On November 29, 2011, the European Court of Justice (ECJ) issued its decision in the National Grid Indus case C-371/10. The case concerns Dutch exit tax imposed on a company that had relocated its place of effective management from the Netherlands to the United Kingdom. The ECJ concluded that exit tax rules that provide for the immediate recovery of taxes upon transfer of effective management to another Member State are not proportionate and therefore in breach of EU legislation.
Facts
The case involved a private limited liability company which, up until December 15, 2000, had its place of effective management in the Netherlands. Since 1996, this company held a receivable of GBP 33,113,000 on a group company resident in Great Britain. On December 15, 2000, the deferred foreign exchange profit amounted to more than NLG 22 million as a result of an exchange rate rise in the British pound against the Dutch guilder. On that same date the company relocated its effective management to Great Britain. Based on the tax treaty concluded between both countries, the company was regarded as a British resident company after the relocation of the real seat. Because the company no longer had a permanent establishment in the Netherlands after the relocation of its real seat, the right to tax the profit generated by the company’s business operations was, pursuant to the tax treaty, allocated exclusively to Great Britain.
According to Supreme Court case law, the application of the tax treaty meant that the company ceased to generate taxable profit from its business operations in the Netherlands. Therefore, pursuant to Section 8 Corporate Income Tax Act 1969 (“CITA”) in conjunction with Section 16 Personal Income Tax Act 1964 (currently Section 3.60 Personal Income Tax Act 2001, respectively Section 15c CITA) exit tax was owed on the capital gains present at the time of the relocation of the real company seat. That is why the tax inspector took the position that the company had to be taxed on the deferred foreign exchange profit.
The company appealed this decision before the Haarlem District Court, which ruled in favor of the tax inspector. The company, in turn, appealed this decision before the Amsterdam Court of Appeals. The Court of Appeals concluded that the levying of an exit tax when a company relocates its real seat from one Member State to another, restricts the freedom of establishment.
Nevertheless, the domestic measure could be justified due to compelling reasons of public interest, in particular the principle of territoriality, related to a temporal component. In order to answer this issue decisively, the Court of Appeals decided to refer a number of questions to the ECJ, in particular whether the exit tax is contrary to the freedom of establishment. And, if this is the case, whether the levying of exit tax could be justified by the necessity to allocate the right to taxation between the Member States.
The ECJ’s decision
The ECJ concluded that a Dutch company may rely on the freedom of establishment when challenging an exit tax imposed upon relocation of its effective management to another Member State. In reaching this conclusion, the ECJ attached relevance to the fact that the relocation of its effective management did not affect its status as a company incorporated under Dutch law.
The ECJ pointed out that transferring a company’s place of management within the Netherlands does not trigger taxation of unrealized capital gains, and concluded that this difference in treatment creates a cash flow disadvantage and hence a disincentive for a Dutch company wishing to relocate its effective management to another Member State. This therefore constituted a restriction of the freedom of establishment principle.
The ECJ also concluded that imposing an exit tax may be justified by the need to ensure a balanced allocation of taxing rights between Member States. However, the ECJ noted that the proportionality of the Dutch exit tax should be reviewed in order to determine the compatibility of such a measure with EU law. In order to do so, a distinction must be drawn between the moment when the tax liability is determined and the moment when it is settled. As regards the former, the ECJ concluded that Member States may impose exit taxes on the amount of unrealized gains recorded by a company at the moment of relocation, i.e. without taking into account potential future decreases. However, national legislation should give taxpayers an option to (i) settle their exit tax liabilities immediately, i.e. when the company transfers its place of effective management to another Member State, or (ii) defer payment of such taxes to the the capital gains are realized. The ECJ noted that the former option provides the benefit of eliminating the administrative burden of tracing relevant assets until the moment of realization, while the latter option removes the cash flow disadvantage under the former option of having to pay the tax up front. The ECJ took the view that under the latter option, Member States would be permitted to charge interest on the deferred tax payment.
The ECJ concluded that exit tax rules that provide for the immediate recovery of taxes upon transfer of effective management to another Member State are not proportionate and therefore in breach of EU legislation. In contrast to its earlier decision in the N case (C-470/04) and the Advocate General’s opinion, the ECJ ruled in the National Grid case that an exit tax regime that does not take into account subsequent decreases in the value of assets subject to exit tax is not as such in breach of the freedom of establishment. The ECJ pointed out that the two cases were different: the N case related to the shares in the company while the National Grid case involved the company’s assets.
Commentary KPMG Meijburg & Co
As a result of this decision the Netherlands will have to change its exit tax rules and offer taxpayers the choice between immediate taxation and deferral, whereby in neither case is it necessary to take into account subsequent decreases in value.
In light of the infringement procedures initiated by the European Commission, today’s decision may be relevant for other Member States that currently impose exit taxes, e.g. Portugal, Spain, Ireland.