Test Claimants in the Thin Cap Group Litigation v Commissioners of Inland Revenue.
Date: 2007-03-13
25. It should be noted at the outset that, although direct taxation falls within their competence, the Member States must none the less exercise that competence consistently with Community law (see, inter alia, Joined Cases C-397/98 and C‑410/98 Metallgesellschaft and Others  [2001] ECR I-1727, paragraph 37; Case C-446/03 Marks & Spencer [2005] ECR I-10837, paragraph 29; and Case C‑374/04 Test Claimants in Class IV of the ACT Group Litigation [2006] ECR I‑0000, paragraph 36).
The freedoms of movement which apply
26. In so far as the national court seeks a ruling from the Court on the interpretation both of Article 43 EC relating to freedom of establishment and of Article 49 EC relating to the freedom to provide services, together with Article 56 EC relating to the free movement of capital, it is necessary to determine whether national legislation, such as the legislation at issue in the main proceedings, is capable of coming within the scope of those freedoms.
27. In accordance with settled case-law, national provisions which apply to holdings by nationals of the Member State concerned in the capital of a company established in another Member State, giving them definite influence on the company’s decisions and allowing them to determine its activities, come within the substantive scope of the provisions of the EC Treaty on freedom of establishment (see, to that effect, Case C‑251/98 Baars [2000] ECR I-2787, paragraph 22; Case C-436/00 X and Y [2002] ECR I-10829, paragraph 37; and Case C-196/04 Cadbury Schweppes and Cadbury Schweppes Overseas [2006] ECR I-0000, paragraph 31).
28. In the present case, as the Advocate General noted in points 33 and 34 of his Opinion, the national provisions at issue providing for the re‑characterisation as a distribution of interest paid by a resident company (‘the borrowing company’) in respect of a loan granted by a non-resident company (‘the lending company’) apply only to situations where the lending company has a definite influence on the borrowing company or is itself controlled by a company which has such an influence.
29. In the first place, in the case of the legislation in force prior to the amendments made in 1998, the relevant provisions of ICTA applied to loans granted by a non-resident company to a resident subsidiary of which the former company owned 75% of the capital or where each of the companies was a 75% subsidiary of a third company.
30. In the second place, in the case of the amendments made in 1998, the legislation at issue applies only where the two companies in question are subject to common control in the sense that one of them participates directly or indirectly in the management, control or capital or the other company concerned or a third party participates directly or indirectly in the management, control or capital of both the other companies concerned.
31. As the Commission of the European Communities has pointed out, legislation such as the legislation at issue in the main proceedings, which is directed against thin capitalisation of resident companies by a related non-resident company, concerns only situations in which the latter company enjoys a level of control over other companies belonging to the same group which allows it to influence the financing decisions of those other companies, in particular the decision as to whether those companies are to be financed by way of loan or equity capital.
32. Moreover, the order for reference shows that the cases selected as test cases in the proceedings before the national court involve United Kingdom-resident subsidiaries which are at least 75% owned, directly or indirectly, by a non-resident parent company or by another non‑resident company which is also at least 75% owned, directly or indirectly, by that parent company.
33. Legislation such as the legislation at issue in the main proceedings, which is targeted only at relations within a group of companies, primarily affects freedom of establishment and should, accordingly, be considered in the light of Article 43 EC (see, to that effect, Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 32, and Case C-446/04 Test Claimants in the FII Group Litigation  [2006] ECR I‑0000, paragraph 118).
34. If, as submitted by the claimants in the main proceedings, it were to be accepted that that legislation has restrictive effects on the freedom to provide services and the free movement of capital, such effects must be seen as an unavoidable consequence of any restriction on freedom of establishment and do not justify an independent examination of that legislation in the light of Articles 49 EC and 56 EC (see, to that effect, Case C-36/02 Omega [2004] ECR I‑9609, paragraph 27; Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 33; and Case C-452/04 Fidium Finanz  [2006] ECR I-0000, paragraphs 48 and 49).
36. Freedom of establishment, which Article 43 EC grants to Community nationals and which includes the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, under the conditions laid down for its own nationals by the law of the Member State where such establishment is effected, entails, in accordance with Article 48 EC, for companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the European Community, the right to exercise their activity in the Member State concerned through a subsidiary, branch or agency (see, inter alia, Case C-307/97 Saint‑Gobain ZN  [1999] ECR I-6161, paragraph 35; Marks & Spencer , paragraph 30; and Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 41).
37. In the case of companies, their registered office for the purposes of Article 48 EC serves, in the same way as nationality in the case of individuals, as the connecting factor with the legal system of a State. Acceptance of the proposition that the Member State in which a subsidiary seeks to establish itself may freely apply different treatment merely by reason of the fact that the registered office of its parent company is situated in another Member State would deprive Article 43 EC of all meaning (see, to that effect, Case 270/83 Commission v France [1986] ECR 273, paragraph 18; Case C-330/91 Commerzbank  [1993] ECR I‑4017, paragraph 13; Metallgesellschaft and Others , paragraph 42; and Marks & Spencer , paragraph 37). Freedom of establishment thus aims to guarantee the benefit of national treatment in the host Member State, by prohibiting any discrimination based on the place in which companies have their seat (see, to that effect, Commission v France , paragraph 14, and Saint‑Gobain ZN , paragraph 35).
49. It must be pointed out in that regard that, in the absence of any unifying or harmonising Community measures, Member States retain the power to define, by treaty or unilaterally, the criteria for allocating their powers of taxation, particularly with a view to eliminating double taxation (Case C-336/96 Gilly [1998] ECR I-2793, paragraphs 24 and 30; Case C-470/04 N  [2006] ECR I-0000, paragraph 44; and Case C‑513/04 Kerckhaert and Morres  [2006] ECR I-0000, paragraphs 22 and 23). In that context, it is for the Member States to take the measures necessary to prevent double taxation by applying, in particular, the apportionment criteria followed in international tax practice, including the model conventions drawn up by the OECD (see, to that effect, Gilly , paragraph 31; N , paragraph 45; and Kerckhaert and Morres , paragraph 23).
53. Moreover, even if, in some cases, the application of the provisions at issue in the main proceedings did no more than implement criteria laid down in DTCs, the fact remains that, in exercising the powers of taxation allocated under them, the Member States are obliged to comply with the rules of Community law (see, to that effect, Saint‑Gobain ZN , paragraphs 58 and 59, and Case C‑385/00 De Groot  [2002] ECR I‑11819, paragraph 94) and, more particularly, the freedom of establishment which Article 43 EC guarantees.
54. As regards, lastly, the fact that, under the provisions of a DTC, an increase in taxable profits resulting from a re-characterisation of interest may be matched by a corresponding reduction in taxable profits in the State in which the lending company is resident, it is true that, since the tax regime resulting from a DTC forms part of the legal framework applying in the main proceedings and has been presented as such by the national court, the Court must take it into account in order to provide an interpretation of Community law that is relevant to the national court (see, to that effect, Case C-319/02 Manninen  [2004] ECR I‑7477, paragraph 21; Case C-265/04 Bouanich  [2006] ECR I-923, paragraphs 51 to 55; Test Claimants in Class IV of the ACT Group Litigation , paragraph 71; and Case C-170/05 Denkavit Internationaal and Denkavit France [2006] ECR I-0000, paragraph 45).
61. Secondly, it must be held that a difference in treatment between resident subsidiaries which is based on the place where their parent company has its seat constitutes a restriction on freedom of establishment, since it makes it less attractive for companies established in other Member States to exercise freedom of establishment and they may, in consequence, refrain from acquiring, creating or maintaining a subsidiary in the Member State which adopts that measure (see Lankhorst‑Hohorst , paragraph 32).
62. Contrary to what the United Kingdom Government submits, in order for such legislation to be considered to be a restriction on freedom of establishment, it is sufficient that it be capable of restricting the exercise of that freedom in a Member State by companies established in another Member State, and it is not necessary to establish that the legislation in question has actually had the effect of leading some of those companies to refrain from acquiring, creating or maintaining a subsidiary in the first Member State.
64. Such a restriction is permissible only if it is justified by overriding reasons of public interest. It is further necessary, in such a case, that its application be appropriate to ensuring the attainment of the objective in question and not go beyond what is necessary to attain it ( Marks & Spencer , paragraph 35, and Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 47).
68. In that respect, it should be pointed out that, in paragraphs 28 and 21 respectively of the judgments in Case C-204/90 Bachmann [1992] ECR I-249 and Case C‑300/90 Commission v Belgium [1992] ECR I-305, the Court recognised that the need to maintain the cohesion of a tax system can justify a restriction on the exercise of the fundamental freedoms guaranteed by the Treaty. However, for an argument based on such a justification to succeed, a direct link must be established between the tax advantage concerned and the offsetting of that advantage by a particular tax levy (see, to that effect, Case C‑484/93 Svensson and Gustavsson  [1995] ECR I-3955, paragraph 18; Manninen , paragraph 42; and Case C-471/04 Keller Holding [2006] ECR I-2107, paragraph 40).
72. It must be pointed out that, according to established case-law, a national measure restricting freedom of establishment may be justified where it specifically targets wholly artificial arrangements designed to circumvent the legislation of the Member State concerned (see, to that effect, Case C-264/96 ICI [1998] ECR I‑4695, paragraph 26; Lankhorst‑Hohorst , paragraph 37; Marks & Spencer , paragraph 57; and Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 51).
73. The mere fact that a resident company is granted a loan by a related company which is established in another Member State cannot be the basis of a general presumption of abusive practices and justify a measure which compromises the exercise of a fundamental freedom guaranteed by the Treaty (see, to that effect, Case C-478/98 Commission v Belgium  [2000] ECR I-7587, paragraph 45; X and Y , paragraph 62; Case C-334/02 Commission v France [2004] ECR I‑2229, paragraph 27; and Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 50).
74. In order for a restriction on the freedom of establishment to be justified on the ground of prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory ( Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 55).
75. Like the practices referred to in paragraph 49 of the judgment in Marks & Spencer , which involved arranging transfers of losses incurred within a group of companies to companies established in the Member States which applied the highest rates of taxation and in which the tax value of those losses was therefore the greatest, the type of conduct described in the preceding paragraph is such as to undermine the right of the Member States to exercise their tax jurisdiction in relation to the activities carried out in their territory and thus to jeopardise a balanced allocation between Member States of the power to impose taxes ( Cadbury Schweppes and Cadbury Schweppes Overseas , paragraph 56).
77. By providing that that interest is to be treated as a distribution, such legislation is able to prevent practices the sole purpose of which is to avoid the tax that would normally be payable on profits generated by activities undertaken in the national territory. It follows that such legislation is an appropriate means of attaining the objective underlying its adoption.
80. By contrast, legislation of a Member State may be justified by the need to combat abusive practices where it provides that interest paid by a resident subsidiary to a non-resident parent company is to be treated as a distribution only if, and in so far as, it exceeds what those companies would have agreed upon on an arm’s-length basis, that is to say, the commercial terms which those parties would have accepted if they had not formed part of the same group of companies.
81. The fact that a resident company has been granted a loan by a non‑resident compa ny on terms which do not correspond to those which would have been agreed upon at arm’s length constitutes, for the Member State in which the borrowing company is resident, an objective element which can be independently verified in order to determine whether the transaction in question represents, in whole or in part, a purely artificial arrangement, the essential purpose of which is to circumvent the tax legislation of that Member State. In that regard, the question is whether, had there been an arm’s-length relationship between the companies concerned, the loan would not have been granted or would have been granted for a different amount or at a different rate of interest.
82. As the Advocate General stated at point 67 of his Opinion, national legislation which provides for a consideration of objective and verifiable elements in order to determine whether a transaction represents a purely artificial arrangement, entered into for tax reasons alone, is to be considered as not going beyond what is necessary to prevent abusive practices where, in the first place, on each occasion on which the existence of such an arrangement cannot be ruled out, the taxpayer is given an opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial justification that there may have been for that arrangement.
83. In order for such legislation to remain compatible with the principle of proportionality, it is necessary, in the second place, that, where the consideration of those elements leads to the conclusion that the transaction in question represents a purely artificial arrangement without any underlying commercial justification, the re-characterisation of interest paid as a distribution is limited to the proportion of that interest which exceeds what would have been agreed had the relationship between the parties or between those parties and a third party been one at arm’s length.
89. In so far as, in such a case, the Member State in which the former company is resident may lawfully treat interest paid by that company as a distribution of profits, it is not, in principle, for that State to ensure that profits distributed to a non-resident shareholder company are not subject to a series of charges to tax (see, to that effect, Test Claimants in Class IV of the ACT Group Litigation , paragraphs 59 and 60).
90. It is only where a Member State decides to exercise its powers of taxation not only, as regards resident subsidiaries, in relation to profits made in that State but also, as regards non-resident companies receiving distributions, in relation to the income which the latter receive from those subsidiaries, that that State is obliged, in order for the latter companies not to be confronted with a restriction on freedom of establishment which is prohibited, in principle, by Article 43 EC, to ensure that, under the procedures laid down by its national law in order to prevent or mitigate a series of liabilities to tax, non-resident companies receiving distributions are subject to the same treatment as resident companies which receive such distributions (see, to that effect, Test Claimants in Class IV of the ACT Group Litigation , paragraph 70, and Denkavit Internationaal and Denkavit France , paragraph 37).
109. It must be stated in that regard that it is not for the Court to assign a legal classification to the actions brought before the national court by the claimants in the main proceedings. In the circumstances, it is for the latter to specify the nature and basis of their actions (whether they are actions for restitution or actions for compensation for damage), subject to the supervision of the national court (see Metallgesellschaft and Others , paragraph 81, and Test Claimants in the FII Group Litigation , paragraph 201).
110. However, the fact remains that, according to well-established case-law, the right to a refund of charges levied in a Member State in breach of the rules of Community law is the consequence and complement of the rights conferred on individuals by Community provisions as interpreted by the Court. The Member State is therefore required in principle to repay charges levied in breach of Community law ( Test Claimants in the FII Group Litigation , paragraph 202 and the case-law cited there).
111. In the absence of Community rules on the refund of national charges levied though not due, it is for the domestic legal system of each Member State to designate the courts and tribunals having jurisdiction and to lay down the detailed procedural rules governing actions for safeguarding rights which individuals derive from Community law, provided, first, that such rules are not less favourable than those governing similar domestic actions (principle of equivalence) and, secondly, that they do not render virtually impossible or excessively difficult the exercise of rights conferred by Community law (principle of effectiveness) ( Test Claimants in the FII Group Litigation , paragraph 203 and the case-law cited there).
112. In addition, where a Member State has levied charges in breach of the rules of Community law, individuals are entitled to reimbursement not only of the tax unduly levied but also of the amounts paid to that State or retained by it which relate directly to that tax. As the Court held in paragraphs 87 and 88 of the judgment in Metallgesellschaft and Others , that also includes losses constituted by the unavailability of sums of money as a result of a tax being levied prematurely ( Test Claimants in the FII Group Litigation , paragraph 205 and the case-law cited there).
115. While it has not gone so far as to rule out the possibility of a State being liable in less restrictive conditions on the basis of national law, the Court has held that there are three conditions under which a Member State will be liable to make reparation for loss and damage caused to individuals as a result of breaches of Community law for which it can be held responsible, namely that the rule of law infringed must be intended to confer rights on individuals, that the breach must be sufficiently serious, and that there must be a direct causal link between the breach of the obligation resting on the State and the loss or damage sustained by the injured parties (see Brasserie du Pêcheur and Factortame , paragraphs 51 and 66; Case C-224/01 Köbler [2003] ECR I-10239, paragraphs 51 and 57; and Test Claimants in the FII Group Litigation , paragraph 209).
116. It is, in principle, for the national courts to apply the criteria for establishing the liability of Member States for damage caused to individuals by breaches of Community law, in accordance with the guidelines laid down by the Court for the application of those criteria ( Test Claimants in the FII Group Litigation , paragraph 210 and the case-law cited there).
117. In the main proceedings, the first condition is plainly satisfied as regards Article 43 EC. That provision confers rights on individuals (see Brasserie du Pêcheur and Factortame , paragraphs 23 and 54, and Test Claimants in the FII Group Litigation , paragraph 211).
122. As regards the third condition, namely the requirement for a causal link between the breach of the obligation resting on the State and the loss or damage sustained by the injured parties, it is for the national court to assess whether the loss and damage claimed flows sufficiently directly from the breach of Community law to render the State liable to make it good ( Test Claimants in the FII Group Litigation , paragraph 218 and the case-law cited there).
123. Subject to the right of reparation which flows directly from Community law where those conditions are satisfied, it is on the basis of the rules of national law on liability that the State must make reparation for the consequences of the loss and damage caused, provided that the conditions for reparation of loss and damage laid down by national law are not less favourable than those relating to similar domestic claims and are not so framed as to make it, in practice, impossible or excessively difficult to obtain reparation ( Test Claimants in the FII Group Litigation , paragraph 219 and the case-law cited there).
124. It should be made clear that, in order to determine the loss or damage for which reparation may be granted, the national court may inquire whether the injured person showed reasonable diligence in order to avoid the loss or damage or limit its extent and whether, in particular, he availed himself in time of all the legal remedies available to him ( Brasserie du Pêcheur and Factortame , paragraph 84).
125. In that regard, the Court held in paragraph 106 of the judgment in Metallgesellschaft and Others , with respect to tax legislation which did not afford the possibility of benefiting from the group taxation regime to resident subsidiaries of non-resident parent companies, that the exercise of rights conferred on private persons by directly applicable provisions of Community law would be rendered impossible or excessively difficult if their claims for restitution or compensation based on infringement of Community law were rejected or reduced solely because the persons concerned had not applied for a tax advantage which national law denied them, with a view to challenging the refusal of the tax authorities by means of the legal remedies provided for that purpose, invoking the primacy and direct effect of Community law.
128. The answer to Questions 5 to 10 must therefore be as follows:
– In the absence of Community legislation, it is for the domestic legal system of each Member State to designate the courts and tribunals having jurisdiction and to lay down the detailed procedural rules governing actions for safeguarding rights which individuals derive from Community law, including the classification of claims brought by injured parties before national courts and tribunals. Those courts and tribunals are, however, obliged to ensure that individuals have an effective legal remedy enabling them to obtain reimbursement of the tax unlawfully levied on them and the amounts paid to that Member State or withheld by it directly against that tax. As regards other loss or damage which a person may have sustained by reason of a breach of Community law for which a Member State is liable, the latter is under a duty to make reparation for the loss or damage caused to individuals under the conditions set out in paragraph 51 of the judgment in Brasserie du Pêcheur and Factortame , but that does not preclude the State from being liable under less restrictive conditions, where national law so provides.
– Where it is established that the legislation of a Member State constitutes an obstacle to freedom of establishment prohibited by Article 43 EC, the national court may, in order to establish the recoverable losses, determine whether the injured parties have shown reasonable diligence in order to avoid those losses or to limit their extent and whether, in particular, they availed themselves in time of all legal remedies available to them. However, in order to prevent the exercise of the rights which Article 43 EC confers on individuals from being rendered impossible or excessively difficult, the national court may determine whether the application of that legislation, coupled, where appropriate, with the relevant provisions of DTCs, would, in any event, have led to the failure of the claims brought by the claimants in the main proceedings before the tax authorities of the Member State concerned.
The application for a limitation on the temporal effects of the judgment
131. In addition, the amount put forward by that Government proceeds on the hypothesis that the answers given by the Court would, in their entirety, be those proposed by the claimants in the main proceedings, which, however, it is for the national court to determine.