The issue of exit taxes has been dormant in the European Court of Justice (ECJ) for a few years following after the key judgments in de Lasteyrie (C-9/02) and N (C- 470/04). The recent opinion of Advocate General Kokott in Case National Grid Indus. BV (C-371/10) has put exit taxes for companies squarely back on the agenda for the ECJ, though it should be noted that the European Commission’s interest in exit taxes generally (personal and corporate) has been consistent, notable particularly in the number of infringement proceedings it has brought on exit tax legislation in recent years.
The issue of exit taxes is a particularly interesting one because the issue of whether a law is discriminatory is often clear in these types of cases and the answer to whether a member state can defend its legislation will usually come down to justification and proportionality, with justification in particular being an area which has seen quick recent development.
Exit tax laws are usually discriminatory because they often seek to tax a latent gain on an asset made by a departing entity (that is, where that asset has not been realised).By contrast, domestic taxpayers would not be liable to tax until the asset was realised. That this situation appears discriminatory is not particularly controversial. The question of justification is therefore key in this area, which means that the judgment in National Grid will be awaited keenly, particularly by those who fall within the ambit of laws which are the subject of the various infringement proceedings open now in different member states. In the UK context, taxpayers subject to the transfer of assets abroad legislation or the attribution of gains legislation, in particular, should consider the implications of the judgment.
To recap, broadly speaking de Lasteyrie and N decided that:
- the immediate taxation of latent capital gains on assets transferred to another member state breaches the freedom of establishment;
- that discrimination arises where a moving taxpayer is subject to tax on capital gains not yet realised if there is no such taxation for similar domestic situations; and
- that member states may not place a disproportionate burden on the taxpayer on exit.
N appears at least to have departed from de Lasteyrie in accepting the justification of the balanced allocation of taxing rights as a justification for the breach of EU law, though some argue that this is because the type of rule in de Lastyerie was sufficiently limited in scope that the arguments based on balanced allocation and fiscal coherence were not relevant. In the end the taxpayer still won in N because the rule was found to be disproportionate. It is well noted that both de Lasteyrie and N are exit taxes for individuals and questions have arisen as to whether the case law can be applied to companies.
Daily Mail forerunner
The case law in N and de Lasteyrie came some time after the case law of Daily Mail, after which many thought that the ECJ simply allowed exit taxes in the context of companies. Pause for thought has given many commentators the more refined view that Daily Mail is about the transfer of a company seat rather than properly an exit tax case. The Commission, in any event, has been clear in its view that the reasoning derived from de Lasteyrie and N should be applicable in the context of companies (in particular in its communication on exit taxation and the need for coordination of member states' tax policies (COM (2006) 825 fin)). It took the view that it follows from de Lasteyrie that taxpayers who exercise their right to freedom of establishment by moving to another member state may not be subject to a tax charge which is either earlier or higher than taxpayers who remain in their member state. Reflecting the opinion of AG Kokott, the Commission also noted that proportionate responses to the situation are possible, insofar as it would be possible for the Member State of departure to “establish the amount of income in which it wishes to preserve its tax jurisdiction, provided this does not give rise to an immediate charge to tax and there are no further conditions attached to the deferral”.
Need for information
The knotty problem that the Commission’s communication fails to deal with and AG Kokott’s opinion attempts to deal with is this. On the one hand, the requirement for a company to file records of the asset that is the subject of the exit tax on departure can be considered to be a disincentive to free movement (paragraph 38 of the judgment in N). On the other hand, without some way of informing themselves of the realisation of the asset in another member state, the member state of departure leaves itself open to potentially abusive practices whereby value is accrued in one member state and shifted simply to realise it in another where the tax rate or base make it worth doing so. It does not seem particularly unreasonable for member states to try to tax that which has accrued in its territory in some way. The question, however, necessarily comes down to whether the measure is sufficiently closely targeted and proportionate.
AG Kokott takes the interesting approach that the exit tax on companies discussed in National Grid can be justified because of the balanced allocation of taxing powers and the need to ensure the coherence of the Dutch system. She goes on to say that exit taxes are permissible where accurate cross-border monitoring is almost impossible due to the nature and extent of the assets or if it would entail high costs to do so. Where monitoring is easy, AG Kokott considers that immediate taxation would be disproportionate. This is an interesting approach for several reasons. First, it affirms the allocation of taxing powers as a defence in the context of exit taxes, which if you recall, was a discrepancy between de Lasteyrie (where the allocation of taxing powers was not considered a relevant justification) and N (where the allocation of taxing powers did amount to a good justification). Second, fiscal coherence has been accepted, where it was rejected in de Lasteyrie and not raised in N. That balanced allocation was accepted in National Grid was not particularly surprising given the development of the acceptance of this justification generally and given the acceptance of the justification in N. That fiscal coherence was accepted was somewhat more surprising.
As touched upon above, the Commission has been moving consistently and quite comprehensively regarding its infringement proceedings on exit taxes.
Individuals in spotlight too
In the context of the UK, taxation of individuals has been a focus for the Commission. To recap, the European Commission issued a press release on February 16 2011 about section 13 Taxes and Capital Gains Act (TCGA) 1992 and sections 714-751 Income Taxes Act (ITA) 2007, noting that it had formally requested the UK to change two discriminatory anti-abuse regimes on the transfer of assets abroad and the attribution of gains to members of non-UK resident companies. On the transfer of assets abroad legislation the Commission considered that the legislation breached EU law because:
- if a UK resident individual invests in a company by transferring assets to it, and if this company is incorporated and managed in another Member State, then the investor is subject to tax on the income generated by the company to which he/she contributed the assets. However, if the same individual invested the same assets in a UK company, only the company itself would be liable for tax.
- With the comparable situation described in this light, it is difficult to see how the legislation could not be in breach of EU law. As for the attribution of gains legislation, the Commission considered the legislation infringed EU law on the basis that:
- if a UK-resident company acquires more than a 10% share of a company in another Member State, and the latter company realises capital gains from the sale of an asset, the gains are immediately attributed to the UK company, which becomes liable for corporation tax on these capital gains. If, on the other hand, the UK company had invested in another UK resident company, only the latter would be taxable on its capital gains.
Again, it is difficult to see how the legislation could not be in breach of EU law.
The Commission goes on to say that the provisions are discriminatory, and restrict the freedom of establishment and free movement of capital (articles 49 and 63 of the Treaty for the Functioning of the EU) and are disproportionate. This last point is, of course, the key battleground for these provisions, especially in light of the recent developments referred to above and it will be interesting to see whether the ECJ follows AG Kokott’s opinion concerning methods of ensuring a proportionate response when faced with an exit tax situation.
UK keeps silent
Some have been of the opinion that HMRC would have responded to the reasoned opinion of the European Commission on the basis that the rules, while they almost certainly do breach EU law, are proportionate to their aims. Indeed, the Financial Times reported that ‘Britain is understood to have told Brussels it does not accept that there is any infringement….The UK has defended the rules, saying they are used only to combat avoidance rather than genuine investment'. If the UK has defended its rules on this basis, it will be interesting to see whether the Commission uses the AG Kokott's opinion to take a robust approach in its response to the UK. Since the judgment of the Court is due imminently, however, and the next stage of the infringement proceedings against the UK is for the Commission to decide to refer the case to the ECJ, it seems likely the Commission will await the judgment or even potentially the outcome of some of its other infringement proceedings on exit taxes.
Judgment to command attention
The progress of the National Grid case is likely to be particularly keenly awaited by the Commission, as well as potentially affected taxpayers, not least because it has infringement proceedings on exit tax legislation pending before the ECJ against Portugal, Denmark, the Netherlands and Spain. It has also sent reasoned opinions on exit taxes to Ireland and Belgium. Sweden was also sent a reasoned opinion but amended its law to make it EU law compliant.
Clearly, then, corporate exit taxes are high on the agenda of the Commission. It is worth pointing out that AG Kokott’s opinion, to the extent it takes an end view of the answer to the proportionality question, takes the baton offered by the Commission in its communication on exit taxes insofar as both the Commission and AG Kokott take the view that exit tax rules can be made compatible through the use of coordination at the EU level making for a deferral of payment of tax until it is properly due, while allowing for the interests of member states to be protected in ensuring that an exit tax is acceptable where mutual assistance will not work. Presumably the reasoning AG Kokott gives has implications for exit taxes in the context of third countries since mutual assistance obligations tend to be lesser with third countries than in the EU. The effect of the awaited judgment for those with third-country issues may therefore be somewhat sobering.
Kelly Stricklin-Coutinho (firstname.lastname@example.org)
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