CFC-legislation, the Freedom of Establishment and Tax Treaties- A Comparative Study in the Light of the Cadbury-Schweppes judgement

Abstract: Although direct taxation falls under the sovereignty of each individual Member State, that sovereignty must be practiced with respect for community legislation and the EC Treaty. National legislation that in any way hinders the freedoms guaranteed by the Treaty or discourages nationals of a Member State to practice those freedoms is infringing the EC Treaty and is not to be tolerated. The number of cases put before the ECJ regarding direct taxation has increased in the last years and the judgments delivered has helped Member States to understand the relation between national- and community legislation and forced them to adjust the former after the latter. Up until the much-awaited judgment in the Cadbury Schweppes case there had been no case dealing with the compatibility of national CFC-legislation and the EC Treaty. The matter of dispute was simple. Can we have a unified market and guarantee the freedoms of the Treaty while at the same time applying anti-abuse legislations to corporations established in another Member State? The ECJ answered the question with the classical juridical reply&semic it depends. On the one hand, CFC-legislation is a clear infringement of the freedom of establishment as it hinders or at least discourages nationals of one Member State to establish themselves in another Member State. On the other hand, the ECJ stated, CFC-legislation can be justified if it is only applied to wholly artificial arrangements that lack real business substance and whose sole purpose is to avoid taxation. Following this judgment, many Member States changed their CFC-legislations so that they would only apply outside the EU/EEA unless the establishment were wholly artificial. It can be argued that the Member States over interpreted the ECJs judgment and that their changes actually changed nothing. What the ECJ meant by wholly artificial arrangement and the abuse of community legislation is still a grey area as the CS case was referred back to the national court to be decided. The ECJ is still to deliver a judgment clarifying how high the demands may be set. In December 2007 the Commission released a communication regarding abusive situations but supplied no further details regarding the definition of wholly artificial arrangement. In late April, the ECJ delivered an order in the CFC and Dividend Group Litigation case repeating its judgment in the CS case. In the order, the Court set out some guidelines concerning the distribution of the burden of proof when it comes to applying anti-abuse legislation within the community, but nothing about defining abusive situations. There is an immediate need of a clearer definition of wholly artificial arrangement issued at community level. Today, the Member States demands for an establishment to be considered business motivated and therefore Treaty protected and excepted from CFC-legislation varies widely. While some Member States find it sufficient that there is some business motivated activity at the establishment, others claim that the effective management and the majority of personnel must be present. It is the authors view that if an establishment exists, meaning at least one person performing activities that is of essence to the corporation it is genuine. Furthermore, if an establishment falls under the scope of the freedom of establishment, it can never be artificial and hence CFC-legislation not applied.