Saturday, January 07, 2012

EU Court of Justice Rules that Unrealized Capital Gains Can Be Taxed When Company Transfers to Another Member State

EU law does not in principle preclude the charging of tax on unrealized capital gains relating to the assets of a company when it transfers its place of management to another Member State, ruled the Court of Justice of the European Union. However, the immediate recovery of the tax at the time when the company transfers its place of management, without the company being given the possibility of deferred payment of the tax, is not compatible with EU law. National Grid Indus BV v. Inspecteur van de Belastingdienst Rijnmond/kantoor Rotterdam, C 371/10, 29 November 2011.

The case involved a company incorporated under Netherlands law that transferred its place of management from the Netherlands to the UK. After the transfer, it was deemed to be resident in the UK by virtue of a Convention on the avoidance of double taxation concluded between the Netherlands and the UK. Consequently, the company ceased to obtain profits taxable in the Netherlands so that, under Netherlands legislation, a final settlement of unrealized capital gains existing at the time of the transfer of the place of management was drawn up by the Netherlands tax authorities, who demanded immediate payment of the tax. The company contested that decision, claiming that it was contrary to the principle of freedom of establishment.

The Court of Justice first confirmed that the company could rely on freedom of establishment in order to challenge the decision of the Netherlands tax authorities. The Court then found that a company incorporated under Netherlands law wishing to transfer its place of effective business outside the Netherlands suffers a disadvantage in terms of cash flow compared to a similar company keeping its place of management in the Netherlands.

Under the national legislation, the transfer of a Netherlands company's place of management to another Member State entails the immediate taxation of the unrealized capital gains relating to the assets transferred, whereas such capital gains are not taxed when a Netherlands company transfers its place of management within the Netherlands. That difference of treatment is liable to deter a company incorporated under Netherlands law from transferring its place of management to another Member State, reasoned the Court, and constitutes a restriction that is in principle prohibited by the Treaty provisions on freedom of establishment.

However, the Court also noted that preserving the allocation of powers of taxation between EU Member States is a legitimate objective. Also, in the absence of any harmonizing measures of the European Union, Member States retain the power to define, by treaty or unilaterally, the criteria for allocating their taxing powers. In that context, the transfer of the place of effective management of a company of one Member State to another does not mean that the Member State of origin has to abandon its right to tax a capital gain that arose within the ambit of its powers of taxation before the transfer. The legislation at issue is therefore appropriate for ensuring the preservation of the allocation of powers of taxation between the Member States concerned. The Court pointed out that the Treaty offers no guarantee to a company that transferring its place of effective management to another Member State will be neutral as regards taxation.

However, in order to assess the proportionality of such legislation, the Court drew a distinction between the establishment of the amount of tax and the recovery of the tax. The Court found that the Member State of origin complies with the principle of proportionality if, for the purpose of safeguarding the exercise of its powers of taxation, it determines definitively, without taking account of decreases or increases in value which may occur subsequently, the tax due on the unrealized capital gains that have arisen in its territory at the time when its power of taxation in respect of the company in question ceases to exist. But the Court did rule that legislation prescribing the immediate recovery of tax on unrealized capital gains relating to assets of a company transferring its place of effective management to another Member State at the very time of that transfer is disproportionate.

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