Reprinted from British Tax Review Issue 5, 2014

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1 Reprinted from British Tax Review Issue 5, 2014 Sweet & Maxwell Friars House 160 Blackfriars Road London SE1 8EZ (Law Publishers) To subscribe, please go to 8&productid=6614. Full text articles from the British Tax Review are also available via subscription to or

2 Case Notes SCA Group Holding BV, X AG and others, and MSA International Holdings BV and another: the CJEU considers the impact of EU law on the scope of tax groups or fiscal unities Introduction Although groups are composed of legally distinct companies, the Member States tend, in different ways, to treat them more or less as a single company for the purposes of taxation law. However, where a group is composed of companies from different Member States and is thus subject to more than one tax jurisdiction, treatment as a single company becomes problematic. 1 Fiscal unities allow groups of related entities to be treated as a single entity for the purposes of tax law. The benefits of a fiscal unity typically include the disregard of otherwise taxable transactions within the fiscal unity, and the consolidation or pooling of profits and losses across the entities that form part of the fiscal unity. The joined cases of Inspecteur van de Belastingdienst/Noord/kantoor Groningen v SCA Group Holding BV (SCA), X AG (and others) v Inspecteur van de Belastingdienst Amsterdam (X) and Inspecteur van de Belastingdienst Holland-Noord/kantoor Zaandam v MSA International Holdings BV (MSA) (the Joined Cases) 2 shine a light on the issues that can arise for multinational groups, where ownership of entities in the group is rarely via an uninterrupted chain of companies established in a single jurisdiction. In the decision in Société Papillon v Ministère du Budget, des Comptes Publics et de la Fonction Publique (Papillon), 3 the CJEU held that EU law was breached where the French fiscal unity rules did not allow a French parent company and a French sub-subsidiary owned via a Netherlands subsidiary to be grouped for French corporate income tax purposes. The CJEU has again held, for slightly different reasons, that national law restricting a fiscal unity to entities owned directly by companies established in the same Member State is an unjustified infringement of the fundamental freedom of establishment enshrined in the Treaty on the Functioning of the European Union (TFEU). 4 1 Opinion of Advocate General Kokott delivered on February 27, 2014 in the Joined Cases Inspecteur van de Belastingdienst/Noord/kantoor Groningen v SCA Group Holding BV (C-39/13); X AG and others v Inspecteur van de Belastingdienst Amsterdam (C-40/13); and Inspecteur van de Belastingdienst Holland-Noord/kantoor Zaandam v MSA International Holdings BV (C-41/13) (Opinion of Advocate General Kokott) [2014] BTC 14 at [1]. 2 Joined Cases Inspecteur van de Belastingdienst/Noord/kantoor Groningen v SCA Group Holding BV (C-39/13); X AG and others v Inspecteur van de Belastingdienst Amsterdam (C-40/13); and Inspecteur van de Belastingdienst Holland-Noord/kantoor Zaandam v MSA International Holdings BV (C-41/13) [2014] STC 2107 (ECJ). 3 Société Papillon v Ministère du Budget, des Comptes Publics et de la Fonction Publique (C-418/07) [2009] STC 542; [2008] ECR I-8947 (ECJ). 4 See TFEU Arts

3 Case Notes 531 Facts of the Joined Cases The relevant Netherlands tax legislation allowed a Dutch parent company to form a fiscal unity with subsidiaries in which it held at least 95 per cent of the nominal paid-up share capital and 95 per cent of the voting power, and where it had entitlement to at least 95 per cent of the distributable profits of the subsidiary. In addition, both the parent company and its subsidiaries had to be established and resident for tax purposes in the Netherlands, 5 or have a permanent establishment (PE) in the Netherlands. Non-Dutch companies which are not carrying on business through a Dutch PE are not permitted to be members of a Dutch fiscal unity: this aspect of the Netherlands regime was upheld by the CJEU in the case of X Holding BV v Staatssecretaris van Financien. 6 The key question in the Joined Cases 7 was whether the degree of affiliation needed to create a Dutch fiscal unity could be established by tracing ownership through a non-dutch European Economic Area (EEA)-resident company with no Dutch PE. Cases C-39/13 and C-41/13 intermediate subsidiaries established outside the jurisdiction of residence of the parent company SCA Group Holding BV (SCA) and MSA International Holdings BV (MSA) were companies established in the Netherlands. Both companies owned, either directly or indirectly, companies established in Germany. Those German subsidiaries themselves did not have a Dutch PE, but owned companies established in the Netherlands. SCA and MSA and their respective Dutch sub-subsidiaries established in the Netherlands sought to be treated as single tax entities under the Netherlands fiscal unity rules. There was no question of the German intermediate holding companies seeking membership of the Dutch fiscal unity. Their requests were refused on the basis that the intermediate companies had neither been established in the Netherlands nor had a PE there. The Dutch District Court found that the refusal 5 Netherlands Law on corporation tax 1969 Art X Holding BV v Staatssecretaris van Financien (C-337/08) [2010] STC 941; [2010] ECR I-1215 (ECJ). 7

4 532 British Tax Review contradicted the EU principle of freedom of establishment. 8 The Inspector of the Tax and Customs Administration appealed to the Regional Court of Appeal which decided to stay proceedings and to refer the issues on freedom of establishment to the CJEU for a preliminary ruling. 9 Case C-40/13 parent company established outside the jurisdiction of residence of its sister subsidiaries X AG (X) was a company established in Germany. It owned companies X3 Holding GmbH (X3), D1 BV (D1) and D2 BV (D2). X3 was incorporated in Germany but had a PE in the Netherlands. 10 D1 and D2 were established in the Netherlands. The request of X3, D1 and D2 to be treated as a single tax entity was refused on the ground that X, their common parent company, was neither established in the Netherlands nor had a PE there. X3, D1 and D2 unsuccessfully appealed to the District Court. 11 They then appealed against its judgment to the Regional Court of Appeal which decided to stay proceedings and to refer questions on freedom of establishment to the CJEU for a preliminary ruling. 12 Restriction of freedom of establishment In both cases, the CJEU found that the Netherlands fiscal unity rules restricted the right to freedom of establishment under the TFEU. Specifically: 1. prohibiting Dutch sub-subsidiaries held through non-dutch EEA subsidiaries from forming a fiscal unity with a Dutch ultimate parent 13 ; and 2. prohibiting Dutch sister subsidiaries from forming a fiscal unity where those subsidiaries are held by a non-dutch EEA parent, 14 are not compatible with Articles TFEU. The relevant Netherlands rules created a mismatch between the tax treatment of groups consisting solely of Dutch entities, whose Dutch members could form fiscal unities, and groups with Dutch entities and entities established in other Member States, whose Dutch members could not be part of a fiscal unity where they were not directly owned by a Dutch parent. As Advocate General Kokott noted: 8 Rechtbank Haarlem, June 9, 2011, AWB 10/2288, LJN BQ Gerechtshof Amsterdam, January 17, 2013, nr 11/ References in this article to X3 are to the Dutch PE of X3 Holding GmbH. 11 Rechtbank Haarlem, January 25, 2011, AWB 08/ Gerechtshof Amsterdam, January 17, 2013, nr 11/ SCA (C-39/13), above fn.2, [2014] STC 2107 (ECJ); and MSA (C-41/13), above fn.2, [2014] STC 2107 (ECJ). 14 X (C-40/13), above fn.2, [2014] STC 2107 (ECJ).

5 Case Notes 533 In the field of taxation law, the [CJEU] considers establishment to be hindered in cases where there is a disadvantageous difference in treatment of an establishment in another Member State in comparison with a purely domestic establishment. 15 In the cases of SCA 16 and MSA, 17 the Advocate General considered that the freedom of establishment of both the Dutch parent company and the German intermediate companies was restricted by the Netherlands regime prohibiting a fiscal unity between the Dutch parent and its Dutch sub-subsidiaries, 18 and likewise in the case of X, 19 that the freedom of establishment of the German parent was restricted. 20 The CJEU agreed. Germany and the Netherlands argued that there was no difference in treatment between Dutch and non-dutch entities that would lead to a disadvantage, since: 1. the Netherlands fiscal unity rules do not allow companies and sub-subsidiaries to form a single entity for tax purposes without including any intermediate subsidiaries; and 2. sister subsidiaries may not form a fiscal unity without the parent company. However, the Advocate General and the CJEU rejected these arguments. The disadvantage stemmed from the prohibition on including any non-dutch entities in a fiscal unity. On 1., the key point was that a Dutch parent company with only Dutch subsidiaries and sub-subsidiaries would have the option of entering into a fiscal unity, even if it chose not to, whereas a Dutch parent with non-dutch intermediate subsidiaries would not have that opportunity. On 2., a Dutch parent could form a fiscal unity with its Dutch subsidiaries, but a non-dutch parent could not. Justifications for breach of freedom of establishment? A prima facie restriction on freedom of establishment can nevertheless be justified under EU law by an overriding reason in the public interest, 21 provided that its application is appropriate and proportionate in light of the objective to be achieved. The Netherlands argued, in defence of the fiscal unity rules, first that they were necessary to preserve the coherence of the domestic tax system including preventing the double use of losses, and secondly that they prevented tax avoidance. The CJEU swiftly dispensed with the second possible ground of defence, on the basis that Cadbury Schweppes plc v IRC 22 is authority for the premise that preventing tax avoidance does not of itself justify a restriction on freedom of establishment if it is not relied on in conjunction with a specific objective of combatting wholly artificial arrangements which do not reflect economic reality and the purpose of which is to escape the tax normally due Opinion of Advocate General Kokott, above fn.1, [2014] BTC 14 at [21]. 16 SCA (C-39/13), above fn.2, [2014] STC 2107 (ECJ). 17 MSA (C-41/13), above fn.2, [2014] STC 2107 (ECJ). 18 Opinion of Advocate-General Kokott, above fn.1, [2014] BTC 14 at [36] [42]. 19 X (C-40/13), above fn.2, [2014] STC 2107 (ECJ). 20 Opinion of Advocate-General Kokott, above fn.1, [2014] BTC 14 at [80]. 21 See, for example, Felixstowe Dock and Railway Co Ltd and Others v HMRC (C-80/12) [2014] STC 1489; [2014] 3 CMLR 660 (ECJ). 22 Cadbury Schweppes plc v IRC (C-196/04) [2006] STC 1908; [2006] ECR I-7995 (ECJ). 23 Joined Cases (C-39/13), (C-40/13) and (C-41/13), above fn.2, [2014] STC 2107 (ECJ) at [42].

6 534 British Tax Review The other concern raised by the Netherlands was that the losses of a Dutch sub-subsidiary that is a member of a fiscal unity with a Dutch parent could be double counted, and that such double counting would harm the coherence of its tax system. The Netherlands argued, first, that the loss could be used at the parent level by way of the consolidation of profits and losses across the fiscal unity. Secondly, a loss could also be claimed because of a reduction in the value of the shares in the sub-subsidiary held by the non-dutch intermediate company. 24 However, the Netherlands has a holding exemption that essentially ignores, for most tax purposes, 25 gains or losses from the possession, acquisition or disposal of a shareholding greater than 5 per cent in another company. 26 A Netherlands fiscal unity requires, among other things, ownership by the parent of at least 95 per cent of the shares in a relevant subsidiary. Therefore, the holding exemption should apply to any shareholding of a parent in respect of a subsidiary, but crucially, this exemption applies whether or not a fiscal unity has been created with that subsidiary. The CJEU found that there was no direct link under Netherlands law between the tax benefits of fiscal unity status and the disallowance of gains and losses in respect of a shareholding in a subsidiary. Without such a direct link the justification based on reserving the coherence of the tax system does not apply. The existence and operation of this participation exemption distinguished the Joined Cases 27 from Papillon, 28 which concerned the French tax grouping rules. 29 In that case, France argued that the rule preventing a French-resident parent company and French-resident sub-subsidiaries from forming a group via a non-french intermediate company was necessary to avoid the double use of losses (that is, first by the losses being transferred within the tax group, and secondly as a deductible loss in respect of the loss-making company s shares in the hands of its non-french parent). To combat such a double use of losses, the French rules provided for the neutralisation of certain transactions intra-group where all group members were French and all intermediate companies were French. However, the potential double use of losses would not be prevented by the French rules where a non-french-resident subsidiary was interposed between the French parent and the French sub-subsidiary, because the non-french-resident intermediate subsidiary was not subject to those neutralisation rules Advocate General Kokott noted that the losses of a Dutch sub-subsidiary could be used twice even if there was no fiscal unity among the Dutch parent and its Dutch sub-subsidiaries: losses of the Dutch sub-subsidiary could be carried forward by it, in addition to reducing the value of its shares on the books of the non-dutch intermediate company. Therefore, the double use of losses could not be prevented by the restrictions on forming a Netherlands fiscal unity (Opinion of Advocate General Kokott, above fn.1, [2014] BTC 14 at [54]). 25 Losses arising on a liquidation may be deductible in certain restricted circumstances. 26 Netherlands Law on corporation tax 1969 Art The relevant French rules (Code Général des Impôts arts 223B, 223D and 223F) differed from the Netherlands fiscal unity rules. The French rules in force at the time allowed a French parent to form a tax group with a French subsidiary where it owned 95% of the share capital of the subsidiary either directly, or indirectly via an unbroken chain of French subsidiaries that were also part of the group. Only companies subject to French corporation tax could be included in the group. 30 In addition to the aggregation of profits and losses of all group entities, the French rules regarded as neutral certain intra-group transactions such as payments; waivers of debt; transfers of fixed assets; provisions for risks between group companies; and provisions for depreciation of shares held in other group companies. See the Opinion of Advocate General Kokott delivered on September 4, 2008 in Papillon (C-418/07), above fn.3, [2008] ECR I-8947 at [9].

7 Case Notes 535 Preventing a grouping relationship because of the presence of a non-french-resident intermediate subsidiary within the ownership chain was a restriction on freedom of establishment. For this to be justified on the ground of preserving the coherence of the tax system, France needed to show that there was a direct link between the tax grouping regime and the neutralisation of intra-group transactions. The CJEU accepted that there was such a link. However, departing from Advocate General Kokott s Opinion, 31 it held that the French grouping rules still went beyond what was strictly necessary to preserve the coherence of the tax system. On the basis that there were less restrictive measures to ensure that losses were not utilised twice, the CJEU in Papillon, 32 found the French grouping rules incompatible with EU law. In the Joined Cases, 33 Advocate General Kokott s analysis was similar. By contrast, the CJEU simply held in the Joined Cases 34 that there was no direct link established between the granting of the tax advantage (that is, participation in a Dutch fiscal unity) and the non-recognition of gains or losses in respect of shares in a subsidiary because of the holding exemption discussed above. Therefore the restrictions in the Netherlands fiscal unity regime could not be justified by an argument that the status quo was necessary to maintain the coherence of the national tax system. The CJEU also ruled that the justifications claimed were not enough to validate refusing fiscal unity status to Dutch-taxpaying sister subsidiaries of a German parent company in the case of X. 35 Since the Netherlands failed to demonstrate adequate justification for the restriction on freedom of establishment caused by its fiscal unity regime, the Netherlands rules were found to be in breach of EU law. Comment Tax consolidation affords groups of companies considerable simplification of their tax affairs in a particular jurisdiction, for example by allowing them to disregard intra-group transfers, and to aggregate profits and losses on a group-wide basis. It is good news for taxpayers that groups for tax consolidation purposes can be traced through non-resident EEA companies in the group, whether these non-resident companies are intermediate subsidiaries or the group parent itself. Together with the Papillon 36 decision, the Joined Cases 37 illustrate that it seems to be a settled principle of EU law that Member States are not permitted to restrict group tax consolidation because parent entities or intermediate entities are established in another Member State. It also appears that this principle applies regardless of the precise mechanics of tax consolidation in a Member State. Given the decision in the Joined Cases, 38 it would be surprising if further reform of Member States tax grouping rules were not precipitated. For example, the French grouping 31 Opinion of Advocate General Kokott delivered on September 4, 2008, in Papillon (C-418/07), above fn.3, [2008] ECR I X (C-40/13), above fn.2, [2014] STC 2107 (ECJ)

8 536 British Tax Review rules were amended in 2009 in light of the Papillon 39 decision, to allow grouping between a French parent and French sub-subsidiaries owned via a non-french EEA intermediate company. However, that rule change did not permit grouping of French sister subsidiaries of a foreign parent. In response to the decision in the Joined Cases, the French Parliament is currently considering a legislative change that would allow the grouping of French sister subsidiaries of a parent company located in an EU Member State, or a Member State of the EEA, that has entered into a tax treaty with France providing for administrative assistance. Arguably, this change would be the minimum necessary to bring the French regime in line with EU law. The Joined Cases 40 are also a helpful reminder that preventing tax avoidance is not a catch-all justification for restricting fundamental TFEU freedoms, and that Member States cannot always rely on preserving the coherence of the tax system to justify such restrictions. In fact, Member States have historically had limited success justifying infringement of EU fundamental freedoms on the basis of protecting the coherence of the tax system, a justification first articulated by the European Court of Justice in Bachmann v Belgian State. 41 In light of the CJEU jurisprudence in Papillon 42 and the Joined Cases 43 other Member States such as the Netherlands may consider allowing tax consolidation of companies resident in a Member State where parent entities or intermediate entities are established outside the EEA. This would go beyond what is strictly necessary to comply with freedom of establishment under EU law and the proposals currently being considered by the French Parliament do not take such an expansive approach. However, the UK took such an approach in response to Imperial Chemical Industries plc v Colmer (Colmer), 44 when it enacted changes to its direct tax grouping rules. In the Finance Act 2000 (FA 2000), as well as allowing the UK PE of a non-uk-resident company to join a UK tax group, the UK permitted such group affiliations to be traced via non-uk-resident parent companies and/or intermediate subsidiaries. The UK generally did not require the non-uk-resident parent or intermediate company to be EEA-resident. In short, the UK went some way beyond what the Colmer 45 decision strictly required. At the time of FA 2000, the issue of double use of losses (discussed extensively in the Joined Cases 46 ) did not attract so much attention. Interestingly, that issue did surface some years later when the UK sought, unsuccessfully, to rely on it to deny the benefit of the post-2000 grouping rules to the UK PE of a non-uk-resident EEA company. 47 As and when more Member States amend their tax grouping/tax consolidation rules to take account of the Joined Cases, 48 it will be necessary to adjust specific features of those rules. For example, under the Netherlands fiscal unity rules (unlike the UK group relief rules), the effect of the fiscal unity is to create a single taxpayer, the parent company, rather than a family of Bachmann v Belgian State (C-204/90) [1994] STC 855; [1992] ECR I-249 (ECJ) Imperial Chemical Industries plc v Colmer (C-264/96) [1998] STC 874; [1998] ECR I-4695 (ECJ). 45 Colmer (C-264/96), above fn.44, [1998] ECR I-4695 (ECJ) HMRC v Philips Electronics UK Ltd (C-18/11) [2013] STC 41; [2013] 1 CMLR 210 (ECJ). 48

9 Case Notes 537 separate affiliated taxpayers. If the parent company of the fiscal unity can now be a non-dutch company with no Dutch PE, a mechanism will be needed whereby the effect of the fiscal unity is to treat one of its Dutch-taxpaying members as the single taxpayer. Emma Hardwick * and Michael McGowan ** Corporation tax; EU law; Freedom of establishment; Groups of companies; International tax planning; Netherlands; Permanent establishment; Tax administration * Associate, Sullivan & Cromwell LLP. ** Partner, Sullivan & Cromwell LLP. The writers would like to thank Bert van der Poel, Tax Advisor, Loyens & Loeff NV, who assisted with the analysis of the relevant Netherlands legislation.

Opinion of Advocate General Kokott, 27 February Joined Cases C-39/13, C-40/13 and C-41/13

Opinion of Advocate General Kokott, 27 February 2014 1 Joined Cases C-39/13, C-40/13 and C-41/13 Inspecteur van de Belastingdienst Noord/kantoor Groningen v SCA Group Holding BV (C-39/13), X AG, X1 Holding