FII 2)
Nominal rate
CT: 30
Effective rate: 15
Statutory rate: 30
Effective rate: 15
Total Burden
Total Burden
CT at 30% with DTR at
effective rate
Joseph Hage Aaronson LLP
FII (UK ACT system)
Tax Credit
Dividend paid
under GIE
Corporation Tax
Joseph Hage Aaronson LLP
FII (Foreign dividends)
Tax Credit
Dividend paid
under GIE
No or limited
surrender possible
CT subject
to DTR
Joseph Hage Aaronson LLP
 No tax credit
ACT repayable
CT subject to DTR
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.
Joseph Hage Aaronson LLP

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