Legal issue: Whether freedom of establishment precludes national tax legislation from imposing, under certain conditions, a charge upon a parent company as regards the profits made by its foreign subsidiary.
Background of the case: The Cadbury Schweppes group (UK) had established two subsidiaries in Ireland solely in order that profits related to the internal financing activities of the Cadbury Schweppes group might benefit from the more favourable tax regime there. After the national tax authorities demanded the corporation tax, Cadbury Schweppes appealed. In the view of the national court, the subsidiaries were incorporated in Ireland in order not to fall within the application of certain UK tax provisions on exchange transactions. In the end, the relevant UK court referred the case to the ECJ to clarify the EC law implications.
The decision: In Cadbury Schweppes the ECJ indicates that it is necessary to examine the behaviour of a taxpayer who incorporates a company in another Member State in light of the aim of freedom of establishment in order to assess whether the behaviour at stake is a mere exercise of freedom of establishment or a legal abuse. In this context, national measures restricting freedom of establishment may be justified only if they specifically relate to wholly artificial arrangements aimed at circumventing application of the legislation of the Member State concerned. The ECJ considered that freedom of establishment requires a stable and continuing basis in the economic life of a Member State other than the state of origin. According to the ECJ, a restriction of freedom of establishment is therefore possible in cases of a ‘letterbox’ or ‘front’ subsidiary. The final conclusion was this:
‘Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a CFC [controlled foreign company] in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that CFC is actually established in the host Member State and carries on genuine economic activities there.’
Significance and implications: With this ruling the ECJ seems to move away from Centros, where the company founders set up a company that had never engaged in any economic activity in its founding state and was aimed solely at avoiding Danish company law.