Exit Tax: Fiscal Territoriality and Company Transfer
| Author | Carla De Pietro |
| Pages | 1-21 |
Page 1
While initial development of the European Court of Justice case law in direct tax matters mainly focused on conditions of market access, subsequently and currently most ECJ cases concern definition of market equality. 1Thus, now the ECJ largely considers cases which concern member state tax jurisdiction delimitation, determining what exclusively pertains to member state sovereign tax jurisdiction and what can cause discrimination or restrictions in breach of EU law.
The most recent judgments of the Court highlight a progressively more strident contrast between the concept of the internal market, where allocation of taxing power should be neutral, and the existence of twenty-seven national jurisdictions.
The Court now chiefly aims at developing the balanced allocation of taxing power between the state of departure and the state of destination as a mandatory requirement of public interest under its rule of reason. It is worth noting that the justification of balanced allocation of taxing power is closely connected with the abuse of rights doctrine, since abuse is an intentional disruption of fiscal territoriality and cohesion. Page 2
In order to develop this "balanced allocation of taxing power" the European Court of Justice in its decisions refers to international law criteria on which the OECD Model Convention against double taxation is based.
In respect to the above, the Court seems to consider that the source criterion prevails over the residence criterion. This conclusion can be inferred from the ECJ decisions dealing with capital income flow. On the one hand, the Court obliged the taxpayer's residence state to apply credit, exemption or, in general, more favorable tax measures also to non-resident taxpayers2; on the other hand, in the opposite situation - specifically in the Class Act IV decision3 - the Court did not consider the source state obliged to apply credit to non-resident taxpayers as well. This would imply that the source state should renounce "its right to tax a profit generated through an economic activity undertaken on its territory".
The choice to give the source criterion prevalence over the residence criterion is not justified under EU law and, therefore, one could doubt its legitimacy as a means of supporting a justification based on the territoriality principle.
Nevertheless, given the lack of harmonization within the EU, the Court had to make a choice even if it could not be completely justified.
In this context, exit tax is an emblematic example of when the Court tries to develop a model, which inevitably is the result of trying to reach a compromise between the necessity of preserving source state taxing power and the necessity to guarantee fundamental freedoms provided in the EC Treaty.
Restrictions caused by levying a tax on emigration alone, without a real act of disposal, can only be justified by the right of each state to tax income produced within its territory. This is the case both when national legislation aims at curbing tax avoidance, such as in the de Lasteyrie case, and when the domestic measure has the purpose of guaranteeing a balanced allocation of taxing power, such as in the N case. Page 3
In the de Lasteyrie case4 the European Court of Justice stated that art. 167 bis of the Code Général des Impôts, which is now abrogated, was not compliant with freedom of establishment under the EC Treaty. French legislation provided for taxation upon tax residence transfer outside France on capital gains accrued on substantial holdings but not yet realized.
Payment deferral was subject to the condition that the emigrant taxpayer would declare the amount of tax due, apply for the benefit of suspension, designate a representative in France and, before his departure abroad, release guarantees sufficient to ensure the levy of the tax by the state.
The ECJ based its reasoning, firstly, on the argument that levying a tax- usually due at the moment of actual realization- restricts freedom of establishment if the payment is demanded exclusively upon transfer for tax purposes. A taxpayer willing to transfer his tax residence is in a disadvantageous position compared to the taxpayer who continues to reside for tax purposes in France.
Thus, restrictions are not caused by taxation in itself, but by the fact that one has to pay tax when exercising one of the fundamental freedoms guaranteed by the EC Treaty.
Indeed, the ECJ allowed the source state to tax capital gains accrued during the entire period of residence for tax purposes in France, stating that a mandatory requirement of public interest existed, i.e. the anti-avoidance purpose of the French exit tax regime.
Nevertheless, the Court did not consider the provisions in question proportionate, since they contained a general presumption covering all cases of taxpayer's transfer abroad and not only cases of tax avoidance. The Court did not believe that art. 167 bis of CGI was intended to preserve the coherence of the French tax system. The applicable exit tax regime did not Page 4 definitively assure taxation of accrued capital gains. A credit was guaranteed in the case of actual realization abroad and, in any case France renounced the levy of exit tax when capital gains were not realized within five years of the transfer.
Finally, the Court did not consider the French regime to be justified by the necessity to guarantee allocation of taxing power between the state of origin and the state of destination. The ECJ simply stated, without any further clarification, that "the dispute does not concern either the allocation of the power to tax between Member States or the right of the French authorities to tax latent increases in value when wishing to react to artificial transfers of tax residence, but the question whether measures adopted to that end comply with the requirements of the freedom of establishment".5
This is clearly an unjustifiable statement and, as I'm going to highlight below, it contradicts other statements made by the Court in the subsequent N case, which involved an exit tax regime that was the same as the French one, and in which the Court justified Dutch legislation as it is aimed at assuring a balanced allocation of taxing power.
In addition, the Court contradicted itself when it affirmed that the proportionality principle was respected when providing for the deferral of the payment without setting up any guaranty. As the French exit tax regime was justified under an anti-avoidance mandatory requirement of public interest, proportionality is consistently guaranteed only by giving the taxpayer possibility to rebut the presumption, or by levying tax only when a purely artificial situation is ascertained.
Also the possible solution proposed by the Court of levying tax upon return of the taxpayer after a relatively short period of time abroad cannot be considered appropriate to assure proportionality in respect to an anti-avoidance justification. Also in this case a presumption of tax avoidance would be introduced and, in itself, it would not give the right to prove the absence of bad faith to the taxpayer. Page 5
The N6 case, which came after the de Lasteyrie du Saillant7 case, concerned the Dutch exit tax regime in regards to capital gains accrued on substantial holdings. The legislation in question was virtually the same as in the earlier French case8.
And the Court's reasoning was largely the same as that for the de Lasteyrie decision; it stated that the Dutch regime restricted freedom of establishment. Although, in fact, there were no obstacles for the taxpayers transfer abroad, taxation that was levied solely upon the basis of emigration, which causes a deemed realization, had the effect of dissuading taxpayers wishing to transfer their tax residence. Emigrant taxpayers were in a disadvantageous position in respect of taxpayers who remained in the Netherlands.
Thus, in the N case as well as in the de Lasteyrie case the dissuasive effect of the tax regime in question represented a restriction of freedom of establishment. And this restriction was worsened, as with the French case, by the obligation to set up guarantees in order to obtain a payment deferral.
This hindrance of freedom of establishment was nevertheless justified by the Court. It considered that the Dutch regime assured the allocation of taxing power between member states on the basis of the territoriality principle.
As mentioned above, this is a recurring argument in recent case law for the Court. Indeed, this argument is now considered a mandatory requirement of public interest9. Page 6
In the N case, the ECJ highlighted that, lacking the multilateral agreements that were envisaged in art. 293 EC aimed at preventing double taxation, it is reasonable that states rely on the OECD Model Convention.
Art. 13(5) of the OECD Model Convention attributes to the source state where the alienator resides the right to tax gains from the alienation of any property, other than that referred in the previous paragraphs of the article.
Furthermore, the Court highlighted what Advocate General Kokott stated in her Opinion10: the...
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