The European Court of Justice is the supreme court of the European Union, the European Commission its executive. Cross-border tax arbitrage in the EU takes advantage of different rules and rates in different member states. Member states have resisted attempts of taxpayers to utilise freedom of establishment to reduce their tax liabilities, but taxpayers have scored some notable successes. In de Lasteyrie, the French charged an exit tax when the taxpayer moved to another member state: the Court held this was an impermissible barrier to his treaty freedom his right of establishment. In X&Y, a Swedish company was held to be entitled to the same tax deferral on a transfer to another EU company as it would have if the transferee were Swedish. It appears that a tax triggered by change of residence of a company may not be applied on change of residence to another EU country. Member states are going to have to harmonise abolishing the charge or applying it equally to domestic and cross-border transactions. In Centros, the Danish authorities refused to register a branch of a UK company, saying that the company had been formed in the United Kingdom simply to avoid the capital duty charged in Denmark. The Court held such refusal unlawful. In Saint-Gobain, a branch in Germany was held to be entitled to the same tax treatment as a purely domestic business. In Cadbury Schweppes, the group located its treasury function in Ireland, the Court has to consider whether CFC rules are overridden by the Treaty of Rome. In Lankhorst-Hohorst, the German thin capitalisation rules were so overridden, on the grounds that they did not apply similarly to purely domestic transactions. The United Kingdom has harmonised down making thin capitalisation rules applicable domestically; Ireland has harmonised up abolishing thin capitalisation rules altogether. In Marks & Spencer, the UK Revenue denied group loss relief to EU-resident subsidiaries. The Advocate-General has opposed this, but appears to want to avoid double dipping the same loss being allowed in two countries. It is possible to tax plan based on ECJ decisions, but important to ensure legislation in relevant states supports the plan: planning purely on the basis of ECJ decisions is not necessarily secure.
The United Kingdom enjoys a singular climate of honesty. This is reinforced by the money laundering rules. Tax avoidance is much frowned on by the courts, though judges nowadays are less hostile to avoidance than they were. Predicting the attitude of the courts is a special skill of the Bar. Most disputes with the Revenue are settled; a determination by the taxpayer to stand his ground is the key to a favourable settlement. The burden is on the taxpayer to prove his case. To pretend that avoidance is not intended will be counter-productive. Many schemes fall down because they have been carelessly implemented. At the same time, the Treasury is hungry for tax. The new disclosure requirements have presented the Revenue with more information than they can handle: often they lack the skills to understand and counter the schemes disclosed to them. On the other hand, the UK system is very generous to the non-resident and the non-domiciled. The United Kingdom offers a particularly favourable tax regime for charities. A charity offers power without ownership. It can buy reputation, votes, influence or publicity. The law relating to charities has evolved over many years, but now a Bill is being proposed for a statutory codification a measure which is essentially designed to take away the advantageous tax position from the public i.e. fee-paying schools. A charity may take the form of a company or a trust. It is supervised by the Charity Commissioners. A charity is exempt from tax on capital gains and virtually all income. It is not necessarily exempt from VAT.A UK charity may nevertheless obtain the benefit of the UK tax treaties. The UK thin trust enables non-residents to take advantage of the capital gains provisions in the UK treaties.
The Directive derived from the European Council agreement of 19th June 2000. It is evident from the preamble to the Directive that tax harmonisation in Europe is not possible, and that EU residents are evading tax by taking advantage of this. The aim of the Directive is to put a stop to this evasion by introducing automatic information exchange. But pension and insurance benefits are unaffected. The Directive is to be reviewed every three years i.e. for the first time on 1st July 2008. Art. 4 defines a paying agent and exempts payments to legal entities. Art. 6 defines interest payment widely. Certain UCITs are outside the scope of the Directive. Art. 10 provides for Belgium, Luxembourg and Austria to withhold tax for a transitional period. Art. 15 provides for grandfathered bonds, issued before 1st March 2001. EU-resident individuals can generally choose between information exchange and withholding tax. Resident but not domiciled individuals are not affected.The Directive has stimulated the growth of a variety of transactions intended to fall outside it e.g. the deferred interest account. These may offer only a short-term solutions. Switzerlands agreement with the EU does not require information exchange, but a Swiss bank may pay interest gross if the depositor instructs the bank to inform his government of the payment. Otherwise tax is withheld, as in Austria, Belgium and Luxembourg. The UK resident but non-domiciled individual is not treated as a UK resident for these purposes. Currency trading profits the proceeds of a swap for example – are outside the Directive, even though they are essentially the equivalent of interest. The yield of a Sharia-compliant investment is also outside the Directive, because it is not interest. European bankers can offer exemptions which are competitive with Singapore, and individuals may change residence, create legal entities, or make investments falling outside the Directive. One needs to be aware that changes will come, if slowly.
What effect are the ECJ decisions having on tax treaties? The Treaty of Rome encourages tax treaties; the Commission is preparing a paper. In Gilly, the ECJ approved a tax treaty embodying discrimination on the grounds of nationality; but Saint-Gobain the Court departed from treaty practice and afforded treaty relief to a branch. But the Court does not always favour the taxpayer: in the D case, the Court held despite the Advocate Generals opinion that the Netherlands could refuse a German resident a wealth tax allowance to which a Dutch or Belgian resident would have been entitled. This leaves a number of unsolved issues on treaty provisions e.g. limitation on benefits, the credit/exemption alternative, state aid in favouring export credit guarantee interest. Has competence to enter into treaties shifted from member states to the Community? Where is the ECJ going? The taxpayer has lost Schempp and Bloakhaert as well as the D case. There is a backlog of Advocate-Generals rulings without any Court decision. In Meilicke, the Advocate-General opined that German taxpayers should have credit for underlying tax on foreign shares, but subject to a temporal limitation, on the grounds of serious economic consequence and previous uncertainty. The OECD has published a new model and commentary. In Indofood, the UK court has offered a meaning of beneficial ownership: it excluded an agent, nominee or conduit. The OECD is still considering the allocation of profits to permanent establishments. There is a need for a new technique for rapid amendment of tax treaties.
Legal systems develop alongside the changing attitudes of the societies they serve. The common law has proved itself particularly adaptable. In the 1960s, English judges saw the law as restraining changes in social attitudes. But since then judicial attitude has developed significantly e.g. allowing restitution for a mistake of law in the Kleinwort Benson case. The court has responded to social and economic pressures. Many examples can be found in the decisions of the US Supreme Court. The consequences of judicial decisions are often unintended and unforeseen. When these consequences become apparent and then appear undesirable, the court is apt to make a different decision. Such changes have occurred in the field of tax. The court at first found nothing the matter with dividend stripping, but when the consequences of this attitude became apparent, the court changed its mind. The background to Ramsay was an attempt to take advantage of statutory language to reduce tax. The court formed the view that there was too much tax avoidance about and it had to be reduced. The ways in which the court has done this have changed over the years, but essentially has come to apply a smell test the UK court in this respect following the lead of the United States. In Australia, this process has taken the form of broadening its approach to the statutory prohibition against avoidance. The process in Canada has been similar. This development is not beneficial. It deprives the statutory provision of certainty, and it is damaging to profit-making activities and in the longer term actually reduces the tax take.
The OECD Report of 1998 (with subsequent updates) aimed to promote fair tax competition. Harmful tax competition involves no or nominal taxes, no exchange of information, lack of transparency and absence of substantial activity. Low tax rates are not necessarily harmful, but lack of substance generally is. Substance is hard to define. The 2001 version of the Report contained a list of tax havens, but this was followed by a list of non-cooperative jurisdictions, and there was a shift of emphasis to exchange of information and transparency. Part of the purpose of the EU Code of Conduct was also to prevent harmful tax competition. The Savings Directive was primarily concerned to promote exchange of information; the alternative of withholding tax was regarded as a second choice. Exchange of information was expected to reveal lack of substance. Intelligent substance does not require bricks and mortar. But it does require true residence: a company needs to have an effective and genuine seat of management. Beneficial ownership also indicates substance: here one looks at the true owner, not the agent, nominee or conduit. Transfer pricing guidelines are machinery for ascertaining the true location of profit. The new ruling regime in the Netherlands requires substance in the Netherlands and needs the risk-bearing functions to be performed there. The Netherlands has no CFC legislation, though the OECD encourages it. So long as an offshore structure has the necessary substance, it can still be effective.
Tax is a business cost, and transfer pricing in relation to intangibles offers opportunities for managing this cost. The new UK regime is now six years old; it is now applied to domestic transactions; it provides for Advanced Pricing Agreements; it adopts the OECD Guidelines; it applies to the overall arrangement and not simply to the contract between two parties. It essentially requires parties who are not dealing at arms length to adopt for tax purposes the price which would be charged if they were. This principle is notoriously difficult to apply in practice: various methods are set out in the OECD Guidelines. Structuring opportunities exist. Intangibles need to be identified. The location of assets and risk needs to be considered. The new UK regime has had a significant impact on the planning opportunities available to groups. But the first step is often to identify the situations where a royalty is not being paid, but the intangible is being used: licences can be used to create an income flow and an advantageous tax treatment, and can also open up possibilities of commercial advantages. The relationship between companies within a group wishing to develop and exploit intangibles may be managed by a cost contribution arrangement: the OECD Guidelines provide for them; the UK authorities just about tolerate them; but other tax authorities accept them. By deconstructing the business process and identifying the relevant function, it may be possible to locate intangibles and the associated risk and corresponding reward in a low-tax jurisdiction. The UK risk assessment rules are to be found in Tax Bulletin 60. A group should commit its position to writing and make it widely known within the group.
Tax avoidance is good for the economy. An example of treaty-shopping to Malaysia through Germany illustrates the point. A tax treaty clarifies the taxing rights of two countries. It avoids the levying of two taxes on the same income or gain. It combats evasion by exchange of information. UK property development by a Guernsey dealing company is an example of using a tax treaty: the profit escapes UK tax, and the local tax liability is substantially reduced. A similar effect follows if a Netherlands company is used; a dividend may be declared via Malta. To reduce tax on Eastern European property investments, local investments companies borrowed from a Dutch company to make the investments; they were all subsidiaries of a Cyprus holding company. Most European countries offer beneficial holding company regimes. Cyprus is particularly favourable. In 2002, the United Kingdom introduced a holding company regime: the capital gains exemption does not apply to the sale of the only or last subsidiary, unless the holding company is liquidated within a reasonable time. In a capital trust, a UK company is a co-trustee with one or more non-UK residents and is beneficially entitled to the income; the income suffers UK tax, but capital gains do not, and both are entitled to treaty benefit. This structure avoids local taxes on dividends flowing e.g. out of France and Portugal. In another structure, a UK branch of an Icelandic company financed a Bulgarian company; a similar effect resulted where a Netherlands company establishes a Swiss branch. In the field of licences, Hungarian companies are much used e.g. a Japanese royalty is paid to a Hungarian company and thence to a zero-tax vehicle. A Swiss employment company receives fee from Russia for the services of its employee, and pays much of it out as remuneration, or to an employee benefit trust which in turn can invest in equity or stock options in the enterprise. Licensing image rights presents opportunities for using a global employment company.