Exit taxes are levied by many member states on accrued capital gains when taxpayers move their residence or transfer individual assets to another member state. A communication adopted by the EC as part of its direct taxation initiative examines how member states' exit tax rules on individuals and companies can be made compatible with the requirements of EC law. It also gives guidance on how to make such national rules compatible with each other with a view to removing double taxation or unintended non-taxation and preventing abuse and tax base erosion.

"Exit tax rules have already been subject to litigation before the European Court of Justice on several occasions," observed Laszlo Kovacs, Commissioner responsible for Taxation and Customs Union.

"I urge member states to sit down together to discuss co-ordinated solutions that will remove all tax obstacles to the freedom of establishment related to the levying of exit tax and at the same time ensure that member states can safeguard their taxing rights," he added.

Many member states seek to tax their resident individual and/or corporate taxpayers on capital gains in respect of their assets. In domestic situations, such capital gains will usually be taxed when they are realised, that is, when the assets are sold or otherwise disposed of.

However, if an individual taxpayer moves to another member state before selling his assets, his original state of residence risks losing the taxing rights on the capital gains which have accrued on those assets. Similarly, if a company transfers its residence to another member state or transfers individual assets to its branch (permanent establishment) in another member state (or vice versa), the original state of residence risks the loss of its taxing rights on the gains which have accrued while the company was resident in its territory.

Many member states have attempted to deal with this issue by taxing such accrued but as yet unrealised capital gains at the moment of transfer of residence by the taxpayer or of the individual assets to another member state.

The European Court of Justice has already stated that immediate taxation of latent capital gains on assets transferred to another member state infringes the principle of freedom of establishment. Indeed, taxpayers will be discriminated against by being subject to immediate taxation in their member state of origin on capital gains not yet realised if no such taxation occurs in similar domestic situations.

The Court also stated that member states cannot put a disproportionate burden on the taxpayer by imposing bank guarantees or the obligation to appoint a fiscal representative that would guarantee the payment of the tax when the asset will be realised in the new member state of residence.

However, the EC law does not prevent a member state from assessing the amount of income on which it wishes to preserve its tax jurisdiction, provided this does not give rise to an immediate charge to tax and that there are no further conditions attached to such deferral, and provided due account is taken of any reduction in value of the assets incurred after the transfer. Member states should therefore provide for an unconditional deferral of collection of the tax due until the moment of actual realisation.

Although granting an unconditional deferral may resolve the immediate difference in treatment between taxpayers who move to another member state and those who remain in the same member state, it will not necessarily provide a solution for double taxation or unintended non-taxation which may arise due to mismatches between different national rules.

Double taxation could arise if the exit state calculates the capital gain at the moment of deemed disposal at the time the taxpayer leaves the country and the new state of residence taxes the whole capital gain from the acquisition up to the moment of actual disposal. Similarly, in the case of companies differences in valuation methods of assets between member states can give rise to double taxation or inadvertent non-taxation.

Effective administrative cooperation will be key to ensuring the effective protection of the exit state tax base. The new member state of residence will need to inform the exit state of any future realisation of the assets.

The communication expresses the Commission's willingness to assist member states in developing guidance to remove discrimination and double taxation and, at the same time, prevent unintended non-taxation, abuse and tax base erosion.