that a resident company establishes a secondary establishment, such as a subsidiary, in
another Member State cannot set up a general presumption of tax evasion and justify a
measure which compromises the exercise of a fundamental freedom guaranteed by the
Treaty. The UK CFC legislation clearly constituted a restriction on the freedom of
establishment. The Court held that 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. The restriction must not go beyond what is necessary to
achieve that purpose.
Such tax measures 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, a CFC is actually established in the host Member State and carries on
genuine economic activities there. Thus availing of a lower tax jurisdiction cannot of
itself be grounds for CFC treatment The attractiveness of the tax regime is accepted
to be as legitimate a factor as any other in a company’s choice of location.
The Cadbury Schweppes decision meant that countries with CFC legislation would
have to review these rules to ensure their compatibility with EC law. The FDI
implications of the decision will clearly be to increase the attractiveness of lower-tax
EU locations with licensing restrictions that prevent the establishment of brass-plate
companies.13
Treatment of cross-border losses
Companies are generally regarded as separate legal entities for tax purposes.
However, in recognition of the fact that groups of companies may comprise a single
economic entity, many countries operate some form of “group relief” under which the
losses of one company in a group may be set off against the profits of other group-
member companies. The problem is that such off-set is generally confined to cases
where the surrendering company and the claimant company are both tax resident in
the relevant State. The general justification for denial of relief for cross-border losses
is that the profits of foreign subsidiaries are not within the charge to tax in the relevant
State.
In its 2003 Communication, the European Commission noted that the “ current limits
to cross-border relief within the EU, in particular as regards subsidiaries, can lead to
(economic) double taxation and constitute significant obstacles to economic activity
in more than one Member State.” 14
In Futura Singer, the ECJ appeared to accept that a tax rule confining compensation
for losses to losses economically related to income received locally was justified by
the principle of territoriality. However, the judgment did not elaborate on the
13 Ireland is one such case, in that it does not meet the OECD (2001) criteria for a harmful tax haven.
These are: (i) no or very low taxes, (ii) a lack of exchange of information, (iii) lack of transparency and
(iv) no substantial activities in the country.
14 COM (2003) 726 final.