«Ahti Vapaavuori Despite the fact that the EC Treaty includes hardly any orders specifically dealing with direct taxation issues, the European Court ...»
On Justification in EC Tax Law
Despite the fact that the EC Treaty includes hardly any orders specifically
dealing with direct taxation issues, the European Court of Justice (ECJ) has been
applying the regulations of the agreement and principles of EC Law also in cases
concerning income taxation. The ECJ has worked on the assumption that the
realisation of the aims of the EC Treaty might be endangered if the basic
freedoms included in this agreement could not be applied in these kind of questions, too. When interpreting the provisions of the EC Treaty more comprehensively, the ECJ has in its legal practice created specific justifications by which it is possible to get rid of the obligations of the agreement in exceptional cases. This article deals with the ways in which the ECJ has been applying these justifications in issues related to income taxation.
1 On Justifications in Accordance with the EC Treaty Direct discrimination cannot be successfully justified in the EC Law by using other justifications than the ones listed in article 30 (former article 36) of the EC treaty. The ECJ has also noted this fact in its legal practice concerning direct taxation.1 Consequently, as for direct taxation issues, we cannot speak for direct discrimination by referring to other facts than the ones listed in the abovementioned article. It is due to the nature of these facts that they cannot generally be applicable in questions related to taxation. The ECJ has not applied them yet so far in cases concerning direct taxation.
As for the issue on direct discrimination Avoir fiscal, concerning the right of a foreign company’s permanent establishment in France to receive imputation credit on the same conditions as French companies, the ECJ stated that France could not successfully explain its negative attitude towards granting an imputation credit by referring to a risk of tax avoidance, as the Court considered 1 ECJ 29 Apr 1999, Case C-311/97, (Royal Bank of Scotland), par. 32, dealt with direct discrimination of a foreign company, the Court considered such discrimination to be acceptable only on grounds mentioned in the EC Treaty.
© Stockholm Institute for Scandianvian Law 1957-2009 376 Ahti Vapaavuori: On Justification in EC Tax Law that no exception to the fundamental order in article 52 (present article 43) could be made on such grounds.2 In this connection the ECJ has interpreted the exceptions strictly, as well as not accepting reasons of economic kind as justifications.3 As for article 58 of the EC Treaty concerning the freedom of movement of capital, however, the text of the agreement provides an opportunity to apply a certain kind of justification. In accordance with the text, the orders concerning the freedom of capital movement do not affect the Member States’ right to take the necessary actions, particularly in the field of taxation, to prevent evasion of the national laws. Nevertheless, this addition made by the Union Agreement on 1 January 1994 contains a statement that it shall only be applied in terms of such jurisdiction of the Member States that was valid at the end of the year 1993.
Furthermore, the application of the abovementioned article must not lead to arbitrary discrimination or disguised restriction of free movement of capital. So far the dimensions of the article have not been specifically tested in the legal practice of the ECJ.4 It has been considered possible that article 58 could also work in its area of application as a justification for direct discrimination in cases where the regulations aim at preventing tax avoidance.5
2 On the Justifications of Indirect Discrimination
To make an exception from direct discrimination, those procedures that only deal with indirect discrimination may be successfully supported by proposing arguments that support their application, if certain prerequisites can be considered to exist. In carrying on its legal practice, the ECJ has developed a rule of reason stating that indirect discrimination, which according to the legal practice is as such against the rules of the EC Treaty, can in certain cases be regarded as justified. The following three prerequisites must, however, be fulfilled; namely, the purpose of the rule must be to aim at the realisation of an important public interest, the rule must be necessary for reaching this objective, as well as being proportionate to the objective it is aiming at.6
2.1 Tax Treaty In accordance with article 307 (former 234) of the EC Treaty, the rules do not affect such rights or obligations that result from an agreement made by one or more Member States with one or more third countries before 1 January 1958 or, 2 ECJ 28 Jan 1986, Case C-270/83, (Avoir fiscal), par. 25.
3 See Terra, B. and Wattel, P., European Tax Law, 3rd ed., The Hague 2001, at 23 and Ståhl.
K. and Persson Österman, R., EG-Skatterätt, Uppsala 2000, at 122.
4 Cf., however, case ECJ 6 Jun 2000, Case C-35/98, (Verkooijen).
5 By Ståhl, K. and Persson Österman, R., op.cit. note 3, at 123; the authors point out that the mention of prohibition of arbitrary discrimination in the article could, however, lead to it not being approved as a justification.
6 Cf. Terra, B. and Wattel, P., op.cit. note 3, at 33.
© Stockholm Institute for Scandianvian Law 1957-2009 Ahti Vapaavuori: On Justification in EC Tax Law 377 in the case of a country that has become a member, from an agreement made before the date of accession. Furthermore, it is stated in the article that in so far as such agreements are not in harmony with the EC Treaty, the Member States concerned will take all justified measures to eliminate conflicts. The ECJ considered that this article concerns all agreements independent of their special field; consequently, tax treaties are also regulated by them.7 As a result of this, it is clear that the state cannot successfully refer to a justification stating that the claimed indirect discrimination is based on a tax treaty and not on the internal, purely national legislation.
However, the tax treaties involve a built-in principle of reciprocity, which means that the contracting states have on both sides partly or totally given up their taxing power as prescribed by their internal legislation. Consequently, one could think that the tax treaty is a bilateral commitment with contractual balance based on the principle of reciprocity, a balance that cannot be shaken by taxpayers resident in third countries. At least in so far as taxation is based on the part of the tax treaty in which the reciprocity between the contracting states plays an essential part, one could consider this to function as a justification, as well as making indirect discrimination of taxpayers resident in third countries possible.
In the legal practice of the ECJ, this question came up in the case Avoir fiscal concerning direct discrimination, in which France did not agree to imputation credit to a permanent establishment of a foreign company in France, although it granted such a benefit connected to dividend to corresponding French companies. The French Government explained the procedure by arguing that granting imputation credit to foreign companies – which was exceptional as such – was covered by the tax treaties between France and foreign countries and that granting it to a permanent establishment of a foreign company would disturb the balance formed by tax treaties with other contracting states.
The European Court of Justice gave the following statement in its judgment8:
”Finally, the French Government is wrong to contend that the difference of treatment in question is due to the double-taxation agreement. Those agreements do not deal with the cases here at issue as defined above. Moreover, the rights conferred by Article 52 of the Treaty are unconditional and a Member State cannot make respect for them subject to the contents of an agreement concluded with another Member State. In particular, that article does not permit those rights to be made subject to a condition of reciprocity imposed for the purpose of obtaining corresponding advantages in other Member States”.
In this part of the judgment, two significant issues are stated. Firstly, the ECJ considered this not to be a situation that had been regulated by the tax treaty.
But, what is more important, the Court, however, continued by saying that the orders of article 52 (presently 43) of the EC Treaty were unconditional and could not therefore be subordinated to the condition of reciprocity, according to which 7 See Lang, M., The Binding Effect of the EC Fundamental Freedoms on Tax Treaties, in Gassner, W., Lang, M., Lechner, E. (eds.), Tax Treaties and EC Tax Law, the Hague 1997, at 21.
8 Case C-270/83, (Avoir fiscal), par. 26.
benefits could only be protected by requiring the other Member States to grant the same benefits for their part.9 Although one may not present any strong reasons for the fact that the case should have been resolved in a different way, we can still question one item included in the reasoning of the ECJ. If the Court’s opinion was that this was not such a tax treaty case that the French Government referred to, would it have been possible to omit the statement on the meaning of the condition of reciprocity in this connection. The part of the judgment that the Court had, however, observed in this connection is unambiguous text that will probably not make it possible to come to a different conclusion in other questions related to reciprocity without resulting in a totally new interpretation of the case.10 The tax treaty law is at least in principal based on the principle of reciprocity, and in the case Avoir fiscal the statement given on this will have extensive repercussions on many questions related to the relationship between the EC law and the basic principles of international tax law.
The basic principles of international tax treaties have primarily been formulated in the Model Tax Convention of the OECD, and consequently, tax treaties between the Member States have normally been drawn up according to these guidelines. In practice, the model tax treaty has become a harmonising instrument, and the commentary on the model tax treaty has been of great help in the process. Even though the commentary is not an obliging source of tax treaty interpretation, there is no reason to underestimate its significance in the interpretation of tax treaties between the OECD countries.11 An interesting feature in this connection is that in its legal practice the ECJ has often referred to the existing model tax treaty, although it may be otherwise considered to have taken the basic principles of international taxation into account to a limited extent, particularly as far as its older legal practice is concerned.
As for the case Schumacker, the ECJ stated that residents and non-residents are not principally in a similar position in terms of direct taxation.12 The Court continued by stating that the income received by a non-resident in a Member State comprises in most cases only part of a taxpayer’s total income, which the taxpayer earns in his country of residence. Furthermore, the Court considered that it is easier to define a non-resident taxpayer’s level of the ability to pay, taking into account all his income as well as personal and family-related deductions, in a country in which his personal and financial ties were concentrated. Furthermore, the Court continued that consequently, international taxation and the OECD Model Convention in particular, recognise the principle according to which taking into account the taxpayer’s overall situation, including 9 See also Lehner, M. and Scherer, T., Die Besteitigung der Doppelbesteuerung innerhalb der Gemeinschaft, in Birk, D. (Hrsg.), Handbuch des Europäischen Steuer- und Abgabenrechts, Herne/Berlin 1995, at 958.
10 Cf. Lang, M., op.cit. note 6, at 23, in which he considers the balance of interests in a tax treaty to concern all stipulations, and if the Court has come to a different conclusion, this could have been interpreted so that the existence of a tax treaty as such could act as a justification.
11 Cf. Vogel, K. et al., Klaus Vogel on Double Taxation Conventions, 3rd ed., London 1997, at 43 and onwards.
12 ECJ 14 Feb 1995, Case C-279/93, (Schumacker), par. 31.
© Stockholm Institute for Scandianvian Law 1957-2009 Ahti Vapaavuori: On Justification in EC Tax Law 379 personal and family conditions, is the obligation of the taxpayer’s country of residence.13 As for the case Wielockx, the ECJ also referred to the OECD Model Convention stating that in that particular case concerning the question whether the legislation, according to which only a resident taxpayer had the right to make a pension reserve in taxation, was consistent with the stipulations of the EC Treaty, the tax treaty to be applied was in harmony with the OECD Model Convention. Thus the state levied taxes on all the pensions generally received by the taxpayer in the area, independent of the country in which the insurance premiums had been paid; however, the state did not levy taxes on pensions received from abroad, even if their insurance premiums had been deducted in that country.14 As for the case Gilly, the ECJ also referred to the OECD Model Convention.
The case dealt with the tax levied on earned income received from the public sector and the effects of the method of relieving international double taxation.
As for the principle that the country paying the salary has the power to tax, the Court referred to the international practice and the OECD Model Convention.
The possibility to rely on this principle had been confirmed in article 19 of this treaty. The Court observed that according to the reasoning of the article the principle was based on international rules of politeness and mutual respect between sovereign states, as well as on the fact that the principle had been adopted in so many tax treaties between the OECD Member States that it could be considered to be internationally recognised.15 The case Gschwind dealt with the question whether it was against the stipulations of the EC Treaty that a Member State’s tax scale based on so-called splitting was not applied to those nationals of the Union who were married and who were working in that Member State and residents of another Member State.