The Compatibility of Exit Taxes with EC Treaty

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The Compatibility of Exit Taxes with EC Treaty

• by Marco Greggi

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Preliminary remarks

• What is an Exit Tax?
• Taxation of individuals and companies leaving one
  Country for another where they establish their
  residence for tax purposes
• In most of the cases
• It is a direct tax
• The taxable base is the amount of capital gains
  accrued-but-not-yet-realized by the taxpayer.

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Exit tax or Exit taxes ?

• There is not a single Exit Tax, but according to
  the various experiences of the EU Member States
  the Exit Taxes may be levied on different bases
  and on different times (not necessarily on the
  departure from the Home Country by the taxpayer)
• A rough classification in therefore possible

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Exit / Emigration Taxes

• Exit Taxes (on times levies)
• General
• Limited
• Extended income liabilities (Trailing Taxes)
• Unlimited
• Limited
• Claw back of tax deductions (etc ).

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The Principle Involved

• Art.43 of the EC Treaty freedom of establishment
• restrictions on the freedom of establishment
  of nationals of a Member State in the territory
  of another Member State shall be prohibited. Such
  prohibition shall also apply to restrictions on
  the setting-up of agencies, branches or
  subsidiaries by nationals of any Member State
  established in the territory of any Member State.
  

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The Relevant Case Law (ECJ)

• C-2/90 Hughes de Lasteyrie du Saillant
• C-81/87 Daily mail
• C-208/00 Überseering
• C-376/03 D.

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Fundamental distinction

• Case law related to
• Individuals
• C-2/90
• Companies
• C-81/87
• C-208/00.
• The freedom of establishment generated different
  outcomes.

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C-2/90 the facts of the case

• A French individual owns a qualified
  participation in a French company
• He decides to transfer his resident in another
  Country (namely Belgium)
• Under the French legislation this transfer makes
  the capital gains on those shares taxable (even
  if not yet realized)
• Rules 160, 167a CGI

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What kind of exit tax ?

• Limited exit tax
• Only qualified shares are involved
• Only if the taxpayer sells the shares within 5
  years from the change of residence
• The immediate taxation can be avoided if the
  taxpayer is able to offer adequate guarantees to
  the French revenue service
• A tax credit in attributed in France if the
  capital gains is also taxed in the other State
  (that is, where the French citizen is now
  resident).

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Why the conflict with art.43 of the Treaty ?

• The taxation of accrued but not realized capital
  gains (latent increases in value) is a
  significant limit to the transfer of residence
  into another EU Country
• It hinders the establishment of nationals of a
  Country in the territory of another Member state
• It could also be not consistent with the ability
  to pay principle.

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The arguments against the taxpayer

• Loss of revenue
• Art.13 Oecd Model. No immediately relevant.
• Necessity to secure the payment o taxes
  (effectiveness of fiscal supervision)
• Avoidance must be proved
• Coherence
• Immediate anticipation of tax is
  disproportionate,
• Necessity to efficiently allocate taxing power.

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The Sentence

• The French Exit tax is incompatible with EU
  law
• French means
• Limited, and on individuals
• Characterized by a catch all clause
• The coherence test is not passed due to the FTC
  recognized when the capital gains is realized
  (and taxed) abroad.

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What about companies ?

• No specific cases such as the Lasteyrie, but
• Theoretically a eadem ratio approach should
  apply
• however the starting condition is different

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Daily Mail case (C-81/87)

• UK based and incorporated company moves from UK
  to Netherlands
• Necessity to HM Treasury permission
• The transfer was part of a tax planning scheme to
  have Capital gains as tax exempt in the
  Netherlands.

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The consequences of the transfer

• Daily Mail
• Still hold his legal status in the UK
  (incorporation principle)
• Therefore is not triggered by any Exit Tax
• However is not liable there for any income tax.

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and for the ECJ

• Companies are creature of national law (unlike
  individuals)
• They exist by virtue of the national legislations
  ( 19)
• Therefore the limits imposed are consistent with
  EU law as far as are part of the status of the
  company incorporated.

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more

• Art.44, (3), g and 48 of the EC Treaty point out
  that the Council shall introduce future
  legislation about the transfer of the seat
• Art.293 of the EC Treaty also opens to bilateral
  (or multilateral) agreements on the same field

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Similarly, in Überseering

• 70
• A member state is allowed to introduce limitation
  to the transfer of the seat of a company
  incorporated under its legislation
• In Daily Mail the companies were not entitled to
  any right under EU law to maintain their legal
  status in the home country while transferring
  their legal seat somewhere else.

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A synthesis

• When the seat of the company is transferred
  somewhere else it might cease to exist under the
  company seat principle (if adopted) of the home
  state
• Therefore this transfer can be considered as a
  wind up of the company
• The tax consequences are therefore coherent with
  these basic assumptions.

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The limit of this reasoning

• The situation should be different where a company
  still exist under national law even if not
  resident in the home state any longer (this was,
  all in all, the Daily Mail case)
• This happens when a country chooses the
  incorporation principle
• However, under tax law, even if the incorporation
  principle is accepted, a non resident company
  without a P.E. ceases to exist under a fiscal
  perspective
• Then, what about the Societas europeaea ?

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Exit taxes a different approach

• Transferring the legal seat of a company arises
  two main questions under tax law
• Outgoing issues
• Taxing the accrued capital gains
• Issues related to freedom of establishment
• Incoming issues
• Assessing the tax value of the company assets.
• State aid? No
• Double non taxation? Yes

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Inbound companies

• No clear tax provisions under Italian law
• Academics consider reasonable a step (up) to the
  market value of the assets if they arent
  incorporated in a foreign P.E. of the newly
  Italian resident company.
• Step up in the value of the assets?
• Outcome
• Higher depreciation (tax deductible)
• Possible international double non taxation
  without a proper exit tax.

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Concluding remarks

• ECJ case law is under evolution
• But here weve also seen the limits of a negative
  harmonization (i.e. a case-law driven
  integration)
• (Specific) Exit taxes are incompatible with EC
  Treaty
• Especially if they miss the coherence and
  proportionality test
• However the overall phenomenon should be regarded
  under a comprehensive approach, considering also
  what are the effects in the incoming State of the
  transfer of residence (Constructive dissolution).

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The end

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