Commission and Spain v Gibraltar and the United Kingdom: a landmark case on engineered tax regimes

Transcription

1 Commission and Spain v Gibraltar and the United Kingdom: a landmark case on engineered tax regimes By Timothy Lyons Reprinted from British Tax Review Issue 1, 2012 Sweet & Maxwell 100 Avenue Road Swiss Cottage London NW3 3PF (Law Publishers)

2 Case Notes 55 Commission and Spain v Gibraltar and the United Kingdom: a landmark case on engineered tax regimes The Court of Justice of the European Union (CJEU) regularly concerns itself with tax regimes which do not exist either because the rules are no longer applicable or because they have not yet entered into force. An example of the latter is found in the recent conjoined appeals of European Commission and Kingdom of Spain v Government of Gibraltar and United Kingdom (Gibraltar). 1 Heard by 13 judges, the appeals were brought by the European Commission and Spain and concerned compliance with State aid law of a proposed tax system for Gibraltar. The provisions in question in these most recent appeals were held to constitute State aid. But, as a matter of practical politics, the Government of Gibraltar cannot be too concerned. As from January 1, 2011 it established a tax regime under which corporation tax is, with some exceptions, imposed on profits on a territorial basis and at a rate of 10 per cent. 2 It seems that one thing should be clear at the outset: whatever else the Court s judgment of November 15, 2011 has done, it has not removed Gibraltar s ability to construct an internationally competitive tax regime. The Irish Government, which supported the UK before the Court, will no doubt have noted that, along with the other Member States. In a case involving, Spain, the UK and Gibraltar a mention of constitutional matters is inevitable. The Advocate General duly noted that the extent of Gibraltar was in dispute between the UK and Spain 3 but that as the Court of Justice has concisely stated, Gibraltar was ceded by the King of Spain to the British Crown by the Treaty of Utrecht on 13 July The EU treaties, including the competition and State aid rules, apply to Gibraltar as a European territory for whose external relations the UK is responsible under, what is now, Article of the Treaty on the Functioning of the EU (TFEU). 5 It is true that the application of the treaties was adapted on the entry of the UK into the European Economic Community (EEC). As a result, Gibraltar 1 European Commission and Kingdom of Spain v Government of Gibraltar and United Kingdom of Great Britain and Northern Ireland, Joined Cases C-106/09 P European Commission and C-107/09 P Spain v Government of Gibraltar and United Kingdom, November 15, Income Tax Act 2010 (ITA 2010) s.11 and Rates of Tax (Amendment) Rules 2010 amending the Rates of Tax Rules 1989, both effective from January 1, The legislation is available at [Accessed January 26, 2012]. The Income Tax Act 2010 Sch.9, Pt 1, [1.(1)(a)] repealed almost the entirety of the Income Tax Act Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [49], fn Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [51] (footnotes omitted). The Court of Justice judgment referred to is Spain v United Kingdom (C-145/04) [2006] ECR I-7917 at [14] [19]. 5 Formerly Art EC. See also Declaration 55 by Spain and the United Kingdom annexed to the Final Act of the Intergovernmental Conference which adopted the Treaty of Lisbon, which says: The Treaties apply to Gibraltar as a European territory for whose external relations a Member State is responsible. This shall not imply changes in the respective positions of the Member States concerned. See also the Opinion of Tizzano AG in United Kingdom v European Commission (supported by Spain, intervener) (UK v Commission) (C-30/01) [2003] ECR I-9481 at [33].

3 56 British Tax Review falls outside the scope of certain EU law, for example, the provisions on the harmonisation of legislation on turnover taxes 6 and the customs union. 7 No adaptions were material in this case. 8 Tax regimes in Gibraltar In 2001, the European Commission had decided to investigate under the State aid procedure two corporate tax measures applied in Gibraltar. One concerned exempt companies normally liable to GBP 250 per annum. The other concerned qualifying companies which paid tax at a rate of between 2 per cent and 10 per cent per annum negotiated with the relevant authorities. Both categories of company were prohibited from carrying on or transacting any trade or business in Gibraltar except with other exempt or qualifying companies. The regime was, broadly speaking, intended to attract offshore business to Gibraltar. 9 The regime for qualifying companies was declared by the European Commission to be incompatible with the common market, as it was referred to in Article 87 of the European Community (EC) Treaty. 10 The regime for exempt companies was also considered by the Commission to constitute State aid. The Commission proposed adaptations to the legislation which were accepted by the UK. 11 Earlier, however, in April 2002, the Government of Gibraltar had announced that it intended to repeal all its corporate tax laws and introduce a new corporate tax regime. It was this proposed regime which the CJEU considered in its recent judgment. The aim of targeting offshore business was this time to be achieved by replacing the general system of tax and its derogations for qualifying and exempt companies with three new taxes. First there was to be a payroll tax imposed in respect of employees employed in Gibraltar. Secondly, there was to be a business property occupation tax imposed on property occupied in Gibraltar. Liability to these two taxes together was capped at 15 per cent of profits. Clearly, a company which did not have a property or employees in Gibraltar would not pay these taxes on its profits. It could be liable for the third tax, however, which was to be a small registration fee for all Gibraltan companies. This was to amount to GBP 150 or GBP 300 per annum depending on whether or not the company was intended to generate income. There was also to be a top-up, or penalty, tax imposed on financial service companies at a rate of between 4 per cent and 6 per cent of profits. This tax, if payable, was joined with the first two taxes in calculating the tax cap. Finally, there was to be also a top-up or penalty tax on utility companies to which the cap was to be similarly applied. 6 Act Concerning the Conditions of Accession and the Adjustments to the Treaties (Act of Accession) January 22, 1972 (Treaty Series No.1 (1973) Part II, Cmnd 5179), Art The Act of Accession, above fn.6, Art.29, Annex 1. Consequently, Gibraltar is not within the customs territory of the Community as defined in Council Regulation 2913/92/EC [1992] OJ L302/1, as amended. 8 As to the effects of adaptions in the field of competition law see the Opinion of Tizzano AG in UK v Commission (C-30/01), above fn.5, [2003] ECR I-9481 at fn See the Companies Taxation and Concessions Act 1983 and Commission Decision 2005/77/EC of March 30, 2004 on the aid scheme implemented by the UK in favour of Gibraltar Qualifying Companies [2005] OJ L/29 at 24, [7], indent No See Commission Decision 2005/77/EC, above fn See Authorisation for State aid pursuant to Articles 87 and 88 of the EC Treaty Cases where the Commission raises no objections (2005/C 228/04). See OJ [2005] C 228/9. The Court of First Instance had considered the regimes for qualifying and exempt companies in proceedings which do not need to be referred to here: see Government of Gibraltar v Commission (Joined Cases T-195/01 and T-207/01); [2002] ECR II-2309.

4 Case Notes 57 A continuing desire to attract offshore business has, no doubt, influenced the current tax system which replaced these three taxes from the beginning of Now the profits of a company are taxed only if they are accrued in, or derived from, Gibraltar. 12 Gibraltar joins a number of other jurisdictions in having a system based on territoriality, amongst them Hong Kong. 13 No doubt such a system was attractive, in the light of the arguments on selectivity directed at the previous suite of three taxes, given that it does not distinguish between undertakings. The Commission s decision The Commission made a Decision, on the same day as its Decision on qualifying companies, notifying the UK that the proposed corporate tax reform constituted State aid and was incompatible with the common market. 14 In its view the reform gave rise to both regional and material selectivity. The need to avoid selectivity derives, of course, from the definition of State aid in Article 87.1 EC (now Article 107 TFEU) which considers incompatible with the internal market: aid granted by a Member State or through state resources which distorts or threatens to distort competition by favouring certain undertakings or the production of certain goods in so far as it affects trade between Member States. 15 Regional selectivity arose in the Commission s view because: by providing for a system of corporate taxation under which enterprises in Gibraltar are taxed, in general, at a lower rate than those in the United Kingdom, the reform confers a selective advantage on enterprises in Gibraltar. 16 Material selectivity arose because the payroll tax and business property occupation tax were imposed only on profitable companies. In the words of the Commission: the exemption of unprofitable companies from payroll tax and business property occupation tax through the operation of the 15 % cap is selective and, if the other conditions are fulfilled, may constitute State aid to those companies that benefit from it. It cannot be justified by the nature or general scheme of the proposed tax system ITA 2010 s.11(1) provides that: Tax shall be payable at the rate or rates specified upon the income specified in Schedule 1 accruing in or derived from Gibraltar of any person. Under ITA 2010 s.11(2) tax is payable on income accruing in, derived from or received in any place other than Gibraltar of any person ordinarily resident in Gibraltar other than a company. 13 See CAP 112, Inland Revenue Ordinance, s.14. Other areas of the world have traditionally used territoriality in their tax systems. Sometimes, in addition to taxing income accruing in or derived from its territory, states also tax profits received in the territory as Gibraltar now does other than for companies, see e.g. Singapore, Income Tax Act (Ch.134) s.10 and above fn Commission Decision of March 30, 2004 on the aid scheme which the United Kingdom is planning to implement as regards the Government of Gibraltar Corporation Tax Reform, (notified under document number C(2004) 929) 2005/261/EC [2005] OJ L 85/1. For the decision on qualifying companies, see above fn See further, e.g. Adria-Wien Pipeline GmbH and Wietersdorfer & Peggauer Zementwerke GmbH v Finanzlandesdirektion für Kärnten (C-143/99) [2001] ECR I The Commission Decision, above fn.14, 2005/261/EC [127]. 17 The Commission Decision, above fn.14, 2005/261/EC [133].

5 58 British Tax Review A third area of material selectivity arose because, in the Commission s view, the advantages accruing to offshore companies under the proposed tax regime had the effect of perpetuating the State aid found to exist in relation to the category of exempt companies. 18 The appeal before the CJEU The General Court, hearing cases brought by the UK and Gibraltar, annulled Commission Decision 2005/261/EC 19 that Gibraltar s tax reforms gave rise to State aid. Before the CJEU, the Commission advanced one ground of appeal contending that these provisions gave rise to material selectivity. It succeeded and it was, therefore, unnecessary to consider Spain s additional contention that the provisions were regionally selective. The CJEU also dealt with other matters raised by the UK and Gibraltar in the action before the General Court. These included contentions that the Commission s actions were inconsistent with a notice issued by the Commission on State aid and taxation (the Notice) 20 and that rights of defence were infringed. It then dismissed the claims. This note considers, very briefly, two aspects of what the CJEU said in finding that material selectivity existed. The first of these relates to whether the existence of State aid should be judged by reference to Gibraltar s tax system alone or whether its tax system should be regarded, for these purposes, as part of the UK s tax system. This aspect of the case raised important issues about the extent to which regional autonomy could be recognised in State aid law. The second aspect concerns whether or not material selectivity has to be established by first identifying a framework of normality, or a normal tax regime, against which to determine the existence of alleged tax advantages. State aid and regional autonomy The UK and Gibraltar are not, of course, the only territories to which this issue is relevant within the European Union (EU). Within the UK, the issue is important in relation to the debates over devolution particularly in Scotland. It is noteworthy that EU State aid law was specifically considered in the Final Report of the Commission on Scottish Devolution. 21 The General Court had concluded that it was not possible to assess Gibraltar s tax system by reference to the UK for the purpose of determining whether or not there was material selectivity. 22 It applied the CJEU s decision in Portuguese Republic v Commission of the European 18 The Commission Decision, above fn.14, 2005/261/EC [151]. 19 The Commission Decision, above fn /261/EC. 20 The Notice in question was the Commission s Notice on the application of the State aid rules to measures relating to business taxation (98/C 384/03). 21 Serving Scotland Better: Scotland and the United Kingdom in the 21st Century, Final Report, June Available for download at: [Accessed January 26, 2012]. See in particular [3.18] [3.20]. The Commission on Scottish Devolution recommended that, in order to establish real financial accountability of the Scottish Parliament to the Scottish people, there should be a reduction in the basic and higher rates of UK income tax in Scotland by 10p in the pound, whilst the Scottish Parliament should be given the power to impose on individuals resident in Scotland a Scottish rate of income tax: see [3.174] [3.175] and Recommendation 3.1 at [3.206]. 22 See the first instance judgment in joined cases Government of Gibraltar (T-211/04) and United Kingdom of Great Britain and Northern Ireland v Commission (T-215/04) (Gibraltar, Court of First Instance) [2008] ECR II-3745 at [114] and [115].

6 Case Notes 59 Communities (Azores) 23 in which the Court had concluded that the reductions in Portuguese tax rates applied in the autonomous region of the Azores constituted State aid. The CJEU had identified three conditions to be assessed if the point of reference was to be the tax system of the autonomous region and not the Member State and the General Court therefore had to consider: (i) whether the tax reform has been devised by a regional or local authority which has, from a constitutional point of view, a political and administrative status separate from that of the central government of the United Kingdom, (ii) whether the tax reform has been devised without the central government of the United Kingdom being able to intervene directly as regards its content and (iii) whether the financial consequences for Gibraltar of introducing the tax reform are offset by aid or subsidies from other regions or from the central government of the United Kingdom. 24 In relation to Gibraltar, the General Court concluded that all three criteria were met. 25 The CJEU affirmed the three criteria by, in a somewhat obscure fashion, referring approvingly to the holding of the General Court at paragraph 146 of that court s judgment. 26 In paragraph 146 the General Court had stated that: as Community law currently stands, direct taxation falls within the competence of the Member States. Thus it is solely the latter, and infra-state bodies which have sufficient autonomy as defined in the judgment on the tax regime in the Azores in relation to central government, that have competence to devise systems of corporate taxation which they consider the best suited to the needs of their economies Although the CJEU decided that the proposed regime constituted State aid, it did so because it held that offshore companies obtained a selective advantage having regard to Gibraltar s tax law, not that of the UK. 27 Unsurprisingly, when the Secretary of State for Foreign and Commonwealth Affairs made a statement to the House of Commons on the judgment on November 15, 2011, he specifically noted that there has been no change in the principles established by the Court in the Azores case. 28 He went on to say: The ECJ s judgment does not change Gibraltar s constitutional relationship with the UK or Gibraltar s freedom to set a tax regime that differs from the UK s. 29 What is, perhaps, surprising is that the Commission had concluded in its Decision that: Gibraltar must be considered to form part of the United Kingdom for the purposes of the rules on State aid, including the application of Articles 87 and 88 to fiscal measures Portuguese Republic v Commission of the European Communities (C-88/03) [2006] ECR I-7115 at [67]. 24 See Gibraltar, Court of First Instance, Joined Cases T-211/04 and 215/ , above fn.22, [2008] ECR II-3745 at [86]. 25 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [114]. 26 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [97]. 27 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [106] and [107]. 28 Ministerial statement, Hansard, HC, col 20WS, January 12, Ministerial statement, above fn Commission Decision, above fn.14, 2005/261/EC, [123].

7 60 British Tax Review In its Decision in 2005 on the regime governing qualifying companies in Gibraltar, the Commission had taken a different approach. It had said that: When examining a measure, comparison must be made with the generally applicable system, in this case the standard regime of corporation tax in Gibraltar. 31 Now we know that the latter approach was correct. The Governments of the UK and Gibraltar will, no doubt, be pleased with that conclusion. The CJEU, material selectivity and State aid The UK and Gibraltar continued to have significant success when it came to issues of material selectivity. The CJEU upheld the General Court s finding that there was no selective advantage accruing from the fact that the payroll tax and business property occupation tax was imposed only on profitable companies. It also agreed that there was no selective advantage arising from the fact that the amount of tax was capped at 15 per cent of profits. The Court dealt with these issues relatively briefly: The requirement to make a profit and the capping of taxation of profits are per se general measures applicable without distinction to all economic operators and are therefore not liable to confer selective advantages. 32 The 13 judges of the CJEU and five judges of the General Court have joined, so far, in a notable display of unity. It did not last. When the CJEU came to consider whether offshore companies obtained a selective advantage they disagreed with the General Court s finding that no advantage arose. In order to assess the reasoning of the CJEU it is worth recalling that in the Decision of the Commission at the heart of the litigation, the Commission had said that the reform perpetuates the existing situation in which exempt companies are the beneficiaries of State aid. 33 The CJEU for its part considered that the conclusion of the General Court allowed Gibraltar, by adopting a different regulatory technique, 34 to create tax provisions which could not be selective although they produce the same effects in law and/or fact. 35 The rather inelegant reference to a different regulatory technique indicates that the Court had in mind that the first tax regime contained advantageous derogations for exempt and qualifying companies conducting offshore business from a general system of taxation. In contrast, the entire replacement regime the Court was considering was constructed in such a way as to give advantages to companies engaged in offshore business without the need for any derogations. The Court had to determine whether or not this change in legislative approach was sufficient to permit Gibraltar to perpetuate (to use the Commission s word 36 ) the previous prohibited situation. 31 Commission Decision, above fn.14, 2005/261/EC, [66]. 32 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [80]. 33 Commission Decision, above fn.14, 2005/261/EC, [151]. 34 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [92]. 35 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [92]. 36 Commission Decision, above fn.14, 2005/261/EC, [151].

8 Case Notes 61 The contention that the change in approach was sufficient to achieve compliance with State aid law was based on the proposition, advanced by the UK and Gibraltar that: [t]he mere fact that a tax regime creates an advantage for some companies is not sufficient in itself for that regime to be regarded as selective, since it is necessary first of all to identify the normal regime. That is corroborated by the notice relating to State aid in the field of taxation, which is binding on the Commission in accordance with the principle of the protection of legitimate expectations. 37 In the light of the recent judgment in R. (on the application of Davies and another) v HMRC; R.(on the application of Gaines Cooper) v HMRC, it is interesting to see the UK attempting, unsuccessfully, to rely upon legitimate expectations derived from the statements of a bureaucracy. 38 The Notice is commented on below. 39 So far as concerns the need to identify the normal regime the Court said that it was possible to have selectivity by creating: a tax system which, as in the present case, instead of laying down general rules applying to all undertakings from which a derogation is made for certain undertakings, achieves the same result by adjusting and combining the tax rules in such a way that their very application results in a different tax burden for different undertakings. 40 There is, it seems, a suggestion in the Court s choice of words that it saw itself as preventing, in effect, the avoidance of State aid law. 41 Nevertheless, the Advocate General said that to accept such an approach would be tantamount to triggering a methodological revolution in the application of the rules relating to State aid 42 In his view, rejecting the UK s submission would require the construction of a fiscal comparator for the EU. 43 The CJEU, however, returned to the wording of Article 87.1 EC, 44 and noted that it was concerned with economic effects not regulatory techniques. 45 It also noted that the Treaty did not require the identification of a normal tax system before ascertaining the existence of selective advantages. 46 The existence of tax advantages was, therefore, established by comparing the treatment of offshore companies with other companies under the proposed regime. The fiscal comparator for the EU which the Advocate General thought necessary was not required. 37 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [59]. The notice referred to is the Commission s Notice on the application of the State aid rules to measures relating to business taxation [1988] OJ C384/3, above fn See R. (on the application of Davies and another) v HMRC; R.(on the application of Gaines Cooper) v HMRC [2011] UKSC 47; [2011] STC 2249 and S. Eden and D. Welsh, R. (on the application of Davies and another) v HMRC, R.(on the application of Gaines Cooper) v HMRC: how far can the taxpayer rely on HMRC guidance? [2011] BTR Commission notice on the application of the State aid rules to measures relating to direct business taxation (98/C 384/03), above fn.20 and referred to below in text at fn Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [93]. 41 The writer has discussed the application of a general broad anti-abuse principle in relation to State aid law in T. Lyons, State Aid, Taxation and Abuse of Law in R. de la Feria and S. Voganauer (eds), Prohibition of Abuse of Law: A New General Principle of EU Law? (Oxford: Hart Publishing, 2011), Ch Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [202]. 43 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [93]. 44 Now TFEU Art (formerly Art.87.1 EC). 45 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [87] and [88]. 46 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [92].

9 62 British Tax Review The Court has, consequently, ensured that selectivity is not made conditional on the identification of the normal tax burden 47 in a case concerning an unusual regulatory technique in which the provisions in question were not derogations. It may be said that this does not develop the law of State aid as set out in the Treaty. But the practical implications of the Court s judgment must be assessed bearing in mind that the Notice has played a significant role in the evaluation of State aid relating to business taxation. 48 In disposing of the UK s arguments in relation to the Notice, the CJEU has reminded everyone that the Notice is not a rule of law 49 and that it does not follow from paragraphs [9 and 16] that the existence of an advantage can be shown only by establishing a derogation from a normal tax regime. 50 (emphasis added). That may be so as a matter of law, but paragraph 16 does say: The main criterion in applying Article 92.1[ 51 ] is that the measure provides in favour of certain undertakings in the Member State an exception to the application of the tax system. The common system applicable should thus first be determined. 52 If the law has not changed then it seems its manner of application has, at least where no derogations are present. Indeed, the Commission called it a landmark ruling in its press release welcoming the judgment of the CJEU. 53 It is not, however, inevitable that the practical implications of the ruling for Member States will be radical. Whether they are or not depends upon the future conduct of the Commission. Member States will, no doubt, note that the Commission referred in its press release to a tax regime engineered 54 to give advantages. Engineering an entire tax regime is not something that is likely to be frequent or that most territories within the EU could embark upon with equanimity. Conclusion The UK lost the appeal over the existence of State aid in Gibraltar s tax regime. Despite that it managed to secure some significant goals. It ensured that Gibraltar s tax system was assessed without reference to the UK system and saw the Azores criteria endorsed. In addition, the CJEU agreed with its submission that the imposition of the relevant taxes on profitable companies only and the capping of taxation by reference to profits did not give rise to selectivity. The practical significance of the points on which it lost will become clearer in due course. One may guess, however, that some Member States would have preferred Gibraltar to have discovered its affinity 47 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [91]. 48 See also: Report on the implementation of the Commission notice on the application of the state aid rules to measures relating to direct business taxation. C(2004) Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [128]. 50 Gibraltar (C-106/09 P, C-107/09), above fn.1, [2011] ECR 0 at [131]. 51 TFEU Art.107.1, above fn Commission notice (98/C 384/03), above fn.20 at [16]. 53 See State aid: Commission welcomes landmark Court ruling on proposed 2002 Gibraltar tax reform MEMO/11/784, Brussels, November 15, See MEMO/11/784, above fn.53, Brussels, November 15, 2011.

10 Case Notes 63 with a system of taxation which does not require derogations, or extensive engineering, somewhat earlier in the 21st century than it did. Timothy Lyons Actions for annulment; EU law; Gibraltar; State aid