INTRODUCTION
Tax legislation at the European level affecting group structures is extremely limited. The Parent-Subsidiary Directive enacted in 1990 is the only European statute impacting directly on corporate structure. The Mergers Directive, while facilitating a number of cross-border corporate reorganisations, mergers and demergers, is still not fully implemented across the Community six years after it first came into effect. Even when fully implemented, it will not deal comprehensively with the tax aspects of the transactions it contemplates. Other corporate tax harmonising measures proposed have fallen by the wayside and the future of the current proposals for a directive eliminating withholding tax on interest and royalty payments has its fate inextricably linked with the more politically controversial Savings Directive and Code of Conduct on Harmful Tax Competition.

Despite this, a European corporate tax system is emerging. It is being shaped by the European Court of Justice responding to claims of discriminatory taxation brought by taxpayers pursuant to the fundamental freedoms given under the EC Treaty.

PERMANENT ESTABLISHMENTS
In the Royal Bank of Scotland v Greece (Case C-311/97), the Court was asked to consider the impact of Article 43 (ex 52) on Greek taxation of foreign corporations with a permanent establishment in Greece. They were subject to a tax rate of 40% while Greek companies in similar circumstances were subject to a 35% tax rate. The case also considered different tax treatment for companies whose shares are traded on the Athens Stock Exchange with those of companies whose shares are traded outside Greece.

The Greek Government had sought to justify the differentiation on the basis that 40% is the normal rate of tax and the 35% is exceptional in order to foster economic development. The arguments of the Greek Government, that there was no discrimination on the basis of nationality and that the lack of Community harmonisation in the field of direct taxation allowed member states to impose tax as they saw fit, were rejected. In the opinion of Advocate General Alber, Greece was clearly in violation of the EC Treaty.

This view was followed by the Court in its judgment on 22nd September 1999. The Court noted that Article 43 (ex 52) accords the nationals of a member state the right to take up and pursue activities under the same conditions laid down for local nationals of the country where establishment is effected. Pursuant to Article 48 (ex 58) of the EC Treaty, the right of companies or firms formed in accordance with the law of a member state and having their seat registered office, central administration or principal place of business within the Community enjoy the same rights in relation to a branch or agency. In this context, it is the seat of a company in this sense that serves as the connecting factor with the legal system of a particular state like nationality in the case of natural persons. The Court ruled that if different treatment was applied to a company solely by reason of the fact that its seat is situated in another member state would deprive Articles 43 (ex 52) & 48 (ex 58) of all meaning. The Court dismissed the arguments of the Greek Government noting that they had not relied on any of the grounds referred to in Article 46 (ex 56) of the EC Treaty in order to justify the discrimination in question. The defences contained in Article 46 (ex 56) are limited to "public policy, public security or public health".

Branch Profits Tax
The effect of this decision is to render ineffective tax regimes which seek to impose higher rates of tax on companies from other member states exercising the right of establishment. It would appear to put an end to the possibility of branch profits taxes within the European Union, at least in respect of branches of companies established in other member states. Although the issue was not argued before the Court, one important effect of the decision is to level the playing field as between branches and subsidiaries within the European Union. By restricting corporate income tax to the rates applicable to locally established companies, branches will not be worse off than subsidiaries who are able to benefit from the Parent-Subsidiary Directive. The Directive prohibits withholding taxes on distributions of profits made to parent companies established in other member states.

Treaty Benefits
Most recently, the Court in Compagnie de Saint Gobain v Finanzamt Aachen Innenstadt (Case C-307/97) has considered inter alia the German Schachtelprivileg, a participation exemption granted by treaty with a non-EC member country to companies holding a specified percentage of shares in another company in respect of dividends therefrom and the underlying foreign tax credit for tax paid by a subsidiary in a non-member country to be credited against the corporation tax of the parent. It also considers a similar exemption in respect of capital tax.

Saint Gobain, a French resident and incorporated company, operated a branch in Germany. It held 10.2% of a US corporation and effectively all of the shares of two German incorporated and resident subsidiaries as part of the branch assets. The German branch and subsidiaries were treated as a single entity for German tax purposes ("Organschaft"). The principal company (in this case the branch) was liable for tax on the group’s aggregate results. The profits and losses of the other companies were included in the profits and losses of the principal company. The German companies had substantial holdings in companies established in Austria, Switzerland and Italy. Dividends were received from those companies and under the group profit transfer agreements were included in the income of the PE.

Under German law, these dividends were attributed to the permanent establishment in Germany and liable to German tax. More generally, however, German resident companies are liable to unlimited (worldwide) liability to tax and permanent establishments to limited (German source) tax liability only.

The German tax authorities refused to allow the benefit of treaties between Germany and the United States and Switzerland respectively in relation to the foreign income deemed to be that of the permanent establishment by operation of the Organschaft. In each case, similar dividends paid by US or Swiss companies would have been, subject to certain conditions, exempt from German tax on such dividends in the hands of German residents.

The German tax authorities allowed credit (direct credit) in respect of tax withheld at source on dividends from the various countries. They, however, refused the indirect or underlying credit for corporate tax paid by the foreign subsidiaries. Under German domestic law, the underlying credit is granted only to German resident companies.

Thirdly, the German tax authorities included the shareholding in the American subsidiary in the domestic assets of the permanent establishment taxable by way of capital tax. It did not allow an exemption for international groups, because the concession was limited to domestic companies.

There was no dispute that the concessions granted to domestic German groups resulted in a lighter tax burden. In relation to the capital tax, the German government initially argued that the situation of a permanent establishment is different from a subsidiary but, at the hearing, accepted that inequality arose by virtue of Article 19 of the France-Germany Treaty which excluded from German taxation shareholdings of a German subsidiary in a foreign sub-subsidiary of a company not resident in Germany. As a result, the exemption of all capital tax in relation to international groups also produced a tax burden on a permanent establishment of a foreign company which is different from that on a subsidiary of a foreign company.

The Court held all of the German provisions in question to be contrary to Article 43 (ex 52) and Article 48 (ex 58) of the EC Treaty because permanent establishments are less attractive than subsidiaries since under German domestic law and bilateral treaties, the tax benefits are only granted to German subsidiaries. This restricts the freedom to choose the most appropriate legal form for the pursuit of activity in another member state. This explicit recognition of the need to treat branches and subsidiaries equally endorses the position taken in Royal Bank of Scotland v Greece.

The German government sought to justify the discrimination on the basis that the situations of resident and non-resident companies are not generally comparable. This is particularly because non-residents are only liable to limited tax liability whereas residents are subject to unlimited tax liability. The Court rejected this argument on the basis that the dividends were taxable in the hands of the permanent establishment, regardless of where the dividend paying companies were located, thus the restriction to local source income was theoretical. In fact, the only difference was that the permanent establishment was not entitled to credit or exemption from tax on dividends from foreign shareholdings. The German government argued that the measures were justified by the need to prevent a reduction in tax revenue given the impossibility for the German authorities to compensate for the reduction in revenue if equal treatment were given by taxing dividends distributed by non-resident companies.

The Court rejected this argument, simply on the basis that it is not one of the grounds listed in Article 46 (ex 56) of the EC Treaty and cannot be regarded as a matter of overriding general interest which may be relied upon in order to justify unequal treatment.

It was further argued that the discrimination was justified because there is no tax on the transfer of profits to the head office by a branch compared with the taxation of distributions by a subsidiary to a parent company. The Court did not accept that such advantages exist for permanent establishments and even if they did, they could not justify a breach of the equal treatment required by Article 43 (ex 52).

Finally, it was argued that the treaties with non-member countries were not within the sphere of Community competence. This is a matter for member states who are at liberty to conclude bilateral treaties with non-member countries. On the basis that bilateral treaties are based on the principle of reciprocity, the balance inherent in such treaties would be disturbed if the benefit of their provisions were extended to companies established in member states which were not parties to them. The Court, however, said that it was settled that taxing powers must be exercised consistently with Community law. The balance and reciprocity of treaties concluded with non-member states in question would not be jeopardised by a unilateral extension of the category of recipients in Germany of the tax advantages provided for by those treaties. It would not in any way affect the rights of non-member countries which are parties to the treaties and would not impose any new obligations on them. The Court noted, in any event, that German domestic law had been amended in this respect extending the credits and exemptions to permanent establishments of non-resident companies. It was argued by the Swedish government that in extreme situations, extending the scope of bilateral treaties could lead to no tax being produced at all. This was rejected in the particular case since it had not been argued that there was a risk of non-taxation in any country.

Accordingly, it was held that a permanent establishment in Germany of a company having its seat in another member state was entitled to the exemption from corporation tax for dividends received from companies established in non-member countries provided by tax treaty concluded with a non-member country, as well as a credit against Germany corporation tax for foreign tax paid on profits that were attributed to the permanent establishment. Similarly, the exemption from capital tax for shareholdings in companies established in non-member countries could not be denied to permanent establishments in those circumstances. Thus, equal treatment must be accorded to permanent establishments where they are in the same position as subsidiaries, even though they are inherently not always in the same position in relation to every tax issue.

GROUP STRUCTURES
Member state laws on the taxation of corporate groups are coming increasingly under scrutiny. The two issues that have confronted the Courts are the recognition of groups comprising companies from more than one member state and equal tax treatment for such groups.

One of the most important cases, which involved questions of tax avoidance, is Imperial Chemical Industries Plc v Colmer (Case C-264/96) [1998] STC 874 (ECJ). The case involved the availability of consortium relief where companies established in the United Kingdom belonging to a consortium through which they control a holding company. The tax relief is subject to the requirement that the holding company’s business consists wholly or mainly in the holding of shares in subsidiaries resident in the United Kingdom.

In analysing the United Kingdom group relief rules, the Court found that companies belonging to a United Kingdom resident consortium which have, through a holding company, exercised their right of freedom of establishment in order to set up subsidiaries in other member states are denied tax relief on losses incurred by a resident subsidiary where the majority of subsidiaries controlled by the holding company have their seat outside the United Kingdom. Thus, the location of the subsidiaries was used by the United Kingdom legislation to establish differential tax treatment of consortium companies established in the United Kingdom. The Court had no difficulty in deciding that this constituted illegal discrimination contrary to the right of establishment under Article 43 (ex 52).

The only question was therefore whether there was any justification for the discrimination. The scope for determining whether a discriminatory measure is compatible with Community law is only if it falls within one of the derogations expressly provided by the EC Treaty. The standard is whether the tax measure in question applies without distinction to all persons including foreigners. Measures restricting freedom of establishment granted by Article 43 (ex 52) may be compatible with the EC Treaty, if they are in furtherance of imperative requirements in the general interest, if they are suitable for securing the attainment of the objective pursued and if they do not go beyond what is necessary to attain it.

The Advocate General in his Opinion noted that none of the derogations provided for in Article 46 (ex 56) (public policy, public security or public health) applies in the present case. Considerations of a purely economic nature such as a loss of tax revenue cannot justify restrictions of a discriminatory character. Discrimination may be permitted if it is necessary to safeguard the cohesion of the tax system.

Tax Avoidance
The United Kingdom sought to justify the discrimination on two grounds:-
(1) The legislation was designed to reduce the risk of tax avoidance arising from the possibility for members of a consortium to channel charges of the non-resident subsidiaries to a subsidiary resident in the UK and to have profits accrued to non-resident subsidiaries. The purpose of the legislation is therefore to prevent the creation of foreign subsidiaries from being used as a means of depriving the United Kingdom Treasury of taxable revenues.

(2) A further objective was to prevent a reduction in revenue caused by the mere existence of non-resident subsidiaries since the United Kingdom cannot tax profits made by subsidiaries located outside the UK in order to offset the revenue loss through the granting of relief on losses incurred by resident subsidiaries.

These arguments were quickly dismissed by the Court. It held firstly that the legislation did not have the specific purpose of preventing wholly artificial arrangements set up to circumvent United Kingdom taxation. It applies generally to all situations where the majority of a group subsidiaries are established for whatever reason outside the UK. It regarded the establishment of a company outside the United Kingdom as not of itself necessarily entailing tax avoidance. The risks alleged by the UK Government existed in any event even if there was only one non-resident subsidiary.

The argument about revenue loss was not a ground listed in Article 46 (ex 56) of the Treaty and cannot be regarded as a matter of overriding general interest to justify unequal treatment. There is clearly a distinction therefore in European law between a loss of revenue and tax avoidance.

The UK could not rely on the need to maintain cohesion of the tax system as justifying a restriction on the fundamental freedom. Unlike the cases where cohesion had been found, there was no direct link between the consortium relief granted for losses incurred by a resident subsidiary and the taxation of profits made by non-resident subsidiaries.

In the United Kingdom, the Inland Revenue have responded to the decision by press release (26th February 1999). They have decided that in cases where the existence of a group or consortium is established by reference to a company or companies resident in the European Union or the European Economic area, that a group or consortium relationship will exist for group relief purposes. Since the European Court of Justice did not regard it as being within their jurisdiction to rule on companies outside the EU, the Inland Revenue have indicated that they will not address the issue until the matter has been decided by the House of Lords. The Colmer case has been reheard by the House of Lords on the question as to whether the same principle enunciated by the ECJ applies to non-European companies. It was held not to so apply.

The Irish Republic has responded with several amendments contained in their 1999 Finance Act. There, group relief may be surrendered by an Irish branch of an EU company within the charge to Irish tax to an Irish subsidiary, as well as between fellow subsidiaries of an EU parent. In addition, losses may be surrendered between Irish companies in a sandwich situation. This is where the two Irish companies have another EU company sandwiched in between them, such as an Irish parent company which owns another EU subsidiary which in turn owns an Irish sub-subsidiary. In addition, Ireland has amended its capital gains rules relating to the transfer of assets within groups between Irish resident subsidiaries of EU parents or sandwich structures. The capital gains provisions do not permit transfers of assets between an Irish company and an Irish branch of an EU company. It has also been suggested that the decision will bring into question the legality of controlled foreign companies legislation, at least in some member states.

In the ICI case, Advocate General Tesauro said that the UK Government case was "devoid of substance". The Royal Bank of Scotland case similarly does not raise any new issues of principle. Is there significance in them? Perhaps the real point of these cases is that some member states may be unwilling to voluntarily adapt their tax laws to the requirements of European law even where they are prima facie discriminatory. They prefer instead to take a defensive position and wait until taxpayers seek to challenge legality before the Courts. Clearly, as far as the specific subject matter is concerned, there will be implications that go beyond the legislation that has been examined by the ECJ. Clearly the ICI case will impact on group situations in other member states.

Capital Gains
Recognition of pan-European corporate groups has been given further support in the context of intra-group asset transfers. Thus, in XAB and YAB v Riksskatteverket (Case C-200/98), Swedish corporate income tax applies advantages on the transfer of assets intra group. They are granted under Swedish law to companies in the same group on condition that the companies are all established in Sweden or in a single other state with which Sweden has a treaty containing a non-discrimination clause. This has been attacked as discriminatory against companies in groups established in more than one member state under Articles 43 (ex 52), 48 (ex 58), 56 (ex 73b) and 58 (ex 73d) of the EC Treaty. These were held to be illegal discrimination by the Court.

Cross-Border Dividends
The question of discrimination in relation to cross-border dividends is becoming an increasingly active area of litigation.

Pending cases on Article 43 (ex 52) include Metallgesellschaft Limited and others v IRC and HM A-G (Case C-397/98), and Hoescht AG and others v IRC and HM A-G (Case C-410/98), two important decisions emanating from the UK on groups.

In addition, there has been a reference to the ECJ recently on the Parent-Subsidiary Directive. In Ministerio Publico and others v Epson Europe BV (Case C-375/98), the Portuguese Supreme Administrative Tribunal has referred questions to the ECJ on the interpretation of Article 5(4) of the directive which is a temporary derogation in favour of Portugal, which permits it to levy a withholding tax on profits distributed to parent companies in other member states for a limited period. The case considers the legality of a lump sum tax on successions and donations levied annually on the income of certain securities (shares and bonds).

In the Hoecht case (C-410/98), the German based group raised two claims:-
1. The UK subsidiary made a claim based on the cashflow disadvantage of having to pay advance corporation tax earlier than its year-end corporation tax in relation to distributions made to the German parent company. Intra-group dividends could be paid without ACT if the parent company was UK resident only.
2. The parent company, Hoecht AG, filed separate claim on which it required a refund of ACT incurred in respect of dividends paid by its UK subsidiary.

Although the UK has abolished advance corporation tax, the case will continue to have a number of significant implications for group taxation and taxation generally in Europe. The central issue is whether Article 43 (ex 52) permits favourable group taxation only on condition that the parent and subsidiary are resident in the same member state. Bearing in mind the judgment of the Court in the ICI, Saint Gobain and XAB cases, clearly this is likely to be viewed as discriminatory. This recent line of cases has developed a clear principle that corporate groups for tax purposes cannot be limited to companies within a member state. The Court has not addressed the criteria for determining group membership and the tax consequences of group membership. This is a matter for member states. However, once these have been determined by member states, they must be applied equally to companies and branches established anywhere in the Community.

The resolution of the Metalgesellschaft and Hoechst Cases is also likely to affect the future of imputation systems in Europe. The United Kingdom has already abolished Advance Corporation Tax, but these cases will likely affect other existing imputation systems. While most imputation systems function satisfactorily in a domestic context, they give rise to problems in policy and practice at the international level. If such systems cannot deliver equal treatment within Europe, then their future may be doubtful.

JUSTIFICATION OF DISCRIMINATION
All of the cases taken to the European Court over the last year or so, all found breaches of fundamental freedoms by member states. The Advocate Generals’ opinions are also consistently upholding taxpayers’ complaints of discrimination. In defending these cases, member states have not managed to come up with any new ideas that have convinced the Court. Indeed, in some cases, the discrimination is obvious and the attempts at justification thin to say the least. The Court itself appears to be focussing on the permitted justifications in a more structured way. The question of justification was raised and upheld for the first time in Bachman v Belgium (Case C-204/90) [1994] STC 855. Justification was considered in the earlier cases on this in a general sense. Now the Court appears to be insisting on justifications specifically authorised by the EC Treaty itself. This is found in Article 46 (public policy) and Article 58 which has broader criteria such as the prevention of tax avoidance, but which is only relevant to Article 56 (free movement of capital).

© Jonathan Schwarz 2000. All rights reserved, and all moral rights are asserted.
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