The National Grid Indus Case: A Pyrrhic Victory?

AuthorDaniël Smit
Pages14-25

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Ver Nota1

1. Introduction

On 29 November 2011, the Court of Justice of the European Union (CJEU) handed down its decision in the National Grid Indus case. In this case, the key question was whether the Dutch exit tax upon the transfer of seat of a company from the Netherlands to the United Kingdom contradicts the freedom of establishment. The CJEU has answered this question in the affirmative. In this contribution, the decision of the CJEU is critically discussed2.

2. European framework
2.1. Freedom of establishment

The freedom of establishment is laid down in Article 49 TFEU. Under this provision, restrictions on the freedom of establishment of nationals of a Member State in the territory of another Member State are prohibited. In

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addition, Article 49 TFEU prohibits the imposition of restrictions on the setting-up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State. According to Article 54 TFEU, not only individuals, but also companies or firms, can rely on the freedom of establishment, provided that they are formed in accordance with the law of a Member State and have their registered office, central administration or principal place of business within the Union3. The concept of establishment involves the actual pursuit of an economic activity through a fixed establishment in another Member State for an indefinite period, according to constant case law of the ECJ4. The concept therefore involves two, closely connected, factors: the exercise of an economic activity and a physical location, both on a permanent basis or at least on a durable one5.

The freedom of establishment basically entails a right of national treatment.

According to Article 49 TFEU, the freedom of establishment includes the right to set up and manage undertakings, in particular companies or firms, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the chapter relating to capital. It follows that not only the right to access, i.e. the right to take up an activity, but also the right to exercise, i.e. the right to pursue an activity, may not be restricted6. Furthermore, Article 49 TFEU not only requires the host state to treat establishment by foreign nationals and companies in the same way as nationals of that state.

According to constant case law of the CJEU, this provision also requires the Member State of origin to refrain from hindering the establishment in another Member State of one of its nationals or of a company incorporated under its legislation7. In other words, both inward and outward

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establishment is governed by the Treaty provisions relating to the freedom of establishment.

3. The Court’s decision in National Grid Indus
3.1. Facts of the case

The facts of the National Grid Indus case can essentially be described as follows. National Grid Indus BV is a company which is incorporated under the laws of the Netherlands and which has its place of effective management in the Netherlands. As a result, it is treated as a Netherlands resident corporate taxpayer and liable to tax for its worldwide income accordingly. In December 2000, the company transferred its effective place of management from the Netherlands to the United Kingdom. At the time of transfer, the company owned a substantial group receivable, denominated in British pounds. As the British pound had strengthened against the Dutch currency (at that time: the Dutch guilder), the value of the receivable had increased and a substantial unrealized currency gain rested on the loan receivable. On the date of the transfer, the unrealized currency gain was assessed, based on the exit tax provisions incorporated in the Dutch Corporate Income Tax Act 1969. National Grid Indus BV lodged an appeal against the tax levied on this unrealized currency gain, inter alia arguing that the Dutch corporate exit taxation provision infringed the freedom of establishment under Article 49 TFEU. The Dutch Court of Appeal of Amsterdam was uncertain as to the compatibility of the Dutch corporate exit tax provisions with the freedom of establishment and therefore referred the case to the CJEU.

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3.2. Decision of the CJEU

The decision of the CJEU essentially boils down to the following. Firstly, the CJEU holds that National Grid Indus BV can invoke the freedom of establishment. The reason is that the transfer of the place of effective management to the United Kingdom did not, under the incorporation theory as applied under Netherlands company law, affect the status of National Grid Indus BV as a company incorporated under Netherlands law. In other words, under the civil law incorporation theory, National Grid Indus BV did not cease to exist as a result of its transfer of seat. As a consequence, National Grid Indus BV could rely on the freedom of establishment. Secondly, the CJEU rules that the Netherlands exit tax provision creates a cash-flow disadvantage for companies moving their place of effective management abroad. This is because a company transferring its place of management within the Netherlands is taxed on its hidden reserves no earlier than when they are actually realised. The CJEU consequently rules that the Dutch exit tax provision constitutes a restriction of the freedom of establishment.

The subsequent question is whether this restriction can be justified. The CJEU establishes in this regard that the contested exit taxation is intended to tax unrealised capital gains relating to an economic asset in the Member State in which they arose. Capital gains realised after the transfer of the company’s place of management, by contrast, are taxed exclusively in the host Member State in which they have arisen. Based on this, the CJEU consequently rules that the restriction is justified by the need to preserve a balanced allocation of taxation powers between Member States. The final question is, however, whether an immediate taxation is nonetheless proportionate. In other words, is there a measure available which is less restrictive for the taxpayer and under which the balanced allocation of taxation powers would equally be ensured? The CJEU answers this latter question in the affirmative. On the one hand, it rules that the tax assessment as such is proportionate. This means that the Netherlands is allowed to definitively establish the amount of tax at the time when the

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company transfers its place of effective management to another Member State. The CJEU decides in that regard that the Netherlands is not obliged to take account of any exchange rate losses that may occur after the transfer by National Grid Indus of its place of effective management to the United Kingdom. On the other hand...

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