Article 43 EC - A Freedom with Limitations? : What Constitutes a "Wholly Artificial Arrangement"?

Abstract: Abstract The freedom of establishment in Articles 43 and 48 EC is a fundamental freedom within the EU meaning that companies are free to set up secondary establishments in any other Member State. The freedom of establishment is an important means to achieve the com-pletion of the internal market and therefore it is important that this freedom is protected. Member States are obliged to legislate in accordance with the objectives of the fundamental freedoms, still Member States are restricting Articles 43 and 48 EC by applying discrimina-tory national legislation regarding direct taxation. In the Cadbury Schweppes judgment from September 2006 the ECJ found the British CFC legislation to be contrary to Community law. The purpose of CFC legislation is to prevent tax avoidance by conferring additional tax upon companies having subsidiaries in low tax states. According to the judgment in Cadbury Schweppes, if the CFC rules are too general in its application they are violating the freedom of establishment. Hence, the CFC legislation must be aimed specifically at “wholly artificial arrangements” aimed at circumventing national tax normally payable. Therefore it is of importance, in the context of applying CFC rules, to clarify the difference between use and abuse of freedom of establishment. It is also important to note that the CFC rules ap-ply even when a subsidiary is established outside the EU. The concept of abuse of Community law has been developed through case law and prohib-its companies to improperly use the provisions of Community law in order to circumvent national legislation. Even if an establishment in another State is made to avoid tax in the State of origin, it is not necessarily abuse of the freedom of establishment since companies are allowed to choose to establish subsidiaries in the Member States with least restrictive rules. The ECJ stated that establishing subsidiaries with the sole purpose to benefit from the lower tax regime do not constitute an abuse of the freedom of establishment as long as the subsidiaries pursue genuine economic activity. The criteria for what is regarded as eco-nomic activity has been discussed in both value added tax and direct tax cases. The re-quirements so far is that the subsidiary established has to be physically present in the host State on a durable basis and have staff and equipment to a certain degree. The ECJ has as-sessed the criteria similarly in value added tax and direct tax cases and stated that the activ-ity has to be considered per se and without regard to its purpose or result. The activity also has to be based on objective factors and be ascertainable by third parties. The Cadbury Schweppes case is the first case in the area of CFC legislation and the Court has provided little guidance regarding what constitutes a “wholly artificial arrangement”. As a consequence of this judgement some Member States have already changed their CFC legis-lation to comply with Community law. Nevertheless, there are cases pending before the ECJ that are further questioning the application of CFC rules and how to define a “wholly artificial arrangement”. The judgement of these cases may result in more changes in the na-tional legislation of the Member States. The future development of the difference between use and abuse of freedom of establishment is important for the protection of the principle of legal certainty. A clarification of what constitutes a “wholly artificial arrangement” will improve the foreseeability for companies and their cross-border transactions will be more efficient.