FDI Implications of Recent European Court of Justice Decision on Corporation Tax Matters

have the specific purpose of preventing wholly artificial arrangements from attracting
a tax benefit, but applied generally to any situation in which the parent company had
its seat, for whatever reason, outside Germany. Such a situation did not, of itself,
entail a risk of tax evasion, since such a company would in any event be subject to the
tax legislation of the State in which it was established.

The Court also rejected the argument that the measure was needed to ensure the
coherence of the applicable tax systems, ruling that coherence could only be used as
justification of a discriminatory provision when discriminatory treatment of a
taxpayer is linked to a benefit realised by the same taxpayer.

Following this decision, many Member States had to re-design their thin-
capitalisation rules so as to eliminate unequal treatment of resident and non-resident
EU companies. There were two different national responses. Spain, for example,
amended its legislation to exclude EU companies from its thin capitalisation rules,
while the UK extended its transfer pricing and thin capitalisation rules to cover
domestic as well as international transactions. The FDI implications of these
responses are complicated. The UK route will increase compliance costs within the
UK and could drive investments away, while adoption of the Spanish model could
increase the attractiveness of low-tax EU countries as holding-company locations for
companies that benefit from thin capitalisation practices.

Taxation Of Dividends

All Member States levy some form of corporation tax on the profits of companies.
When a company’s profits are distributed in the form of dividends, the dividends are
then taxed in the hands of the shareholder. This gives rise to what is referred to as
“economic double taxation” - the same income is taxed twice in the hands of different
taxpayers.

The different approaches of Member States in relation to the taxation of dividends can
give rise to difficulties. Some Member States have had preferential tax arrangements
that applied only to dividends from domestic shares, and the ECJ has found such
provisions to be contrary to the free movement of capital.

The taxation of dividends received by companies is to some extent covered by the
Parent-Subsidiary Directive which provides for exemption from withholding taxes on
the outbound payment of a qualifying dividend by a subsidiary or branch to its parent
in another EU Member State and the grant of a tax credit or exemption from tax to the
company receiving the inbound dividend.²³

In 2003, the European Commission produced a paper entitled “Dividend taxation of
individuals in the Internal Market” in which it analysed the various dividend taxation
systems of the then fifteen Member States.²⁴ The paper related to the dividend
taxation of individuals only, noting that this is the area that is most problematic in
practice. It concluded that

²³ Council Directive 90/435/EEC of 23 July 1990.

²⁴ COM 2003 810 final.

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