According to the court, withholding taxes that result in a higher tax bill for the foreign subsidiary than would have been levied in the member state of the parent company are illegal because they restrict freedom of establishment - a fundamental tenet of EU law.

The case concerned Netherlands-based firm Denakvit Internationaal BV which between 1987 and 1989 received 14.5 million French Francs by way of dividends from its two French subsidiaries, Agro-Finances SARL and Denkavit France. In accordance with the Franco-Netherlands Convention and the French legislation, a withholding tax of 5% of the amount of those dividends was levied, corresponding to 725 000 French Francs.

Denkavit Internationaal and Denkavit France claimed repayment of that sum from the French government, which subsequently asked the ECJ to rule on the compatibility of the French withholding tax system with Community law.

However, tax experts have observed that the ECJ's ruling could have ramifications across the EU, particularly for investment and pension funds.

“Today’s ruling dramatically reduces the scope for imposing withholding tax in the EU," said Jonathan Bridges of KPMG’s EU law group.

"Although it specifically concerns French withholding tax, the principle holds true throughout the EU and there will be a snowball effect now as similar cases are brought across Europe. We estimate that the likely rebates arising from Europe-wide challenges to withholding tax will run into hundreds of millions of pounds," he added.

KPMG noted that member states have already begun to amend their tax legislation in anticipation of the ruling. The Netherlands, for example, has introduced exemptions from withholding tax for certain non-residents, such as, in this case, pension funds.

Commenting from a UK perspective, Brian Drummond, financial services tax partner at KPMG, predicted that the decision could have a "significant effect for UK investment funds.”

"The UK double tax treaty network has been a key advantage to UK funds as it reduces withholding tax on overseas income. Today's decision erodes that advantage and it is important that the UK government acts swiftly to at least protect and ideally enhance the attractiveness of the UK as a funds centre," he stated.