European Union: Tax: Exit Charges Go Back to ECJ

The Supreme Court of Amsterdam has recently referred a case to the European Court of Justice (ECJ) on the legitimacy of tax exit charges. Such charges can arise when a company seeks to migrate from one EU Member State to another. A number of Member States have such rules which generally apply to unrealised gains on individuals or companies when (a) they cease to be resident for tax purposes in the relevant state and (b) the unrealised gains relate to assets which are not connected to operations in the relevant state. The issue has always been whether such charges infringe the EU right to freedom of establishment and, despite previous ECJ case law and a 2006 Commission Report on the subject, the Supreme Court of Amsterdam determined that the legitimacy of such charges remains unclear in the case of corporate entities. The ECJ's ruling is likely to have implications for exit charge regimes across the EU, including the UK rules which are set out in the Taxation of Chargeable Gains Act 1992.

The Facts

National Grid Indus BV, a Dutch company, moved its central management to the UK during 2000. Prior to emigrating to the UK, National Grid held a large (and untaxed) inter-company receivable. Pursuant to the Dutch rules, a corporate income tax assessment was issued. It should be noted that the assessment was also based on the doctrine of abuse of law (fraus legis), a finding which was upheld by the Dutch Courts. However, the Supreme Court of Amsterdam felt it necessary to refer the case to the ECJ in July 2010 to determine whether the exit charge was permissible or whether it was incompatible with the EU right to freedom of establishment under Article 49 of the EU Treaty.

Previous Case Law and Developments

This latest reference to the ECJ follows a number of cases which seemed to provide a reasonably settled view of how EU law applies to exit charges. Previously, the ECJ has given broad support to exit charges which seek to preserve a reasonable allocation of taxation rights amongst EU Member States. Such charges, whilst potentially discriminatory, are often justifiable provided they are proportionate to Member States' objectives. Whilst emphasising the need in certain instances to defer the imposition of an exit charge (for example in the case of individuals who can be easily tracked through exchange of information provisions), it has previously been determined that there is no wider EU right for a company to transfer its residence from one Member State to another which could be infringed by exit charges. Directive 90/434/EEC (the Mergers Directive) is also consistent with exit charges on companies that will tax assets leaving a Member State's tax net upon emigration.

So What Has Changed?

Recent judgments of the ECJ have debated the extent to which domestic tax regimes can legislate on tax-avoidance issues such as transfer pricing and thin capitalisation without differentiating in principle between tax-motivated avoidance and commercially-justified operations. For example, in the recent SGI case (C-311/08), the ECJ gave some support to cross-border transfer pricing rules if they were more restrictive than their domestic equivalents but only where the legislation specifically targeted wholly artificial arrangements or had the objective of preventing tax avoidance in the context of a balanced allocation of taxation rights. In each case, however, such rules had to be proportionate. In particular, this meant that the taxpayer had to have an opportunity to establish a commercial justification for the transactions in question. This is something that many exit charge regimes (including the UK), which are also based on the need to limit tax avoidance, do not allow for.

The outlook for the future of exit charges is therefore more uncertain than previously thought. If companies continue to be treated as having no right to move residence within the EU which can be protected by EU law, current corporate exit charge regimes may survive. Alternatively, the ECJ, when it comes to give its judgment on this matter, may now take a different view of the rights of companies to migrate within the EU than it did when it first took this approach twenty years ago. Further, the ECJ may take the view that the taxation of unrealised gains (whether the charge is deferred or not) by an exit charge when such gains are not taxed domestically is discriminatory without an SGI-style ability to justify commercially-motivated migrations. Given the findings of the national court in National Grid, such a decision may mean no infringement has taken place in this instance, but the implications for other Member States of such an approach would be substantial.

How Can DLA Piper Help?

The ECJ is not expected to rule on the National Grid case for some time. If however your business has suffered (or may be about to suffer) an exit charge, you may wish to consider whether any protective action is necessary to ensure recovery of any charge which subsequently turns out to have been unlawfully imposed. We therefore suggest that if an exit charge is or has been suffered, developments in this case are carefully monitored. Alternatively, your usual DLA Piper tax department contact will be happy to discuss this further.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.