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Tax-Free Transfer of Assets in Denmark to Foreign Companies

来源:INTERTAX, Volume 36, Issue 5 作者:Thomas Rùnfeldt,Eri 时间:2014-09-18 23:17

This article investigates the question of whether it follows from Community law that tax-free conversion from a personally owned company to a company under corporate ownership under the Danish Act on tax-free company conversion (VOL) can be made to a company domiciled in an EU or EEC country other than Denmark, notwithstanding the fact that s. 1(1) of the VOL specifies as a precondition for tax-free company conversion that it be made to a public limited company (A/S) or a private (ApS) limited company `registered in Denmark'.


1. The Danish VOL condition that an A/S or ApS be registered in Denmark

Section 1(1) of the VOL requires as a precondition for tax-free company conversion that it be made to a public or private limited company `registered in Denmark'. Section S.D.1.12.2 of the tax assessment guidelines specifies in relation to the question of when a company has unlimited tax liability to Denmark:

`A ``Danish company'' shall be understood under procedural history to mean a Danish public or private limited company. Foreign companies with full tax liability in Denmark under s. 1(6) of the SEL by virtue of their main seats being located in Denmark shall have the same rights as a Danish public or private company provided they fulfil the terms for being ``a company in a member state''.'

However, this passage does not in itself answer the question of whether a VOL conversion of the company can be made to a company which is domiciled abroad under company law, but which has unlimited tax liability in Denmark by virtue of its main seat.

In 1983 it became possible to convert a personally owned business to a company without such conversion triggering tax at the time of conversion. The tax could be deferred to a time when the person sold the shares or the company sold the assets.

When the Act was adopted in 1983, it was a requirement that the conversion be made to a public or private limited company registered here in Denmark. This is specified in s. 1: `If a personally owned business is converted to a public or private limited company registered in Denmark, the owner(s) may use the provisions of this act in place of the ordinary tax rules'. It follows that the company must be registered in Denmark, and that foreign companies do not fall within the scope of the Act.

The law has been changed somewhat since 1983, but in its latest incarnation, Act no. 1166 of 2 October 2007, the same requirement is repeated. Section 1 of the Act has the same wording as in the Act of 1983. The converted company may thus not be transferred to a foreign company. Only Danish companies ± meaning Danish companies in the sense of company law ± can receive the transfer.

Apart from the rule on Danish registration of the recipient company under s. 1 of the Act, it was and is a rule that the owner be fully liable for tax under s. 1 of the Tax at Source Act or s. 1(2) of the Act on Tax on Deceased Estates, or be domiciled in Denmark under the provisions of a double tax agreement. It is thus a binding rule that both transferor and transferee must be subject to taxation in Denmark, that is, the person transferring the company must be fully liable for tax in Denmark, and the recipient public or private limited company must be registered in Denmark. Under the Supreme Court's decision in TfS 2007:264 H, a registration in Denmark under company law means that the company will have unlimited tax liability to Denmark under s. 1 of the Company Tax Act (SEL).

Neither the VOL nor its procedural history indicates the motives for permitting only persons with full tax liability or deceased estates to transfer the assets to a company which must be registered in Denmark. Neither do the tax assessment guidelines provide any clear information on the relationship between the Act and the cross-border element. They merely state that a transfer to a company registered abroad cannot be made: cf. SKM 2007:463 SR. The decision of the tax Commissioners does not, however, provide much of a guideline on this point, as the Commissioners merely state that it is a precondition for application of the VOL that the conversion is to a Danish company registered in Denmark. There is no indication of the basis on which the decision was made.

An entirely natural motive for the requirements under the Act could be that Denmark must ensure its tax base, but there is no clear support for this assumption in the procedural history or other sources. This also suggests that any Danish defence of the rule ± in the event that Denmark should be brought before the European Court ± would be weakened consider- ably by the fact that no strong reasons are given for the provision of safeguards in procedural history or elsewhere. Any such reasons will almost have to be constructed in retrospect.

In our opinion, no opposite conclusion concerning companies registered in countries other than Denmark can be drawn by analogy to the clear wording of the VOL. On the contrary, any such conclusion would imply that under the law, a transfer can only be made to a company domiciled in Denmark under its articles of association, such that the company is also registered as a public or private limited company with the Danish Commerce and Companies Agency in Copenhagen.

The question as to whether there is a basis for such an analogy must therefore be answered in the negative, and the next question to which we must turn is whether the VOL provision complies with the requirements of Community law.


2. Community law protects free movement

A. Free choice between branch (permanent establishment) and subsidiary

The significance of the EC Treaty for the choice of structure under company law has developed successively via case law from being a relatively undefined to being a far more clearly defined and very far-reaching right of cross-border establishment for companies. It should be noted that in this context ± as in the Centros case noted below ± a two-tier establishment is involved: the principal shareholder establishes himself via the company, and the company establishes itself via a branch in Denmark. Community law does not prevent the first of these establishments from proceed- ing from country X, or the second from using country X as country of establishment and host country ± that there is, in other words, a chain of establishments which loops back to the country of original establish- ment. The right to make use of such a chain is in reality an expression of a freedom of choice, the freedom to run one's business in country X via a company from country X or from any other EU or EEA country. Thus, a company established abroad may well be used for resident activities.

The rights of companies under primary Community law at Treaty level can be divided into a fourfold

freedom of company form:

1. The right of a company to establish anywhere in the EU/EEA.

2. The right of the company's owners to conduct business in any EU/EEA country via a company

from any other country within the EU/EEA (cf. the above comments on the accompanying right to use a chain of establishment).

3. The right in a cross-border establishment to choose the form of establishment, including the choice between e.g. subsidiary or branch (permanent establishment).

4. The right after establishment to enjoy the same rights as those enjoyed by the branch country's

own companies etc.

The first item in this four-fold freedom needs no comment as the EU right is so clear and unambiguous

here that the freedom of establishment for both persons and companies is absolute. The following discussion will therefore concentrate on the remaining three items.

The more general matters pertaining to the right to run a business in another Member State, including the protection of the company's legal personality, are considered immediately below. Then follows a discus- sion of the last two items, as they are vital to our understanding of the right of freedom of choice for the company which derives from the basic right of establishment.

1. General on the extent of the freedom of establishment

The right of free establishment has developed successively from being purely a prohibition against discrimination on the basis of nationality into a so-called prohibition against restriction. As early as C-2/74, Reyners, the European Court had established the direct applicability of freedom of establishment, and with this decision, the right of establishment came to have an influence on the choice of structures under company law at an early stage.

The big breakthrough for the freedom of establishment came in earnest with C-55/94, Gebhard, where the European Court extended the scopes of Arts. 43 and 48 of the EC Treaty to include a so-called prohibition against restriction on a par with what C- 120/78, Cassis de Dijon, had introduced several years previously to protect the free movement of goods.

The prohibition against restriction has a wider scope than the pure prohibition against discrimination, in that it also applies to national measures of the kind which may well provide equal treatment for foreign and resident companies in purely formal terms, but which in effect make it less attractive for businesses and businesspeople to establish in another Member State. In other words, the prohibition against restriction also applies in cases where there is no differential treatment.

The decision in C-55/94, Gebhard, does not exclude the possibility of introducing national measures, but in premise 37, the European Court has specified four basic conditions for such measures:

(1) They must be applied without differential treatment.

(2) They must be based on compelling public interests.

(3) They must be appropriate to the objective which is being pursued.

(4) They must not go beyond what is necessary to achieve the objective, i.e. a proportionality principle applies.

The exception to the freedom of establishment embedded in the four conditions must be interpreted narrowly, and this automatically makes the area of application of the free choice of structure under company law very far reaching, as only quite specific and concrete measures can justify differential treatment or other impediments to the freedom of establishment.

Since C-55/94, Gebhard, the prohibition against restriction, and therewith the four basic conditions, have been the object of interpretation in a number of important cases, e.g. C-212/97, Centros, and also C- 167/01, Inspire Art, all of which have confirmed the far-reaching nature of the prohibition.

Only where national measures ± including under tax law ± fulfil the four cumulative provisions in question is interference with the freedom of establishment accepted.

With the decision in C-212/97, Centros, the European Court was able to define the extent of the prohibition against restriction established in the Gebhard case. The summary details of the case are given below.

The case concerned the Danish married couple Bryde, who established a private limited company domiciled in England. The company was properly established in England under applicable English law, in particular with payment of the required capital, amounting to only UKP100 (which `requirement' is actually no more than a tradition, as English company law does not require any minimum capital to be paid into a private limited company).

The Danish Commerce and Companies Agency refused to register a Danish branch of the company Centros Ltd. which was domiciled in England as the Agency deemed the construction (a co-called `chain of establishment') to be an attempt to circumvent Denmark's minimum capital rules for private limited companies, then DKK200,000 (now DKK125,000). The Danish founders also admitted during the case that their motivation for placing the primary establishment in England was a wish to evade the relatively high capital requirement in Denmark (cf. the European Court's premise no. 18).

The Danish Supreme Court referred the denial of registration to the European Court for a preliminary ruling under Art. 234 of the EC Treaty, and the latter court found that the right of secondary establishment for Centros Ltd. was protected under the Treaty. Notwithstanding the fact that the establishment was made with the object of running all the main activities in a Member State (Denmark) other than Centros' country of domicile (England), this did not constitute misuse of the right of establishment.

The Court left no doubt in the Centros case that there are narrow bounds to Member States' scope for interfering with the freedom of establishment. The Court pointed out with reference to Gebhard that national measures can only be upheld if the four basic conditions are fulfilled ± and this was not the case here.

Special notice should be taken of the principles of proportionality and `compelling public interest', which place stricter limits on the measures which may be permitted in national law: see also the automatic effect on tax law of the four conditions in C-250/95, Futura Participations, where the Court's consideration of the proportionality principle in particular led to the restriction being set aside as contrary to Community law.

Not even a ± hypothetical ± interest in the prevention of possible fraud can justify measures which categorically deny registration. Community case law does, however, keep open the option of combating fraud by denying or limiting registration in cases where fraudulent intent can be specifically demonstrated in connection with the establishment as such: cf. C-264/ 96, Imperial Chemical Industries, and C-9/02, du Saillant, where similarly preventive measures under tax law can only be upheld in concrete cases of demonstrated tax avoidance.

More recent case law confirms and develops the court's line from Centros, insofar as the scope of the freedom of establishment has been further refined, and the Eleventh Company Law Directive (the Branch Disclosure Directive) has been applied in the interpretation: see C-167/01, Inspire Art.

A company established in the United Kingdom (Inspire Art Ltd.), which conducted its business activities in the Netherlands exclusively via a branch, as faced with Dutch measures aimed against so- called pseudo-foreign companies, i.e. companies which, in the view of the Netherlands, were foreign only in a formal sense but ought in reality to be Dutch. Under the measures, such foreign companies had to fulfil a Dutch capital requirement of _18,000 besides other formal requirements regarding company operations which exceeded the formal requirements permitted by the Eleventh Company Law Directive (the Branch Disclosure Directive). The Dutch measures contained provisions under which the company's failure to comply with the Dutch capital requirements would trigger a more onerous liability under which personal and unlimited liability was imposed on all persons with the power to bind the company.

Kantonengerecht Amsterdam, which referred the case to the Court for a preliminary ruling, held that Inspire Art was governed by the Act on `pseudo- foreign companies'. The Court, however, found these formal measures to be contrary to Community law, and ruled that the disclosure provisions of the Eleventh Company Law Directive were fully adequate, and thus set the maximum permissible limit for any national disclosure requirements of the branch state. The most relevant point in this context is the line which the Court continues to take, under which national law may not impose stricter requirements than those permitted by the Eleventh Company Directive. There must be the same opportunities for establishing a branch as there are for establishing a company, whether or not most or all of the branch's activities take place in its host state.

2. Community law guarantees neutrality in the choice between branch and subsidiary

Community case law includes a series of leading decisions which contribute to the interpretation of the treatment of neutrality in the choice of branch or subsidiary. The freedom of cross-border establishment, via a branch or a subsidiary, is empty unless it is also secured after the fact, i.e. unless the branch is also a neutral alternative to the establishment of a company in the host country in terms of its operation. The neutrality principle should be understood to contain both a company law and a tax law aspect.

Centros and Inspire Art are both examples of issues under company law ± liability and guarantee ± where the host country did not provide for neutrality in the treatment of foreign versus resident companies. To this should be added a series of tax law decisions, which are just as important for the interpretation of the current neutrality principle, as tax law is particularly likely to create obstacles in connection with cross- border establishments: see C-307/97, Compagnie de Saint Gobain, and C-9/02, du Saillant. Community law has the same effect whether the measure to be tested is of company law or tax law ± see C-20/92, Hubbard, in which the court established the so-called `Hubbard rule': Community law cannot differ in its effect depending on which area of national law it is affecting. The freedom of establishment therefore has the same effect on tax law as on company law, and it follows that measures under tax law are in principle subject to the same testing under the right of establishment as any other national legal measure.

The Centros decision has a particularly broad application which extends beyond company law, affecting also the interpretation of any tax rules which are affected by the freedom of establishment: see in particular the rules on restrictive national measures listed in the decision.

Apart from being the first decision under tax law, case C-270/83, Avoir fiscal, has also had vital importance in several other areas and, it must be admitted, is not without value as a precedent. The French tax authorities sought to maintain a state of law under which provisions on tax repayments discriminated against branches of foreign companies. Tax repayments were made to companies domiciled in France, and France argued that all foreign companies needed to do was form a company in France and receive payment through it.

Rejecting the French defence of the rule, the Court declared it to be discriminatory. It also rejected the argument that the rule was motivated by an attempt to prevent tax avoidance. Two aspects of this decision in particular deserve special notice:

. Businesses must be free to choose the least restrictive and most advantageous legal form when deciding between a permanent establishment and a company in the host country in connection with a cross-border establishment.

. Unequal treatment by the host country of full tax subjects and limited tax subjects cannot be justified by the existence of other tax advantages granted to branches but not to resident companies. In other words, an advantage in one area does not justify a disadvantage in another.

Later decisions have also dealt with the question of whether advantages can balance out disadvantages ± see inter alia C-107/94, Asscher ± but the Court has had occasion several times to refer to the basic principle and the reasons set out in C-270/83, Avoir fiscal, which allows differential treatment only in

situations where there is a clear and direct link between advantages and disadvantages.

With the principles laid down by the Court in Avoir fiscal, this decision formed an early foundation stone which secured companies genuine freedom of choice between branch and subsidiary.

The Court has had occasion in more recent cases to follow up on Avoir fiscal, thus contributing further to the interpretation of the branch versus subsidiary neutrality requirement. This applies particularly to the decisions in C-330/91, Commerzbank, C-311/97, Royal Bank of Scotland and C-307/97, Compagnie de Saint Gobain.

Although the borderline between the third and fourth elements in the fourfold freedom of establishment, i.e. the right in the event of cross-border establishments to freely choose one's preferred form of establishment, e.g. between branch and subsidiary, and the subsequent right to enjoy the same rights as the host country's resident companies do, can appear somewhat vague, the distinction can be illustrated by C-307/97, Compagnie de Saint Gobain, a far-reaching decision in its own right in terms of its approach to the neutrality requirement in the choice of branch or subsidiary. The decision shows that all rights granted to a company must also flow to a branch of a company in another EU or EEA country which is located in the same country. The term prohibition against `discrimi- nation against branches' is sometimes used ± a useful shorthand term as long it is remembered that it is not the branch as such which may be discriminated against, but the foreign company which owns the branch.

A branch in Germany of a company domiciled in France was denied some tax advantages (exemptions

for subsidiaries) concerning tax on dividends on shares in foreign companies as the exemptions were, under national German law or bilateral agreements, reserved for companies with unlimited tax liability to Germany.

The central point of the Court's decision was the following: by not allowing companies with limited tax liability to Germany (i.e. French companies which had `only' a branch in Germany) the same advantages as German companies (i.e. companies domiciled in Germany), German tax law placed foreign companies in a less favourable position, thus making it less attractive to conduct business in the state of activity (Germany) via a branch than it was to conduct similar activities via a company (a subsidiary) domiciled in Germany.

The decision, which thus establishes `branch discrimination', may seem far-reaching, but it is necessary to apply a broad interpretation in order to secure genuine neutrality in the choice between branch and subsidiary, also in triangular situations such as those in Saint Gobain.

The conflict of rights arose because subjects with unlimited tax liability were accommodated via a double taxation agreement (a DTA) which does not provide the same rights for subjects with limited tax liability ± thus leading to a situation of `branch discrimination'. The assumption that a DTA can only be claimed by tax subjects with unlimited tax liability to one of the Contracting States became untenable after this decision, and the rights under a DTA must therefore also be granted to subjects with limited tax liability who have business activities in the Contracting State. Or put in simpler terms: what are the rights of a resident company (here: tax-free dividend from a company in a third country) must also be the rights of the branch of a foreign company. Saint Gobain has had numerous knock-on consequences, and the decision is set to play a highly important role in relation to existing and future legislation.

To sum up the question of tax neutrality in the choice between branch or subsidiary in light of the above decisions by the European Court, it may be said that these cases indicate just how far-reaching are the rights which have been secured for companies in their choice between branch and subsidiary. It is clear in particular that no state may use its legislation to force foreign companies to choose a particular form of establishment (e.g. by preferring a subsidiary to a branch) for its cross-border activities. These cases also indicate that irrespective of how Member States may formulate their legislation or their DTAs, the all- dominant principle will apply that the legislation will be contrary to the freedom of establishment of the Treaty's Arts.43 and 48 if a branch is placed in a less favourable position than a resident company in connection with the establishment and subsequent activities. If this is so, a case of `branch discrimination' contrary to Community law exists.

B. National advantages and options must also be available `across the border'

Not only do the provisions on free movement under Community law guarantee the right to establish in another Member State, they also decree that national rules providing persons or companies with the right of conversion etc. must also apply in cross-border situations. The question of how to understand this right to enjoy the same right in cross-border conversions as would be enjoyed if the natural or legal person in question had elected to keep a purely national base is explained in recent European case law.

At the level of company law, under which elements of the freedom of establishment are developed, the leading case is C-411/03, SEVIC Systems AG. The case concerns the denial of a planned merger between the company SEVIC Systems AG domiciled in Germany and the company Security Vision Concept SA domiciled in Luxembourg, where SEVIC was to be the continuing company with no change of name.

The decision in the case found a merger to be a form of establishment in another Member State, despite the fact that the traditional understanding of an `establishment' in another Member State had tended rather in the direction of establishment of either a subsidiary or a branch, i.e. it had been seen as a secondary establishment in relation to an existing company in a primary state of establishment.

The Court expressed the view in SEVIC that like other company transformations, mergers constitute particular methods of exercise of the freedom of establishment, important for the proper functioning of the Internal Market, and they are therefore amongst those economic activities in respect of which Member States are required to comply with the freedom of establishment laid down by Art. 43 of the EC Treaty: see premise 19 of the decision.

These considerations offer some highly interesting approaches to our understanding of the scope of the freedom of establishment: the single market must not only ensure free access to the territories of the individual Member States (a requirement which could be fulfilled by allowing companies to establish subsidiaries, branches and agencies) ± the states must also ensure that conversions within the single market are accepted by the states. This Court ruling that the rights available to companies at national level must also apply in equal measure at cross-border level also applies under tax law.

The decision in C-446/03, Marks & Spencer, is an example of this. Marks & Spencer is a company

registered in Great Britain. During the 1990s, the company was realizing increasing losses in its subsidiaries outside Great Britain, especially in Continental Europe. The parent company announced in 2001 that it planned to sell its activities on the Continent, and they were subsequently sold or closed.

In connection with these sales and liquidation activities, the parent company in Great Britain claimed group relief, i.e. tax deduction for losses incurred in Belgium, Germany and France in the years 1998±2001. The claim was denied by the British tax authorities, and Marks & Spencer then appealed the decision to the High Court of Justice (England and Wales), which decided to ask the European Court whether the practice of allowing tax relief only to groups on British territory while denying such relief to groups with subsidiaries in other Member States constituted a restriction on the freedom of establishment.

Before addressing the question of a restriction, the Court stressed that although taxation falls within the powers of Member States, they must exercise these powers in accordance with Community law. The Community law to which the Court thus refers includes the freedom to form an establishment in any Member State, and there to conduct one's business on equal terms with that Member State's own nationals (cf. Arts. 43 and 48 of the Treaty). European case law had already established that no demands may be made regarding the form of establishment chosen under the exercise of the freedom of establishment, and this freedom of choice implies that the natural or legal person involved is free to choose whether to establish a subsidiary, a branch or an agency: see inter alia case C- 307/97, Saint-Gobin.

The same applies to the state of origin, i.e. the country from where the establishment is carried out. The state of origin is thus prevented from placing obstacles in the way of its own nationals or companies wishing to form an establishment on the territory of another member state: see inter alia cases C-81/87, Daily Mail, C-264/96, Imperial Chemical Industries, and C-9/02, du Salliant. The freedom of establishment thus imposes requirements not only on the host country where the legal or natural person plans to establish, but also on the country of origin from where that legal or natural person is exercising its freedom of establishment. The freedom of establishment thus includes rights both `on entering' and `on leaving'. The latter aspect has also been expressed in the sentence that the right of establishment also protects against `exit restrictions'.

The tax rules under scrutiny in Marks & Spencer meant that losses incurred in Great Britain could be applied directly (i.e. deducted) by a group company within the territory of the same Member State, whereas losses incurred by a group company outside the Member State's territory could not be applied by the parent company in the computation of its taxable earnings. Such a scheme, where the possibility of applying a loss is moved to the year in which the loss arises if another group company can make use of the loss that year (instead of the loss-giving company merely carrying the loss forward for deduction in any future profits of its own), constitutes an obvious tax advantage for the group in terms of liquidity.

Given that the British tax law did not allow such deduction for losses incurred by establishments abroad, the parent company was restricted in its exercise of the freedom of establishment: see premise 33 of the decision. No such obstacle, the Court continued, may be maintained in national law unless in pursuit of a legitimate objective which is compatible with the Treaty, and which is justified by compelling public interest. Further, any such restriction must be appropriate to its purpose and it may not exceed what is necessary to achieve that purpose ± in other words, proportionality must be observed.

In defence of the contention that the tax relief scheme was compatible with Community law, Great Britain argued that the situations of resident and foreign subsidiaries were not comparable with regard to the group relief at issue. The scheme was, Great Britain argued, in accordance with the territorial principle under tax law, a principle which is also recognised by Community law, in that the right of taxation did not fall to the parent company's home state but to the Member State where the subsidiary was conducting its economic activities.

The Court commented first that the residence of the tax subject (or the company) can in some cases justify national provisions of a differential nature, but that this is not always so. A concrete assessment must be made in each individual case, as the recognition of a general distinction based on the residence of the various companies would render Art. 43, and hence also Art. 48, of the Treaty empty of meaning.

Great Britain made three points in defence of limiting access to group relief:

(1) the division of the right of taxation between home state and host state,

(2) the group's access to `double dipping', i.e. access to deduction of the same loss twice, and

(3) the risk of tax avoidance.

On to the point regarding the division of the right of taxation, the Court commented that a lower tax income relative to previous practice was not a reason of such compelling public interest as to justify a restriction. The Court does, however, state that the preservation of the division between Member States of the right to impose taxes can endanger the balanced distribution among Member States unless the application of the tax rules of one Member State is allowed with regard to profit as well as loss, as the transfer of a loss would increase the tax base in one Member State and reduce it in the other, resulting in a genuine loss of tax income in the former Member State.

At first sight, it might therefore look as if the Court is venturing on to a kind of modified `tax base' thinking, as a tax loss cannot be permitted in the former Member State at the cost of a tax income in the latter ± as would be the case if companies are allowed to decide in which Member State a loss should be included.

In the final analysis, this would mean that companies could `tailor' their deduction options to taste ± as would have been the case e.g. under the Finnish system, which allowed deduction for group subsidies to another company if it had been possible for Finnish companies to pay such subsidies to non- Finnish companies with full right of deduction for the paying Finnish company. And indeed, this obvious tax loophole, which could not be plugged in any other way than by denying deduction for subsidies made to foreign companies, moved the Court in its decision of 18 July 2007 in C-231/05, Oy AA to recognize the Finnish tax system, which denies deduction for such cross-border group subsidies. (The principle regarding compelling public interest was satisfied and these interests could not be served by any less invasive measure than by denying the right of deduction.)

In answer to Great Britain's argument in Marks & Spencer that `double dipping' and the risk of it justified differential treatment, the Court stated that Member States must have the right to prevent situations of double dipping. The Court thus accepted the claim that the transfer of losses from non-resident subsidiaries to resident parent companies creates a risk of double dipping. The decision found accordingly that double dipping is a compelling public interest against which Member States are entitled to safeguard themselves.

The Court further stated that there is a risk of tax avoidance, as a group relief scheme of the kind involved will lead groups to organise themselves to ensure that any losses are transferred to the companies domiciled in the Member State with the highest corporate tax rate, in order to maximize as far as possible the loss's tax value. This practice can be prevented by excluding non-resident subsidiaries from using the group relief system.

To sum up, the Court stated that restrictive legislation like the British legislation pursues a legitimate aim which is compatible with the Treaty and which concerns compelling public interest, and the legislation is appropriate for its purpose: see premise 51 of the decision.

Having established that the group relief scheme in question, under which groups established in Great Britain have a tax advantage relative to groups established in other Member States, constitutes a restriction on the freedom of establishment, but that this restriction is justified by reasons of compelling

public interest which have a legitimate purpose (prevention of double dipping) and is appropriate to its purpose, the Court considered whether the scheme in question was proportionate in its present form. The Court found that the British group relief scheme was not proportionate in cases where the non-resident company had exhausted all options for itself applying the loss abroad. Neither was it proportionate in cases where there is no option at all available to the company or to third party for applying the non- resident subsidiary's loss in its home state.

The Court therefore stressed that national rules which do not generally allow deduction of losses incurred by non-resident subsidiaries are acceptable under Community law, but that the general rule must cease to apply in situations where the parent company is able to demonstrate that all options for applying the loss in the other Member State have been exhausted by the subsidiary itself or a third party. In such cases, the Member State must allow the parent company to apply the non-resident subsidiary's loss in the parent company's income statement if the scheme is to pass the proportionality assessment under Community law.

Yet another case on national legislation which must be extended to include cross-border establishments is C-436/00, X and Y. X and Y were natural persons, Swedish nationals resident in Sweden. They petitioned the Swedish tax authorities for a binding decision on the tax consequences of a planned transfer, at purchase value, of their shares in the Swedish company X AB to another Swedish company Z AB, which in turn was a subsidiary of the Belgian company Y SA. Before X and Y reorganized the group, they had found it expedient to transfer some activities to Y SA. X AB is the parent company in a group and is owned in equal shares by X and Y and by a Maltese company. X and Y have no shares in the Maltese company. Y SA is also a parent company owned by the present owners of X AB.

In their submission, X and Y asked inter alia whether the difference in tax which could result, depending on whether the share transfer was done to undervalue to a Swedish company with no foreign owners or to a Swedish company with foreign owners, was contrary to Community law.

In testing the case, the Court addressed the question of whether the national provision constituted an

obstacle to EC freedoms. The Court found that the Swedish tax rule led to differential treatment of purely national transactions and cross-border transactions, more specifically such that the transferor in cross- border transactions loses the right to defer liability for capital gains tax on shares transferred at below value, leading to a strain on the transferor's liquidity when the acquiring company in which the transferor is part owner is domiciled in another member state. The fact that this tax advantage is denied when the acquiring company of which the tax subject is part owner is domiciled in another Member State also involves a risk that the transferor is denied its right under Art. 43 of the EC Treaty to conduct its business in another Member State via a company.

Such unequal treatment constitutes a restriction on the freedom of establishment for nationals of the Member State in question (and for the nationals of other Member States who are resident in that Member State) who are part owners of a company in another Member State, provided, however, that their owner ship is substantial enough to yield such influence on the company's decision that they can decide its activities.

The national provision in question therefore constituted a restriction on the exercise of the freedom of establishment under the Treaty, and the only thing that could save the Swedish measure was if it was justified by compelling public interest and satisfied the proportionality requirements.

The loss of tax income which could result if the tax advantage was extended to cross-border share transfers was not a reason of compelling public interest which could justify differential treatment. Such purpose is purely economic and cannot, therefore, constitute a compelling public interest under established case law: see inter alia case C-35/98, Verkooijen.

As regards the Swedish claim concerning the need to secure coherence in the tax system, the Court stated that the coherence of the tax system is not so stringent that it would collapse if it allowed the rules on share transfer to apply to foreign companies. The Court similarly denied the claim that the fear itself that people will move away from their tax liability is adequate reason for refusing to apply the rules on deferred tax when transferring to a foreign company ± any such refusal would be out of proportion.

To sum up, the decision means that the Court overrode the Swedish tax rules under which shares could not be transferred with tax deferred to a foreign company, given that this option was available for purely national transfers. The Court thus required that it may not be easier to carry out national conversions than it is to undertake transnational conversions, and national advantages must also be available in equal measure to companies with cross-border activities. It is clear that these principles have considerable bearing on the testing of the viability under Community law of the Danish restrictions on tax-free company transformations.

Using the above basis, we now examine whether the Danish Act on tax-free company conversions (VOL) complies with Community law, and if it does not, whether it may still be justified on grounds of compelling public interest and proportionality.


3. Do Danish company transfer requirements constitute an obstacle to the freedom of establishment?

Given the discussion above on Community law requirements under which national conversion measures must be available for international as well as national conversions, it is a relatively simple matter to assess whether the VOL requirement that assets transfers must proceed to a Danish-registered company constitutes an obstacle to the freedom of establishment.

The answer is that this requirement does undoubtedly constitute an obstacle to the freedom of establishment, insofar as the law requires the transferee to be a Danish-registered company. The Act's clear refusal of the possibility of making a tax-free transfer of assets to a non-resident company means that para. 1(1) of the Act under which transfer must be made to a company registered in Denmark constitutes an obstacle to the freedom of establishment.

The Danish state of law under VOL is quite similar on this point to the situation in C-436/00, X and Y, where capital gains tax could not be deferred on a transfer of shares to a company outside Sweden, a state of law which the European Court found to be an obstacle to the freedom of establishment. The difference between a share transfer with tax deferred and an assets transfer without is not so different in the context of Community law as to allow any doubt that the VOL is clearly an obstacle to the freedom of establishment.

One might be a little bold and say that this aspect of the assessment is the `easy part'. It would probably not require many lines from the European Court to arrive at this result if the Danish Act were to be submitted to it for scrutiny. The difficult part of the assessment, on the other hand, is to answer the following question: is the VOL's restriction on the freedom of establishment justified by compelling public interest, and if so, does it meet the proportionality requirement? This question is discussed in the following section, and for reasons which will soon be obvious, its dual aspects will be answered together.


4. Are the restrictive Danish VOL measures justified by `compelling public interest', and are they proportionate?

Support for this question may be found in the Danish state's own position on the issue. As previously noted, the procedural history is silent on the point, and the Danish tax authorities have made no attempt to explain the restriction on the freedom of establishment. For this reason alone, the justification for the measures in terms of the need to establish safeguards is already weakened somewhat ± given that Denmark has made no effort to justify them in terms of the need for safeguards in the procedural history of the VOL, in the taxation guidelines or elsewhere. Even less attempt has been made to provide support for them by referral to Community law.

One reason for maintaining the VOL rules must be presumed to rest on the same line of argument on

which the defences of other national rules in contravention of Community law have been based ± typically the need to prevent the risk of tax avoidance and tax evasion, or the need to protect the coherence of the tax system etc.

Some of these considerations do admittedly constitute `compelling public interest', as is clear from the case law reviewed above in section 3 of this article. But the rules must also meet the criterion of proportion ality, and as is the case with so many other disallowed national measures, this is where the VOL has its biggest problem.

An absolute refusal of the possibility of applying the rules very often appears to lead to problems in meeting the proportionality requirement: the Court is almost always able to point to a less invasive alternative. Only in the case of the Finnish group subsidies discussed above did the Court have to admit that no less invasive alternative to the total refusal of the Finnish company's deduction for a group subsidy to a non-Finnish company could be found. In contrast to this case, it has in almost all other cases been possible to point to alternative measures which would satisfy both the national needs for safeguarding measures and also the proportionality requirement.

This is, in our view, also the case with the VOL: it is actually possible to point to less invasive measures than the total refusal of the possibility of converting the assets to a non-Danish registered company ± and this means that the VOL restriction is disproportionate, and thus incompatible with Community law.

If the owner of a personally owned company who is also a Danish tax subject wishes to transform his business into a public or private limited company and plans to use a company domiciled e.g. in Great Britain for this purpose, all that is needed is a specification in the VOL that the company must continue to be a Danish tax subject. This would apply whether:

. the company, because of Danish control, is a full Danish tax subject under s. 1(6) of the Company Tax Act, or

. it is a limited Danish tax subject under s. 2(1a) of the Act because it constitutes a permanent establishment (a branch) in Denmark.

The point that the current VOL rule is untenable is further demonstrated by the state of affairs which came into being on 1 July 2007, and under which the company owner can achieve the same result: the conversion of his company into a foreign company by following a two-step procedure:

. he must change into a Danish-registered company;

. he must merge this company with a British company such that the British company is the continuing company and the Danish company is dissolved.

This option follows from the CBM Directive (the Tenth Company Law Directive), which has been implemented in Danish law with effect from the date mentioned.

Denmark will preserve its right of taxation to the extent to which a permanent establishment remains in

Denmark after the merger, no longer on the basis of s. 1(1) of the Company Tax Act on companies with full tax liability in Denmark, but on the basis of s. 1(1a) on companies with limited tax liability. This situation follows from the Merger Directive 90/434, the main elements of which are on the one hand that it must be possible to defer taxation of transnational mergers, and on the other that no state should lose its right of taxation. 、

The restructuring of a personally owned company to a limited company has clear points of similarity with the structural change, occurring when assets are transferred from one company to another:

. either via a tax-free transfer of assets under the Merger Directive 90/434: see also points 15c-d of

the Danish Merger Taxation Act (MTA); or

. via a tax-free merger under the same Directive: see also s. 15 of the MTA. The issue in both these cases is that the application of a deferred taxation principle if so desired, while at the same time no Member State loses its right of taxation: see also the principle embedded in Directive 90/434 (under which the state where the transferred assets are located retains its right to tax on operations, profits etc.).

There is no objective reason at all for treating the transfer of assets from a person to a company in another ± and stricter ± manner, given that the state will retain its right of taxation just as safely in this case, provided it makes the condition that the asset transfer be done to a company with either unlimited or limited tax liability to Denmark, and that the tax liability includes the transferred assets.

Tax deferral under the Danish act on tax-free company conversion has a two-way `price':

1. The company assumes the person's tax liability, i.e. often against a low acquisition value, low purchase price for plant, equipment, goodwill etc.

2. The person is given an artificially low purchase price for his shares in the company as the purchase price is composed of the transferred assets' (often low) tax value.

The transfer is thus often a two-way process in a sense, and the resulting tax liability is thus also two- way, coming to rest not only with the company taking over the assets, but also with the person receiving shares in return.

There are, however, already some excellent means of preventing both the company and the person from evading such latent tax liabilities:

. The company cannot `run away' from its tax liability because the obligation to pay is triggered by its sale or winding up, and this applies whether the company is a partial or full tax subject in Denmark (cf. above). The basic principle of any double taxation agreement is that tax on the asset sale of a permanent establishment falls to the country in which the establishment is located. Liability for capital gains tax follows liability for tax on operations.

. The person ± i.e. the company's shareholder ± cannot `run away' from his tax liability either, as not even his permanent removal from Denmark would enable him to evade such latent tax liability. We have rules to prevent this in s. 38 ff of the Act on capital gains tax. Moreover, the `risk' involved in any such move abroad is entirely one of extent, regardless of whether the assets are transferred to a Danish or a foreign company, as the person owning the Danish company could also be contemplating a move away from Denmark.

This element of risk ± the person's possible move abroad ± is thus not a risk which is specifically associated with the use of a foreign company for the conversion, and it is for this reason alone of no relevance for the question of whether the VOL restriction is compatible with Community law. The risk of the person moving abroad also exists in the case of the above forms of restructuring: tax-free transfers of assets and tax-free mergers. A shareholder who has received shares in payment for the tax-free transfer of assets or shares in these cases may just as well be planning on a subsequent change of tax domicile, but this `risk' must be prevented by different methods. It cannot be allowed to prevent tax-free transfers to foreign companies.

A direct refusal to apply the rules in connection with a conversion where the receiving company is foreign is therefore a disproportionate measure, and hence in contravention of Community law, as it cannot be justified in terms of compelling public reasons and proportionality.


5. Must the Danish VOL act be changed ± or can it be interpreted in light of the European requirements as it stands?

The last question to be answered before drawing our conclusions is whether a Danish company owner wishing to convert his personally owned business into a foreign company will have to wait for the VOL to be changed, or whether he can already claim his right to use a foreign company for the conversion now. We answer the question in the following three steps.

First: the VOL must without a doubt be changed. Denmark is, in our view, in violation of Community law which could result in legal action being taken and judgment being handed down against Denmark for breach of Treaty on the basis that Denmark, via the VOL, is supporting a state of law which constitutes a restriction on the freedom of establishment, and which is disproportionate to what is required for the protection of compelling public interests.

Secondly: a company owner who does not wish to wait for such a change of law can effect a conversion to a foreign company by proceeding in two steps as set out above, i.e. by first making a VOL conversion to a Danish company and then merging this company with a foreign company under the civil law rules of the CBM Directive and the tax rules under the Merger Directive, under which tax-free cross-border mergers must be allowed, but such that no state (in this case Denmark) loses its right of taxation.

Thirdly: the Danish tax authorities (including all levels of administrative and judicial organs) are already bound to observe Community legal requirements in their interpretation of the Danish rules to ensure that they are applied in conformity with Community law, even against their direct wording, for one reason because this is required under Community law under the principle of priority, and for another reason because the Danish tax authorities have already often proved to be prepared to interpret the Danish tax rules in light of Community law even against their wording. The reader is referred to TfS 2003.250 LSK, in which the Danish rules on conversion into full year income of taxable income for part of a tax year were reinterpreted against their wording in order to avoid the specific application of the rules from conflicting with Art. 39 of the Treaty on the free movement of labour.


6. Conclusions

We have now only to sum up our observations by way of conclusion in the following points:

1. The rule in Section 1(1) of the VOL, under which tax-free company conversion is only allowed if the recipient is a public or private limited company registered in Denmark, is in violation of Community law as it constitutes a restriction on the freedom of establishment, insofar as company owners located in the EU/EEA are free to choose the nationality of the company to which they intend to make the transfer.

2. The procedural history provides no reason for the above rule, but it must be assumed to be motivated by a desire to safeguard liability for deferred tax in connection with the company's eventual sale of the assets acquired or its dissolution. This interest can, however, be protected by less invasive means than the absolute refusal to accept tax-free conversions to foreign companies, as it is enough, and undoubtedly also permissible under Community law, merely to set the condition for such a conversion that the recipient company will become fully liable for payment of the deferred tax in Denmark under s. 1(6) of the Companies Act or partly liable for its payment in Denmark under s. 1(1a) of the Act upon any later sale of the assets.

3. Such a condition is entirely in accordance with the principles of the Merger Directive 90/434, which makes provision for tax-free asset transfers in cross-border conversions, but which also ensures that no state loses its right of taxation.

4. The question of measures to protect the converted person's tax liability to Denmark is irrelevant in this context, as the `risk' that the person may leave Denmark after the conversion is the same whether the conversion is made to a company resident in Denmark or abroad.

5. It follows from this that the VOL must necessarily be amended to comply with company law.

6. It also follows, however, that before its amendment, the VOL can now and must be interpreted in accordance with Community law: see its rule on priority over national law and earlier Danish tax law decisions which loyally read Community law into Danish tax rules even against the wording of the latter.


*Thomas Rùnfeldt, PhD student and Professor Erik Werlauff, dr.jur. Aalborg University, Denmark.

This article is from "INTERTAX, Volume 36, Issue 5",p.211-220.



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