EU Tax Alert. CJ considers German rules on taxation of outbound dividends in breach of the free movement of capital (Commission v Germany)

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1 EU Tax Alert Edition 98 November 2011 CJ considers Portuguese taxation of dividends received by foreign pension funds incompatible with the free movement of capital (Commission v Portugal) On 6 October 2011, the CJ issued its judgment in the case Commission v Portugal (C-493/09) finding the Portuguese taxation of outbound dividends paid to foreign pension funds incompatible with the EU rules on the free movement of capital. (See: Top News) CJ considers German rules on taxation of outbound dividends in breach of the free movement of capital (Commission v Germany) On 20 October 2011, the CJ issued its judgment in the Commission v Germany case (C-284/09) where it ruled that the German taxation on outbound dividends is in breach of the EU rules on the free movement of capital. (See: Top News) IN THIS EDITION: Top News State Aid / WTO Direct taxation VAT Customs Duties, Excises and other Indirect Taxes CJ rules on the meaning of valid commercial reasons under the Merger Directive (Foggia) On the 10 November 2011, the CJ issued its decision in the Foggia case (C-126/10) giving guidance on the interpretation of the term valid commercial reasons contained in the anti-abuse provision of Article 11 (1) (a) of the Merger Directive in the context of taking over losses in merger operations. (See: Top News) Please click here to unsubscribe from this mailing. The EU Tax Alert is an newsletter to inform you of recent developments in the EU that are of interest for tax professionals. It includes recent case law of the European Court of Justice, (proposed) direct tax and VAT legislation, customs, state aid, developments in the Netherlands, Belgium and Luxembourg and more. To subscribe (free of charge) see:

2 EU Tax Alert Edition 98 November Contents Top News CJ considers Portuguese taxation of dividends received by foreign pension funds incompatible with the free movement of capital (Commission v Portugal) CJ considers German rules on taxation of outbound dividends in breach of the free movement of capital (Commission v Germany) CJ rules on the meaning of valid commercial reasons under the Merger Directive (Foggia) State Aid / WTO General Court dismisses appeal over double Danish shipping registers (3F v Commission) Advocate General advises to rule against conversion of tax debt into equity (Commission v EDF) Direct taxation EU s highest political forums discuss tax policy coordination and financial transaction tax initiative CJ rules that establishment requirement for tax representatives violates EU law (Commission v Austria) CJ considers Belgian tax credit on income from loans granted to coordination centres for the acquisition of assets used on national territory incompatible with EU law (Waypoint Aviation) Advocate General finds Belgian rules on deductibility of payments for supply of services to non-resident taxpayers or foreign permanent establishments in violation of EU law (SIAT) Belgian Court refers preliminary question to the CJ regarding the Parent-Subsidiary Directive (Punch Graphix) Belgian Court refers preliminary question to the CJ regarding the Belgian definitely taxed income regime (Tate & Lyle Investments) Commission closes several infringement procedures against Belgium Commission closes infringement procedure against Luxembourg Commission refers Spain to CJ over discriminatory inheritance and gift tax rules Commission publishes report Tax reforms in EU Member States Tax policy challenges for economic growth and fiscal sustainability Developments in the Netherlands: Netherlands legislation on fiscal unity still in breach of EU law Developments in the Netherlands: Advocate General considers Netherlands withholding tax on dividends distributed to Netherlands Antilles parent company not in breach of EU law Developments in the Netherlands: Advocate General s Opinion on compatibility of Netherlands thin capitalization rules with EU law VAT CJ rules that place of establishment should be determined on the basis of the seat of the economic activity (Stoppelkamp) CJ rules that the assignment of the co-ownership of an invention in principle qualifies as a VAT taxable activity if that assignment is compatible with national law (Tanoarch) CJ gives guidance for determining the place of supply for services relating to fair and exhibition stands (Inter- Mark) CJ rules that an operator that purchases defaulted debts at a price below face value does not render a VAT taxable service (GFKL Financial Services) Commission is of the opinion that the Netherlands rules on the VAT treatment of participation in supervisory boards is not in line with EU VAT law Commission refers France to CJ over its VAT exemption for certain transactions involving vessels Commission requests Italy to implement two VATrelated Directives in its national legislation Commission requests Bulgaria to amend its rules for the refund of VAT Customs Duties, Excises and other Indirect Taxes CJ rules on the non-repayment of excise duty to purchasers of goods to whom the excise duty has been passed on (Danfoss and Sauer-Danfoss)

3 EU Tax Alert Edition 98 November CJ rules on the CN classification of frozen camel meat (Deli Ostrich) CJ rules regarding Romanian pollution tax (Vijulan, Druţu) Commission asks Italy to pay due amounts of customs duties to EU budget Commission refers Ireland to the CJ over fuel excise duty exemption Commission requests Ireland and Spain to modify rules on vehicles from other Member States Commission refers Cyprus to the CJ over discriminatory car taxation rules EU Trade chief welcomes progress from first Europe- South Korea Trade Committee EU and Moldova endorse customs cooperation EU and Russia agree terms for Russia s eventual WTO accession The tariff and statistical nomenclature 2012

4 EU Tax Alert Edition 98 November Top News CJ considers Portuguese taxation of dividends received by foreign pension funds incompatible with the free movement of capital (Commission v Portugal) On 6 October 2011, the Court of Justice ( CJ ) issued its judgment in the case Commission v Portugal (C-493/09). The case deals with the taxation of outbound dividends paid to foreign pension funds under Portuguese law. According to the Portuguese legislation, dividends received by pension funds established and operating in accordance with Portuguese law are exempt from corporate income tax, provided that the respective shares are kept for at least one year. In contrast, dividends paid to foreign pension funds which are subject to a withholding tax in Portugal of 20% or, if applicable, to a lower tax rate provided in a double tax convention. Considering the different taxation between dividends received by domestic and foreign pension funds which renders the investment performed by those foreign funds less attractive as compared to domestic ones, the Commission brought an action against Portugal before the CJ based on an alleged breach of the free movement of capital provided in Article 63 of the Treaty on the Functioning of the European Union ( TFEU ) and Article 40 of the European Economic Area Agreement ( EEA ). Portugal argued that such taxation was justified in order to ensure: (i) the coherence of its tax system and (ii) the effectiveness of fiscal supervision. As regards the first justification, Portugal referred to the fact that the tax exemption on the income received by domestic pension funds is compensated by the later taxation of the pensions which are paid to the respective beneficiaries. This is part of a policy to encourage savings in these types of products and avoid the economic double taxation of the respective income. In addition, it considered that in the context of pensions, this justification requires a broad interpretation in order to eliminate any risk of interference with the financial balance of the social security system. With regard to the argument of the effectiveness of fiscal supervision, the argument raised by Portugal was that domestic pension funds are subject to several rules concerning the protection of their investors. Those rules involve complex monitoring which requires the possibility to address those funds directly. This would not be possible in the case of foreign funds, in particular, with regard to the possibility to collect information and claim tax liabilities. Following its traditional approach, the CJ started by considering that different treatment between domestic and foreign pension funds constituted a restriction to the free movement of capital as it had the effect of dissuading non-resident pension funds from investing in Portuguese companies and savers resident in Portugal from investing in such pension funds. As regards the first justification, the CJ did not follow the arguments submitted by Portugal. It considered that there was not sufficient evidence of the link between the exemption from corporate income tax on the income received by the pension fund and the income tax paid by members of the pension funds resident in Portugal regarding the avoidance of double taxation. It used two different scenarios to illustrate this: (a) payment of benefits by non-resident pension funds to resident beneficiaries which are not exempt from Portuguese taxation; (b) payment of benefits by resident funds to non-resident beneficiaries in which case, the income received by the funds benefit from income tax exemption irrespective of the tax treatment of the beneficiaries in their respective State of residence. Regarding the second justification, the CJ considered that the absolute rejection by the Portuguese legislation of extending of the benefits to foreign pension funds was also not justified, as it cannot be considered a priori that foreign pension funds will not meet equivalent requirements to those laid down by Portuguese law. This is particularly so considering that the relevant regulatory framework is drawn from Directive 2003/41, which is applicable to all EU Member States and extended to EEA Member States. The CJ further pointed out that, even if this justification ground was accepted, the restriction could not be considered

5 EU Tax Alert Edition 98 November proportionate having regard to the argument of collection of information and recovery of tax debts. In fact, as regards funds residing in other Member States, Council Directive 77/799/EEC of 19 December 1977 concerning mutual assistance by the competent authorities of the Member States in the area of direct taxation ( Mutual Assistance Directive ) and also Council Directive 2008/55/EC of 26 May 2008 on mutual assistance for the recovery of claims relating to certain levies, duties, taxes and other measures would provide the Portuguese authorities with a cooperation and assistance framework enabling them to obtain the information required by national law, and also the means of recovering possible tax debts from non-resident pension funds. As concerns EEA States, equivalent cooperation and assistance would also be available via bilateral agreements. More interesting is the fact that the CJ, following the Opinion of Advocate General Mengozzi, raised the argument that in this subject case, less restrictive measures than those in the law at issue could be envisaged to ensure the recovery of tax debts, such as the obligation to provide, a priori, the necessary financial guarantees for the payment of those debts. In summary, the CJ concluded that the Portuguese taxation on dividends paid to foreign pension funds did indeed breach Article 63 TFEU and Article 40 EEA on the free movement of capital. CJ considers German rules on taxation of outbound dividends in breach of the free movement of capital (Commission v Germany) On 20 October 2011, the CJ issued its judgment in the Commission v Germany case (C-284/09). The CJ ruled that the German taxation on outbound dividends is in breach of the free movement of capital. Germany levies 25% withholding tax when dividends are distributed which are paid on shareholdings below the Parent-Subsidiary Directive s thresholds. This levy of withholding tax applies both to domestic and to cross border distributions of dividends to corporate shareholders; however, a domestic dividend recipient is allowed to set off the withholding tax against its own tax burden. This means that a German corporate shareholder de facto does not suffer a withholding tax, whereas a foreign EU/EEA shareholder has to bear the burden of such tax. According to the Commission, this tax treatment is in breach of the free movement of capital laid down in Article 63 TFEU and Article 40 EEA. Therefore, it had started an infringement procedure, which eventually ended up in the judgment now rendered by the CJ. The CJ noted, invoking settled case law (e.g. Denkavit Internationaal (C-170/05), Amurta (C-379/05) and Aberdeen (C-303/07)), that the situations of resident and non-resident companies receiving German dividends become comparable as soon as Germany imposes a charge to tax on the dividends derived not only by resident companies but also by non-resident companies. Thus, the rules at issue constitute a difference in treatment of comparable situations. The CJ analysed whether such restriction of the free movement could be neutralised by means of bilateral tax treaties. Following the rulings in Commission v Italy (C-540/07) and Commission v Spain (C-487/08), the Court ruled that tax credits granted based on tax treaties do not in every case neutralise the difference in treatment. This is due to the fact that an ordinary credit does not lead to a full set-off of tax when dividends are not, or not sufficiently, taxed in the home State. The CJ rejected Germany s argument that the restriction on the free movement of capital at issue could be justified either by the need to ensure the balanced allocation of the power to tax or the coherence of the tax system. The CJ therefore concluded that the German legislation is in breach of the free movement of capital as laid down in the TFEU and the EEA Agreement. Preliminary comments Albeit the case confirms that cross border dividend distributions may not be treated less favourably than domestic distributions, some issues regarding this matter remained open. In particular, the question that awaits answer is whether only a full credit based on a bilateral

6 EU Tax Alert Edition 98 November tax treaty (and de facto granted) may serve to neutralise a restriction on the free movement, or whether an ordinary credit based on a bilateral tax treaty, which enables a de facto full set off of the withholding tax against the tax liability in the home State is sufficient. The question is still pertinent, as this case - just like Commission v Italy and Commission v Spain - does not relate to a concrete set of facts but rather addresses the issue in the framework of an infringement procedure. Hence, it remains to be seen whether an ordinary credit in a specific case may neutralise a restriction. CJ rules on the meaning of valid commercial reasons under the Merger Directive (Foggia) On the 10 November 2011, the CJ issued its decision in the Foggia case (C-126/10), which concerns the interpretation of the term valid commercial reasons contained in the antiabuse provision provided in Article 11 (1) (a) of Directive 90/434/EEC of 23 July 1990 on the common system of taxation applicable to mergers, divisions, transfers of assets and exchanges of shares concerning companies of different Member States (the Merger Directive ) and which currently corresponds to Article 15 (1) (a) of Council Directive 2009/133/EC of 19 October A Portuguese bank had four Portuguese holding companies. The bank decided to eliminate part of this structure of holding companies and, for that purpose, three holding companies merged, by incorporation, into the other holding company, Foggia - SGPS. One of the incorporated holding companies, Riguadiana, had incurred considerable losses. In order to take advantage of the loss carry-over under the reorganization Foggia - SGPS following the requirements set forth in the Portuguese Corporate Income Tax Code lodged a request with the Ministry of Finance in which it applied for authorization to transfer those tax losses of the companies to Foggia - SGPS. The granting of such authorization for the transfer of losses under restructuring transactions is subject to certain conditions, inter alia, the existence of valid commercial reasons. The Ministry of Finance granted that application in relation to two of the three companies but refused the transfer of tax losses in case of Riguadiana on the ground that for Foggia - SGPS there was no valid commercial reason arising from such transaction. The reason for this was the fact that for the years under consideration, Riguadiana had ceased to have a portfolio of holdings, it had practically no revenue from its activity, it had invested only in securities and the origin of the losses was unclear. Although the removal of Riguadiana from the structure of the group may undoubtedly lead to a reduction in administrative and management costs, that positive effect in terms of the cost structure of the group could not, according to the Ministry of Finance, be considered as being of commercial interest for Foggia - SGPS. Foggia - SGPS appealed this decision. The Administrative Supreme Court referred the case to the CJ. The referral concerned the interpretation of the concept valid commercial reasons and restructuring or rationalisation of the activities of companies participating in operations covered by the Merger Directive. In particular, whether the interpretation followed by the Ministry of Finance according to which there was no apparent commercial interest in acquisition, since the acquired company had developed no activity as a holding company and had no financial holdings, and would consequently transfer only substantial losses, - although the merger might represent a positive effect in terms of the cost structure of the group - would be compatible with Article 11 (1) (a) of said Directive. The arguments raised by the Portuguese Government as a defence were two fold: (i) the transaction was purely national as it involved only Portuguese companies; (ii) the Portuguese provision at stake related to the transfer of losses (which is not regulated under the Merger Directive aside from a mere non-discrimination provision laid down in Article 6) and not with the neutrality regime which is regulated by the Directive.

7 EU Tax Alert Edition 98 November The CJ replied to these questions considering that: (i) As regards the first argument and following settled case-law where, in regulating purely internal situations, domestic legislation adopts the same solutions as those adopted in EU law it is clearly in the EU s interest that, in order to forestall future differences of interpretation, provisions or concepts taken from EU law should be interpreted uniformly; (ii) As regards the second question it considered that it is solely for the national court before which the dispute has been brought, and which must assume responsibility for the subsequent judicial decision, to determine both the need for a preliminary ruling in order to enable it to deliver judgment and the relevance of the questions which it submits to the Court. Then the CJ pointed out that the fact that a merger operation is based, amongst other objectives, on tax considerations does not prevent the operation from having valid commercial reasons provided that such considerations are not predominant. In addressing the questions which were subject to the referral, the CJ considered that a merger operation where the acquired company does not carry out any activity and does not have any assets to contribute to the acquired company may nevertheless be considered to fall within the ambit of valid commercial reasons. However, the fact that the tax losses transferred by the acquired company to the acquiring company are very substantial and of undetermined origin could indicate that the operation had not been carried out for valid commercial reasons. This even if the operation had a positive effect in terms of cost structure savings for that group. According to the CJ, in principle, the reduction of administrative and management costs may constitute valid commercial reasons. However, in the present case the benefits arising from the reduction of administrative and management costs were rather marginal in the light of the anticipated tax benefit (being more than EUR 2 million). The CJ added that it is inherent in any operation of merger by acquisition that the disappearance of the acquired company leads to a simplification of the structure of the group and the reduction of related costs. Therefore, by automatically accepting that such savings in the cost structure constitutes a valid commercial reason without taking into account the other objectives of the proposed operation would deprive the anti-abuse provision of the Merger Directive of its purpose, which consists of safeguarding the financial interest of the Member States. At last, the CJ concluded that it was up to the national court to verify, in the light of all the circumstances of the dispute, whether the constituent elements of the presumption of tax evasion or avoidance, within the meaning of that provision, are present in the context of that dispute. State Aid/WTO Advocate General advises to rule against conversion of tax debt into equity (Commission v EDF) On 20 October 2011, Advocate General Mazák issued his Opinion in the Commission v EDF case (C-124/10P). In 2009, the then Court of First Instance ( CFI ), now the General Court, partly annulled the Commission s decision which categorised as State aid incompatible with the common market a tax debt by Électricité de France ( EDF ) that had allegedly been converted into a capital injection by the French government under the State aid market economy investor principle. Under this principle, it has to be examined whether a government would grant aid if it acted as a normal private investor. The Commission appealed against the CFI s judgment before the CJ. Advocate General Mazák held that the Court misinterpreted the facts of the case, as there was no particular tax debt and that any such debt would have gone to the general budget without any hypothecation in regard to reinvestment. On this point, he recommended the CJ to refer the case back to the General Court. He then continued arguing that the market economy investor principle ( MEIP ) could not have applied in this case at all, even if the facts had been as assumed by the CFI.

8 EU Tax Alert Edition 98 November In his opinion, the French State should have collected the tax first. Even though the Advocate General seems to allow too little room for applying the MEIP, he is right in concluding that as the French State seems to have failed to appraise the prospects of a profitable return in advance before allegedly committing to the reinvestment of the tax debt, it did not act as any reasonable private investor. If the latter holds to be true, an essential element of the MEIP would not have been met. The Advocate General advised the CJ to overturn the CFI s judgement and refer the case back to the General Court. General Court dismisses appeal over double Danish shipping registers (3F v Commission) On 27 September 2011, in the case of 3F v Commission (T-30/03 RENV), the General Court upheld a Commission decision approving the use of two Danish registers for shipping, the Danish International Register of Shipping ( DIS ) and the Danish register of shipping ( DAS ). Among the tax differences resulting from the use of either of these registers was an exemption from Danish income tax of seafarers employed on board DIS-registered vessels. 3F, a labour union, appealed the Commission s decision approving the aid with no objection, without having opened a formal investigation. The latter would have allowed 3F to formally enter its remarks in the procedure. 3F argued that in accordance with the then Community guidelines for State aid in the maritime transport sector, this regime should not have been approved, as it would also exempt non-eu residents from tax. (It also referred to unlawful State aid resulting from bilateral tax treaties, but this issue was not at the centre of this particular judgement.) The Commission, however, argued that allowing nationals of non-member countries access to the tax benefits contributed to the objective of maintaining vessels under EU flags and securing onshore jobs in the EU s maritime sector. The General Court could not find any serious difficulties in regard to this analysis, as a result of which, the Commission was indeed at liberty to skip the formal investigation and go for immediate approval. Direct Taxation EU s highest political forums discuss tax policy coordination and financial transaction tax initiative In the European Council meeting of 23 October 2011 and at the Euro Summit of 26 October 2011, tax policy related issues were also discussed amongst the measures designed to address the challenges posed by the financial crisis and the sovereign debt crisis in the Euro area. The Conclusions of the European Council state that: as regards the reduction of administrative burden, more rapid progress should be made regarding, inter alia, taxation and customs at the next meeting of the European Council in December 2011, the Heads of State and Government will be informed of progress made in structured discussions on tax policy coordination issues. At the same time, the Conclusions recall that legislative work is ongoing on the Commission s proposal for a common consolidated corporate tax base ( CCCTB ) (see EU Tax Alert no. 91, April 2011) and they note the Commission s proposal for a financial transaction tax ( FTT ) (see EU Tax Alert edition no. 97, September 2011) as regards the EU s agenda for the G20 Summit in Cannes, the Conclusions lay down that the introduction of a global financial transaction tax should be explored and developed further. The Statement issued after the Euro Summit reiterates that pragmatic coordination of tax policies in the euro area is a necessary element of stronger economic policy coordination to support fiscal consolidation and economic growth. It also notes the EU s legislative initiatives regarding the CCCTB and the FTT.

9 EU Tax Alert Edition 98 November CJ rules that establishment requirement for tax representatives violates EU law (Commission v Austria) On 29 September 2011, the CJ rendered its decision in the Commission v Austria case (C-387/10). The case concerns the question whether a provision in the Austrian investment fund laws, requiring that a tax representative has to be established in Austria, violates the freedom to provide services (Article 56 TFEU and Article 36 EEA). Both the Austrian investment fund law (InvFG) and the Austrian real estate investment fund law (ImmoInvFG) contain a provision according to which, a tax representative who is responsible for certifying the amount of deemed distributed investment income towards the Austrian tax authorities has to be a financial institution or a chartered public accountant/ tax advisor established in Austria. If no tax representative is chosen, the taxpayer can prove the amount of deemed distributed investment income himself. The CJ held that such a provision constitutes a restriction of the freedom to provide services. The requirement that a tax representative has to be established in Austria in order to be permitted to render his services there is directly opposed to the aim of the freedom to provide services, and implies a negation of that freedom. Moreover, with respect to the argument of Austria that it only implemented the EU directives on UCITS (Directive 85/611/EEC and Directive 2009/65/EC), the CJ pointed out that these directives have nothing to do with the question of who is permitted to certify deemed distributed investment income. According to the CJ, the restriction cannot be justified. Austria claimed that a tax representative needs to have a sound knowledge of the Austrian tax law to secure high quality standards. In this respect, the CJ stated that the requirement that a tax representative has to be established in Austria does not in any way ensure that such person has the required knowledge of Austrian tax law. The CJ also rejected the second argument of Austria, i.e. that the establishment requirement would increase the reliability of the tax representative with respect to his level of knowledge of Austrian tax law and would thus be in the interest of consumer protection. The CJ stated that the reliability of a person with respect to the level of knowledge in Austrian tax law does not depend on that person s place of establishment. The CJ added that under the disputed provisions, Austria permits the taxpayers to submit the necessary evidence themselves, including the possibility to invoke the assistance of a professional of their choice. According to the CJ, this shows that the above-mentioned reason of public interest is not viable. Therefore, the reason given by Austria that a tax representative needs to have a certain knowledge of Austrian tax law, cannot justify the aforementioned restriction of the freedom to provide services. CJ considers Belgian tax credit on income from loans granted to coordination centres for the acquisition of assets used on national territory incompatible with EU law (Waypoint Aviation) On 13 October 2011, the CJ issued its judgment in the Waypoint Aviation case (C-9/11). The case concerns a Belgian provision enabling undertakings which lend to coordination centres to add a notional withholding tax to the interests they charge. This notional withholding tax can be subsequently sett off against the lending company s tax liability. The CJ decided that this tax credit system constitutes a restriction on the freedom to provide services (Article 56 TFEU). In order to qualify for the tax advantage, the capital borrowed must be used by the coordination centre (or a member of its group) to acquire fixed tangible assets in new condition or to reinstate such assets to new condition which are used in Belgium for the exercise of the company s business activity. The right to use the assets cannot be transferred to third parties that form part of the same group but are resident in another Member State.

10 EU Tax Alert Edition 98 November In the CJ s opinion, this condition is likely to discourage companies seeking the application of the tax credit from financing the acquisition of assets that will be transferred to foreign entities. Similarly, undertakings wishing to acquire an asset by means of a loan may refrain from providing services entailing the transfer of the right to use the acquired asset to companies established abroad. Therefore, the CJ concluded that the provision constitutes a restriction to the freedom to provide services. The Belgian Government did not put forward any arguments to justify this restriction, causing the CJ to find that the Belgian legislation at stake violates EU law. Advocate General finds Belgian rules on deductibility of payments for supply of services to non-resident taxpayers or foreign permanent establishments in violation of EU law (SIAT) On 29 September 2011, Advocate General Cruz Villalón delivered his Opinion in the SIAT case (C-318/10). The Belgian legislation at stake provides that payments for the supply of services made to non-resident taxpayers or foreign permanent establishments which are not subject to an income tax or are, for the relevant income, subject to a substantially more advantageous tax regime than the Belgian tax regime are not tax deductible, unless the taxpayer proves, by any legal means, that such payments (i) relate to genuine and proper transactions, and (ii) do not exceed the normal limits. Such double proof is not required for the deductibility of payments for the supply of services made by a Belgian company, even if this company is not subject to any tax on income or is subject to a substantially more advantageous tax regime than the Belgian ordinary tax regime. According to the Advocate General, this legislation constitutes a violation of the freedom to provide services. The case concerns a Belgian company that paid a commission to a Luxembourg holding 1929 for services provided by the latter. The Luxembourg holding was not subject to an income tax comparable to the Belgian income tax. Hence, the Belgian tax administration denied the deductibility of the commission. First, the Advocate General stated that the comparison must be made between, on the one hand, the situation in which the exceptional rule on tax deductibility applies (i.e. payments made to service providers resident in a tax haven ) and, on the other hand, the situation in which the general rule on tax deductibility applies (i.e. payments made to Belgian service providers and to non-belgian service providers that are not resident in a tax haven ). Next, the Advocate General examined both rules on the tax deductibility of payments for services provided. Both the general and the specific rule require that the reality of the underlying transaction is proved. But, as opposed to the general rule on the tax deductibility, the specific rule imposes an additional obligation to provide proof. The taxpayer must prove that such payments (i) relate to genuine and proper transactions, and (ii) do not exceed the normal limits. Hence, if the specific rule applies, the burden of proof for the taxpayer is heavier. The Advocate General holds that this different treatment constitutes a restriction to the freedom to provide services, as it is likely to discourage Belgian taxpayers from making use of service providers situated in a tax haven. Similarly, service providers situated in a tax haven could refrain from providing services to Belgian taxpayers. The Advocate General admits that the restriction could be justified by the need to combat tax evasion and, more precisely, the need to detect payments for fictitious services rendered or abnormal payments for real services. Nevertheless, even if justifiable, it is required that the Belgian rules are proportional and thus, do not go beyond what is necessary to reach that goal. The Belgian rules at stake apply to all payments made to service suppliers residing in tax havens and the double proof has to be provided even if there is no objective suspicion of fraud or if it does not concern wholly artificial arrangements. If the Belgian rules applied in specific cases, for example, between related companies, it would be easier to accept that they are proportional and do not go beyond what is necessary. Furthermore, the Belgian legislation creates legal uncertainty, as it is not clear how the notion of a substantially more advantageous tax regime than the Belgian tax regime should be understood in this context.

11 EU Tax Alert Edition 98 November Therefore, the Advocate General concluded in favour of the taxpayer. Although certain specific aspects of the Belgian rules could be deemed compatible with EU law, the Belgian rule as a whole constitutes a disproportional and thus, unjustified restriction of the freedom to provide services. Belgian Court refers preliminary question to the CJ regarding the Parent- Subsidiary Directive (Punch Graphix) On 13 July 2011, the Court of Appeal of Gent referred a question to the CJ for a preliminary ruling in the Punch Graphix case (C-371/11) regarding the application of the Parent-Subsidiary Directive in the case of a merger deemed as a liquidation of the subsidiary under domestic law. In particular, the Court of Appeal of Gent asks: Can the national tax authorities exclude the application of Article 4(1) of Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States on the basis of the provision in that Article that it is not applicable in a case where the subsidiary is liquidated, by relying on a provision of domestic law (here, Article 210 WIB92 [Income Tax Code 1992]) which treats a merger by acquisition where in reality no liquidation of the subsidiary takes place, as a merger where liquidation of the subsidiary does in fact take place? Belgian Court refers preliminary question to the CJ regarding the Belgian definitely taxed income regime (Tate & Lyle Investments) On 19 July 2011, the Court of First Instance at Brussels, referred a question to the CJ for a preliminary ruling in the Tate & Lyle Investments case (C-384/11) regarding the compatibility of the Belgian definitely taxed income regime with the free movement of capital. In particular, the Belgian court asks: 10% in the capital of another resident company but with a purchase value of at least EUR 1.2 million, is subject to withholding tax of 10%, but whereby such withholding tax is deductible from the corporate tax payable in Belgium and the balance, if any, is refundable, and whereby such a company, where appropriate, is also entitled to the application of a tax regime ( DBI : definitief belasten inkomsten: definitively taxed income) which allows the tax base to be reduced still further by the costs related to the shareholding, whereas for companies established in another Member State of the European Union which receive such dividends, and distributions regarded as dividends, from an identical holding in a resident company, the 10% withholding tax levied constitutes a final tax which is not refundable and which cannot be reduced by relying on the aforementioned tax regime ( DBI )? Commission closes several infringement procedures against Belgium On 29 September 2011, the Commission announced that it had closed the following infringement procedures against Belgium, as Belgium had amended the relevant provisions of its legislation: procedure regarding exit tax legislation for companies (see EU Tax Alert edition no. 78, April 2010) procedure regarding the discriminatory taxation of foreign investment companies (see EU Tax Alert edition no. 80, June 2010) procedure regarding the tax deductibility of interest expenses (see EU Tax Alert edition no. 85, November 2010) procedure concerning discriminatory inheritance tax provisions, under which non-resident heirs or recipients of gifts of movable assets located in Belgium had to provide a guarantee for the payment of inheritance tax (see EU Tax Alert edition no. 92, May 2011) Does Article 63 TFEU (previously Article 56 of the EC Treaty) preclude legislation on the part of a Member State whereby a dividend distributed to a resident shareholder company, which has a holding of less than

12 EU Tax Alert Edition 98 November Commission closes infringement procedure against Luxembourg On 29 September 2011, the Commission closed an infringement procedure against Luxembourg regarding certain provisions of its inheritance tax law concerning non-resident heirs (see EU Tax Alert edition no. 81, July 2010) because Luxembourg had amended its legislation. Commission refers Spain to CJ over discriminatory inheritance and gift tax rules On 27 October 2011, the Commission decided to refer Spain to the CJ for discriminatory rules on inheritance and gift tax that require non-residents to pay higher taxes than residents and imposes higher taxes on assets held abroad. The Commission had already formally requested Spain on 5 May 2010 (see EU Tax Alert edition no. 79, May 2010) and again on 17 February 2011 (see EU Tax Alert edition no. 90, March 2011) to take action to ensure compliance of its inheritance and gift tax provisions with EU law, in particular with the provisions on free movement of persons and capital (Articles 45 and 63 TFEU). However, no amendments have been made to Spanish legislation on the matter. Commission publishes report Tax reforms in EU Member States Tax policy challenges for economic growth and fiscal sustainability On 10 October 2011, the Commission published a new Taxation paper (No. 28) entitled Tax reforms in EU Member States Tax policy challenges for economic growth and fiscal sustainability. The report focuses on recent trends in tax revenues and tax reforms implemented in Member States and wishes to provide guidance to Member States in view of future tax reforms, thereby helping Member States facing various tax policy challenges. The report points to three types of such challenges: the potential need to address severe fiscal consolidation challenges also by measures on the revenue side; the potential to make the tax structure more growth friendly; ways to improve the design of the tax system for individual types of taxes. With regard to the issue of quality of taxation, it analyses the effects of the structure of tax systems on growth and presents a ranking of taxes. It identifies in which euro area Member States higher tax revenues could potentially contribute to consolidation and which countries could benefit from a shift from labour taxes to consumption and real estate taxes. With respect to the design of individual taxes, the report addresses, inter alia, the unequal tax treatment of debt and equity financing and the resulting tax distortions. Concerning VAT efficiency, it presents arguments for the coordination of policies on VAT rates among Member States. Other challenges that the report looks at are possible options to green tax systems and the use of various types of taxes in achieving environment policy objectives, the efficiency of tax collection and issues of tax evasion and adverse interaction between cross-country tax systems in the EU. The report points out the need for tax policy measures to contribute to fiscal consolidation and the sustainability of public finances in the aftermath of the crisis. The centre of attention should be on each country s tax-to-gdp ratio which could be primarily increased by improving tax compliance and administration rather than increasing tax rates and broadening tax bases. In the report, the Commission refers to the European Semester, i.e. the mechanism of integrated economic policy coordination, in the framework of which these tax policy challenges could be further examined.

13 EU Tax Alert Edition 98 November Developments in the Netherlands: Netherlands legislation on fiscal unity still in breach of EU law On 14 September 2011, the District Court of Haarlem ruled that the denial of a fiscal unity between a Netherlands parent company and a Netherlands sub-subsidiary with a German intermediary subsidiary is in breach of the freedom of establishment (Article 49 TFEU). The facts and decision in this case were more or less the same as those of the case of 9 June 2011 (LJN: BQ7515, see EU Tax Alert edition no. 94, July 2011). Forming a fiscal unity between a Dutch parent and a Dutch subsubsidiary was denied in both cases by the Dutch tax inspector because the intermediary subsidiary could not be included in the fiscal unity, as it was established in another Member State and it did not have a permanent establishment in the Netherlands. The Court ruled that this was in breach of the freedom of establishment (see also the CJ s ruling in the Papillon case, C-418/07). The Court acknowledged that not allowing such fiscal unity could be justified by the need to prevent the double use of losses, for example, if losses would result from a liquidation of the foreign intermediary company. The Court considered, however, that the restriction was not proportionate in light of (i) the Mutual Assistance Directive (77/799/EEC), and (ii) the existence of Article 34 and following of the Decree of 17 December 2002 (as amended on 19 December 2006, hereafter the Decree ), which already provide for the prevention of double use of losses. According to the Court, the Mutual Assistance Directive could help the Netherlands tax authorities to obtain specific information about the German intermediary and the origin of the losses. The Decree provides for a rule restricting the use of losses in the case of a liquidation of a foreign subsidiary with a permanent establishment in the Netherlands which is included in the fiscal unity. Such rule could, according to the Court, also be applied to the liquidation of the intermediary subsidiary. Furthermore, the double use of losses could still occur on an international level, because both the German intermediary and the Netherlands parent company could (have) take(n) into account losses in the event of a liquidation of the Netherlands sub-subsidiary. The Court recognized this, but considered it to be a disparity between the tax systems of different countries. Developments in the Netherlands: Advocate General considers Netherlands withholding tax on dividends distributed to Netherlands Antilles parent company not in breach of EU law On 19 August 2011, Advocate General Wattel delivered his joint opinion in two cases before the Netherlands Supreme Court proposing that Netherlands withholding tax on dividends distributed to Netherlands Antilles companies is not in breach of EU law given that the provisions of the TFEU are not applicable to so-called overseas countries and territories ( OCTs ). Both cases concern Netherlands companies distributing dividends to their parent companies, incorporated under the laws of Netherlands Antilles. Both 100% Netherlands subsidiaries were obliged to withhold 8.3% Netherlands dividend withholding tax as provided for in the Netherlands dividend tax law and Article 11.3 BRK (Tax Arrangement for the Kingdom of the Netherlands). In both cases, the Netherlands companies argued in front of the court of first instance that the legal obligation to withhold dividend tax is in breach of the EU fundamental freedoms. The court stated that the freedom of establishment as laid down in Article 49 TFEU was not applicable since the Netherlands Antilles is not an EU Member State. Also, reliance on the Council Decision of 27 November 2001 on the association of the overseas countries and territories with the European Community was denied given that it does not confer obligations on the Netherlands towards a company established in the Netherlands Antilles. And last, the free movement of capital could not be relied on given that, even if the Netherlands Antilles was considered a third State, the grandfathering clause would apply because the obligation to withhold the tax at issue had existed since 31 December 1993.

14 EU Tax Alert Edition 98 November The Amsterdam Court of Appeal shared the conclusion of the court of first instance but took a different approach. It considered that, because the Netherlands and its overseas territory (i.e. Netherlands Antilles) under international law are part of the Kingdom of the Netherlands, the situation at hand is purely internal and therefore, not within the scope of EU law. The free movement of capital cannot be relied on given that the Netherlands Antilles is not considered a third country for the purposes of EU law. This last point in the subject case was contested before the Supreme Court. The interested parties argued that according to the CJ s settled case law, OCTs should be treated as third countries for the purpose of the application of the free movement of capital as laid down in Article 63 TFEU. Reference was made to Van der Kooy (C-181/97) and Dutch Antillian Dairy Industry (C-106/97). Advocate General Wattel agreed with the conclusion of the Amsterdam Court of Appeal that from an EU law point of view, the case at hand concerns a purely internal situation within one Member State. The Advocate General took the position that, even if Netherlands Antilles did qualify as a third country for the purposes of Article 63 TFEU, the applicant could still not rely on the free movement of capital as the relevant applicable freedom would be the freedom of establishment. He referred to the CJ s order in the KBC Bank case (Joined cases C-439/07 and C-499/07). The Advocate General considered that it was not necessary to refer a question for preliminary ruling to the CJ, as the grandfathering clause of Article 64 TFEU would apply if the free movement of capital applied. Developments in the Netherlands: Advocate General s Opinion on compatibility of Netherlands thin capitalization rules with EU law On 9 September 2011, Advocate General Wattel issued his Opinion in a case pending before the Netherlands Supreme Court on, inter alia, the compatibility of thin capitalization rules with the fundamental freedoms set forth in the TFEU and Council Directive 2003/49/EC of 3 June 2003 on a common system of taxation applicable to interest and royalty payments made between associated companies of different Member States ( Interest and Royalties Directive ) (Case No. 10/05268). The interested party in this case was a Netherlands resident company ( DutchCo ), which was financed with debt by group companies in other Member States. 95% of the shares in DutchCo were held by a French SA. DutchCo wanted to deduct the negative amount of group interest, which was rejected by the Netherlands tax inspector based on the Netherlands thin capitalization rules (article 10d Corporate Income Tax Act). DutchCo has raised a number of arguments in front of the Supreme Court against the position of the tax inspector. For purposes of this summary, attention is paid only to the compatibility of said provision with the fundamental freedoms and the Interest and Royalties Directive. These arguments are that (i) a Dutch group would be allowed to form a fiscal unity and escape the thin capitalization rules, and (ii) the Interest and Royalties Directive precludes not only withholding tax on interest payments for the account of the interest recipient but also the non-deductibility of interest expenses at the level of the company paying the interest. Advocate General Wattel is of the opinion that the thin capitalization rules are in line with EU law. His position is based on the X-Holding case (C-337/08) and a Dutch Supreme Court decision (LJN BN3537, dated 24 June 2011) supporting the view that there is no EU law obligation (a) to allow a cross border fiscal unity to cross-border groups, or (b) to allow the application of specific elements (per element or in the words of Advocate General cherry picking ) of the fiscal unity regime to cross-border groups. The Advocate General is also of the opinion that the thin capitalization rules are in conformity with the Interest and Royalties Directive. This follows from the CJ s Scheuten Solar case (C-397/09). In that case, German add-back rules for cross-border interest payments were found not to be precluded by the Directive. The purpose of the