ECJ Threatens National Tax Sovereignty

by Ulrika Lomas, Tax-News.com, Brussels

01 October 2002

In the first case, the Advocate-General (whose Opinions are most often followed by the full court) said that a Dutch company borrowing money from anywhere in the Union to finance a subsidiary in the Union should be allowed to deduct the interest costs for tax purposes, since that would have been the case if the money had been borrowed domestically for the same purpose.

Current Dutch rules allow a tax deduction for the interest costs of financing a subsidiary only if the subsidiary has a source of income in the Netherlands.

The second case concerned a German company which had borrowings from a foreign EU parent, and, again, the Advocate-General opined that the interest costs should be deductible since they would be if the money had been borrowed locally.

If the general direction of these two rulings is followed by the Court (and they are so much in line with the Court's normal pro-Union attitude that it's hard to imagine another outcome) then most countries in the Union will be faced with substantial losses of revenue, since it is almost the norm for revenue authorities to limit the deductibility of cross-border interest payments.

Even more significantly, if the 'level playing field' principle were then to be applied to other aspects of corporate tax law, companies in countries with group relief arrangements (most of them, in one way or another) would be able to insist on being able to deduct the losses of foreign subsidiaries and affiliates, something which is heavily limited at present in many countries.

It's particularly difficult to see how countries could argue against such a 'level playing field' when they have enthusiastically urged on the OECD in its campaign to root out 'ring-fencing' of tax practices in offshore jurisdictions.

The UK's jealously-preserved veto over fiscal affairs counts for nothing in ECJ rulings, and there will be consternation in the Treasury if it turns out that Europe-wide fiscal 'harmonisation by the back door' can run rough-shod over the UK's territorial power via the ECJ.

The sensible conclusion, if tax-gatherers were to be sensible, would be that corporate taxation should be abolished altogether. Many economists recommend just this; but not many finance ministers!

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