Spain Told To Amend Anti-Abuse Rules

by Ulrika Lomas, Tax-News.com, Brussels

28 February 2008

The European Commission has formally requested that Spain amend its anti-abuse rules in the corporate tax area, under which income originating from specific member states or territories of the EU is taxed more heavily than domestic income.

The Commission considers these rules incompatible with the freedoms of the EC Treaty. The EC's 'reasoned opinion' is the second stage of infringement proceedings, and the case may be referred to the European Court of Justice if Spain does not amend the legislation within two months.

Làszlo Kovàcs, Commissioner responsible for Taxation and Customs Union commented: "I understand that member states need to ensure that their tax bases are not unduly eroded because of abusive and overtly aggressive tax planning schemes, but the Commission as Guardian of the Treaties cannot tolerate disproportionate obstacles to cross-border activity within the EU."

He added: "The infringement at stake again reveals that there is a need for better coordination of national anti-abuse tax rules as the Commission stressed in its December 2007 Communication on anti-abuse rules in the area of direct taxation. I invite all member states (and not only Spain) to explore the scope for constructive and coordinated responses which would strike a proper balance between the protection of national tax bases and the need to observe the freedoms of the Treaties."

Under the legislation in question, dividends distributed by companies located in certain member states or territories of the EU in which a Spanish company holds a participation of more than 5%, do not benefit from tax exemption, while such an exemption would be granted if dividends were distributed from companies located in Spain or in other member states. The Commission considers that this difference in treatment restricts the free movement of capital.

The Commission stated that under the EC Treaty, all restrictions on the movement of capital between the member states are prohibited. The national provisions at issue create a higher tax burden for resident shareholders investing in companies established there, and may have the effect of deterring them from investing capital in the companies having their seat in these member states or territories.

Those provisions are also capable of having the effect of impeding companies located in those member states and territories from raising capital in Spain, the Commission noted.

Controlled Foreign Company (CFC) rules typically provide that profits of a CFC may be attributed to its domestic shareholders (usually a parent company) and subjected to current (immediate) taxation in the hands of the latter (whereas normally the parent company would be taxed on the profits of its foreign subsidiary only at the time of distribution). The main purpose of CFC rules is to prevent resident companies from avoiding domestic tax by diverting income to subsidiaries in low tax countries.

Under usual tax rules, a subsidiary established in one member state is only taxed in another member state on the income generated by a permanent establishment (branch) of that company in the latter.

Under Spanish CFC legislation, the profits of a subsidiary established in member states or territories of the EU qualified as tax havens are taxed in the hands of the parent company in Spain as they arise and not only upon distribution, as would have been the case if the subsidiary had been located in another member state or in Spain.

According to the Commission, the ECJ has made clear that, in the granting of a tax advantage, the distinction made on the basis of the subsidiary's seat constitutes a difference in treatment which is not compatible with Article 43 of the EC Treaty, which guarantees the freedom of establishment.

The Court has also recently stated that a national measure restricting freedom of establishment may be justified where it specifically relates to wholly artificial arrangements aimed solely at escaping national tax normally due, and where it does not go beyond what is necessary to achieve that purpose.

The Commission considers that the Spanish legislation is contrary to Community law: It goes beyond what is necessary, since it is applicable not only to wholly artificial arrangements but also to parent companies controlling subsidiaries carrying out genuine economic activities in those member states or territories.

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