New Swedish Emigration Taxes on Business Income

• Author: Katia Cejie
• Pages: 1-13

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Ver Nota¹

1. Introduction

The recent European Court of Justice’s (ECJ) decision in National Grid Indus illustrates the Member States’ difficulty adopting rules on notional taxes due upon exit of legal persons, that remain compatible with the fundamental freedoms². The purpose of the current article is to assess Swedish rules in the light of the requirements set by EU law.

Before the National Grid Indus case was rendered, and over the past five years -nine out of ten Swedish emigration tax rules³ have changed. These changes have been made based on the assumption that the rules were not in compliance with EU law. The exit tax rules for companies were the last ones to be changed. Two of these rules (which came into force on January 1st 2010) will be presented and commented on in this article, i.e. the withdrawal taxation on business income and the claw-back on tax allocation reserves (periodization reserves).⁴ A description of the rules is presented in Section 3. However, even the new rules may be questioned to some extent in relation to the freedoms guaranteed in the TFEU. An analysis regarding this question will be presented in Section 4 below. Before this is done, a background regarding the Swedish company law is presented (Section 2.1). The point of departure is taken in the article written by Professor Emeritus Leif Mutén in Studi Tributari Europei 1/2009,⁵ the so-called

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Malta Case as well as in the Commission’s request for Sweden to change its rules in these matters (Section 2.2 below). In Section 5 some concluding remarks are made. The article refers to legislation and materials updated on 1st December 2011.

2. Background

2. 1 The incorporation principle

Swedish company law has adopted the Incorporation Principle, instead of the Seat Principle. A Swedish company remains a legal entity as long as it remains registered.⁶ Further it can be noted that the board of directors is required to have its seat in Sweden.⁷ The provisions in question do not, however, require that the effective management must be kept in Sweden in order to be recognized as a Swedish legal entity. However, several double tax agreements (DTAs) do regard the effective management as the tiebreaker for determining of the residence of the company.⁸

Should the effective management of a Swedish company be transferred to another State, applying the real seat principle in company law, then it would be possible for a Swedish company to be recognized under the commercial law of both States.⁹

According to the ITA¹⁰ 6:3-4 the company would remain unlimited liable to tax in Sweden after transferring its residence abroad. After transferring its effective management abroad the company would however still exist in Sweden and there would be a case for applying the freedom of establishment. In the Case National Grid Indus the Court states “As a company incorporated under the legislation of a Member State and having its registered office and central management within the European Union, it benefits, in accordance with Article 54 TFEU, from the Treaty provisions on freedom of establishment, and can thus rely on its rights under Article 49 TFEU, in particular

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for challenging the lawfulness of a tax imposed on it by that Member State on the occasion of the transfer of its place of effective management to another Member State.”¹¹

2. 2 Background of the Exit Tax Rules and The Malta Case

Sweden has had rules on withdrawal taxation since 1928. A withdrawal occurs when a taxpayer transfers an asset without consideration as to whether the transfer is not justified commercially (or for a consideration below the market value of the asset). The asset is considered to be sold for a consideration equal to the market value on the basis of which taxation is based (ITA 22:7). The purpose of these rules is to uphold taxation of business income by ensuring that untaxed values of a business activity will not be taken out of the business sector untaxed. This could occur when tax liability in Sweden for business activity ceases (ITA 22:5 p. 4), for instance when the effective management of a company is transferred to another State and the tax residence according to the DTA is considered to be in the host State. Withdrawal taxation leads to an exit tax on the untaxed values on the business assets/assets that are transferred from Sweden. Furthermore, the rules also ensure that the gains that have arisen in Sweden will be taxed here.¹²

A rule with a similar purpose was the rules in ITA 30:8 regarding claw-backs on periodization reserves. According to the rules in Chapter 30 ITA, a company could elect to postpone taxation of 25 percent of taxable annual profits placed in a periodization reserve. This reserve could be added back to taxation at any moment, but no later than six years after its constitution. This provision allows taxpayers to equalize their tax liability between different fiscal years in a business. However, as mentioned above, the reserve is to be taxed earlier if the

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company’s income was not be taxable in Sweden any longer due to a DTA (ITA 30:8).

The Board for Advanced Tax Rulings (the Board) found these two exit tax rules incompatible with the freedom of establishment already in 2006.¹³ The case (also known as the Malta Case) was submitted to the Supreme Administrative Court, confirming the Board’s ruling.¹⁴ Both exit tax rules were considered to be in breach of the freedom of establishment, and justified due to the need to preserve the coherence of the fiscal systems and the principle of territoriality, but they did not meet the proportionality test. Indeed some less burdensome tax measures could achieve the same result.¹⁵ It can be noted that the Supreme Administrative Court did not refer the case to the ECJ, which may be criticized, because the case would have been of great interest for several Member States, with similar rules. However, the ECJ would most likely have reached the same outcome – i.e. the rules were not in compliance with EU law. On the other hand – the ECJ would perhaps have elaborated some of the questions further, which would have been of great interest.

After the ruling by the Supreme Administrative Court, the tax authority did not apply the restrictive rules any longer.¹⁶ One year after the ruling the legislator passed a new legislation.¹⁷ In the mean time the Commission formally requested Sweden to change its exit tax provisions.¹⁸ However, the request never passed the second step of the infringement procedure, as Sweden had amended the

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legislation.¹⁹ The new legislation entered into force on January 1, 2010. However, the new legislation can also be questioned from an EU law perspective (see Section 4 below). This is at least true if one considers the case law of the ECJ ruled on until mid-November 2011. The Case C-371/10 National Grid Indus has however shed new light on this situation²⁰.

3. The New Legislation

According to the new legislation, the withdrawal taxation (exit taxation) on business income according to Chapter 22 ITA still remains. However a possibility of deferring the payment of the tax has been introduced. The payment of the tax is deferred until the assets are sold. A deferral can, after application, be granted one year at the time. The new deferral can be of a similar amount as that previously deferred, but can also be reduced if the taxpayer has sold or otherwise disposed of assets on the basis of which the deferral was granted. For some assets (tangible and intangible assets) a successive reduction of the deferral is mandatory over a five or ten-year period, after which the right to defer entirely ceases.

As a main rule, the deferral will cease when the assets are sold, which means that tax is triggered then. A deferral may be granted provided that: 1) the taxpayer after the transfer of assets/residence is still unlimitedly liable to tax in Sweden, 2) the withdrawal taxation is based on ITA 22:5 p. 4-5, 3) the transfer is carried out within the EEA area and 4) the assets are included in a taxable business activity within the EEA area. A decrease in value on the assets in between the exit taxation and the payment of the tax on the deferral will not be taken into consideration in Sweden, according to the new rules.

The second exit tax, i.e. the claw-back on periodization reserves²¹ has been amended in relation to companies transferring their residence to a State within the EEA-area, with which Sweden has signed and applies a DTA. In this situation,

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the periodization reserve may be clawed back at any time within six years from the time of allocation. This means that the same rule applies in these cross-border situations as in domestic situations.

4. Is the new legislation in compliance with EU law?

4. 1 Introduction

This section analyzes briefly the compatibility of the currently applicable Swedish rules with the case law of the ECJ.²² The rule regarding periodization reserves that was considered a prohibited restriction in the Malta Case no longer applies. Instead the same rule on claw-back applies in domestic as well as cross-border situations. The new rule can therefore probably not be considered a restriction. The following analysis therefore focuses on some aspects of the exit tax on withdrawal and the deferral method used in this context.

The analysis in this section is primarily based on the case law of the ECJ.²³ Both scholars and the Commission...