Free Movement of Capital and Third Countries Miha

Taxation and the Third Country
Dimension of Free Movement of

Capital in EU Law: the ECJs
Rulings and Unresolved Issues
By
Martha OBrien
Reprinted from British Tax Review
Issue 6, 2008
Sweet & Maxwell

100 Avenue Road
Swiss Cottage
London
NW3 3PF
(Law Publishers)
Electronic copy available at: http://ssrn.com/abstract=1356125
Taxation and the Third Country Dimension of Free

Movement of Capital in EU Law: the ECJs Rulings
and Unresolved Issues
MARTHA OBRIEN*
Abstract
The free movement of capital guaranteed by Article 56(1) of the EC Treaty applies not only
within the European Union (EU), but also to movements of capital between EU Member States
and non-EU (or third) countries. Over the last 15 years the Court of Justice of the European
Communities (ECJ) has ruled repeatedly in intra-EU cases that Member States direct tax
laws must not impede exercise of the fundamental freedoms, including free movement of capital.
The ECJ has now begun to define how Article 56(1) applies to direct tax restrictions on capital
movements between the EU and third countries, providing some important indications, but also
raising many questions, as to the differences and similarities in the way the ECJ will approach
third country cases as compared to intra-EU cases. This article provides an analytical overview
of the EC Treaty provisions on free movement of capital, the range of intra-EU cases that
have held Member State tax laws incompatible with free movement of capital, and discusses the
implications of recent third country decisions and the provisions of the Treaty of Lisbon on the
future evolution of the third country dimension.
Introduction
The global potential of Article 56(1)
ARTICLE 56(1) of the EC Treaty1 prohibits all restrictions on the movement of capital
between Member States and between Member States and third countries (emphasis added).
This is an extraordinary provision for what is, at its core, a trade agreement creating a
regional common market. It extends certain EC Treaty benefits and rights to residents
and citizens of countries that are not party to the EC Treaty, without requiring reciprocity
* Associate Professor, Faculty of Law, University of Victoria, British Columbia, Canada. The research
for this article was supported by a Jean Monnet European Module Grant from the European
Commission, and by the Social Sciences and Humanities Research Council of Canada.
1
Treaty establishing the European Community, consolidated version, [2006] OJ 2006 C 321/E37. The
EC has concluded numerous association agreements with third countries which provide in some cases
for greater liberalisation of capital movements. The effects of these agreements on free movement
of capital between the EU and third countries is beyond the scope of this article. See the views of
national reporters from some of these third countries in M. Lang and P. Pistone (eds), Free Movement
of Capital and Third Countries: Direct Taxation (Linde Verlag, Vienna, 2007) and B.J. Kiekebeld and
D.S. Smit, Freedom of establishment and free movement of capital in Association and Partnership
Agreements and direct taxation [2007] EC Tax Review 216.
628
[2008] BTR: No.6 2008 THOMSON REUTERS (LEGAL) LIMITED AND CONTRIBUTORS
Electronic copy available at: http://ssrn.com/abstract=1356125
EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

from these non-Member States. The ECJ has confirmed that this provision has direct
effect with respect to third countries,2 so that individuals and companies may take legal
action to assert their rights under Article 56(1) in the national courts of the Member States.
In light of the significant impact that Article 56(1) has on Member States direct taxation
laws within the European Union, this article examines the third country dimension of
free movement of capital and the implications it may have for third country investors in
EU Member States and for EU residents who invest in third countries.
The second part of this article provides, as background and a basis for comparison of
the cases on the third country dimension of free movement of capital, an overview of the
scope and application of Articles 56(1) and 58(1)(a) within the European Union, including
the definition of capital movements, the ECJs jurisprudence not related to taxation, and a
survey of the direct tax cases according to subject matter. The relationship of the network
of bilateral double taxation conventions (DTCs) between Member States to the direct
taxation principles of EU law is outlined, and the justifications for restrictions of free
movement of capital are reviewed.
The third part of the article first sets out the points on which the intra-EU and
third country case law coincide. Subsequently it examines the differences: the judicial
limitation to free movement of capital in respect of third countries that has emerged in
the Fidium Finanz case3 as applied to direct tax measures in subsequent cases, the specific
limitation to the third country dimension in the standstill provision, Article 57(1), and
the specific new powers of Council and Commission to approve restrictive tax measures
in the third country dimension in the Treaty of Lisbon. Additional justifications that
may be applied in third country cases but which have been rejected, or accepted in only
narrow circumstances, in intra-EU cases are then discussed. The concluding part applies
the preceding analysis to identify where Member State tax laws are most vulnerable to
third country challenges, followed by a short summary of the outstanding issues and likely
future developments.
The evolution of free movement of capital from 1958 to 1993
Free movement of capital has been called the runt of the litter,4 a bit of a wallflower5
and left behind6 in comparison with the other fundamental free movement guarantees
in EU law. Article 67 of the original 1957 Treaty of Rome included free movement of
capital among the foundation provisions of the European common market, but it did
not have direct effect. It was not until 1990, when the third Council directive on the
2
3
4
5
6
Joined Cases C-163/94, C-165/94 and C-250/94 Sanz de Lera [1995] ECR I-482. More recently and
in respect of direct taxation, see Case C-101/05 Skatteverket v A [2007] ECR I-11531 at [26][27].
The issue of whether Art.56(1) has horizontal direct effect has not been resolved. All ECJ decisions
are available at: http://curia.europa.eu/en/content/juris/index.htm
Case C-452/04 [2006] ECR I-9521 (Grand Chamber).
L. Flynn, Coming of Age: The Free Movement of Capital Case Law 1993-2002 (2002) 39 Common
Market Law Review 773 at 773.
B.J.M. Terra and P.J. Wattel, European Tax Law (5th ed., Kluwer Law International, The Hague,
2008) at 58.
A. Cordewener, G.W. Kofler and C.P. Schindler, Free Movement of Capital, Third Country
Relationships and National Tax Law: An Emerging Issue before the ECJ (2007) 47 European
Taxation 107 at 107.
629
BRITISH TAX REVIEW

subject, Directive 88/361,7 became effective, that capital movements were defined for
the purposes of EU law and Member States were required to eliminate barriers in their
national laws to free movement of capital within the European Union.
The explicit prohibition on restrictions of capital movements between EU Member
States and third countries was absorbed into the EC Treaty in its current form when it
was amended by the Treaty of Maastricht, with effect from January 1, 1994. The ECJs
jurisprudence on restrictions of free movement of capital within the EU began to have an
impact in the mid-1990s, at approximately the same time that the general principles for
interpreting and applying all of the fundamental freedomsof goods, workers, services,
establishment, as well as capitalto determine the compatibility of national measures
with the EC Treaty reached a stage of relative clarity and consistency, and converged.8
The successful challenges by taxpayers (and to a lesser extent by the Commission)
to Member States direct tax laws, based on the fundamental freedoms, also began to
multiply in the mid-1990s.9 The first case specifically ruling that a direct tax measure was
incompatible with free movement of capital was Staatssecretaris van Financien v Verkooijen
(Verkooijen)10 in 2000. In 2006 and 2007 the first cases on the third country dimension
of Article 56(1) and direct taxation reached the Court, and the limitations, as well as the
possibilities, for the reduction of tax barriers to free movement of capital between Europe
and the rest of the world began to come into focus.11
The purpose and context of the extension of Article 56 to third countries
The interpretation of provisions of the EC Treaty usually begins with an examination
of their origin and purpose. There is, however, very little commentary to be found in
English on how the third country dimension came to be included in Article 56.12
7
10
11
12
Directive 88/361/EEC of 24 June 1988 for the implementation of Article 67 of the Treaty [1988] OJ L
178/5. Member States were required by Art.1 of the directive to abolish restrictions on movements
of capital taking place between persons resident in Member States by July 1, 1990.
See most familiarly Case C-55/94 Reinhard Gebhard v Consiglio DellOrdine degli Avvocati e Procuratori
di Milano [1995] ECR I-4165 at [37]. For a critical analysis of the different treatment tax cases have
received in relation to the fundamental freedoms, see J. Snell, Non-Discriminatory Tax Obstacles in
Community Law (2007) 56 ICLQ 339.
For a comprehensive review and analysis of the more recent direct tax case law with respect to the
fundamental freedoms, see S. Kingston, A light in the darkness: Recent developments in the ECJs
direct tax jurisprudence [2007] 44 Common Market Law Review 13211359.
Case C-35/98 [2002] STC 654; [2000] ECR I-4071. By contrast, the first case on direct taxation and
freedom of establishment, C-270/83 Commission v France [1986] ECR 273 (Avoir Fiscal) was referred
to the ECJ in 1983.
An early and stimulating analysis of the myriad issues raised by the third country dimension is
provided in P. Pistone, The Impact of European Law on the Relations with Third Countries in
the Field of Direct Taxation (2006) 34 Intertax 234. Prof. Pistone addresses numerous issues that
are beyond the scope of this article, including free movement of capital in agreements between the
European Union and third countries, the EU power to conclude external agreements in the field
of direct taxation, and the open skies jurisprudence and limitation on benefits issues in relation to
taxation and third countries.
A contemporary comment, M. Dassesse, The Treaty on European Union: Implications for the Free
Movement of Capital (1992) 6 Journal of International Banking Law 238 provides a brief analysis of the
relationship between EMU and free movement of capital but does not discuss the reasons behind the
extension to third countries. There are references to commentary in German and Dutch in K. Stahl,
630

The objective of extending free movement of capital beyond the EU was, apparently, to
support the euro as an international reserve currency.13 All of the EU member states at the
time the Treaty of Maastricht was signed were also members of the OECD, so that there
may have been a sense that movement of capital had already been substantially liberalised
between the Member States and third countries in accordance with the OECD Code of
Liberalisation of Capital Movements. That this instrument was in the contemplation of
the drafters of the Maastricht Treaty seems certain, as EC Article 57(1) permits Member
States to retain their reservations from the Code in place notwithstanding Article 56(1).14
The ECJ has now clearly disconnected the substance of the principle of free movement
of capital between the EU and third countries from its underlying motivation. At [31] in
Skatteverket v A,15 the Court stated:
. . . even if the liberalisation of the movement of capital with third countries
may pursue objectives other than that of establishing the internal market, such as,
in particular, that of ensuring the credibility of the single Community currency
on world financial markets and maintaining financial centres with a world-wide
dimension within the Member States, it is clear that, when the principle of free
movement of capital was extended, pursuant to Article 56(1) EC, to movement of
capital between third countries and the Member States, the latter chose to enshrine
that principle in that article and in the same terms for movements of capital taking
place within the Community and those relating to relations with third countries.
As will be examined in the third part of this article, the third country dimension of
free movement of capital is limited in ways that intra-EU free movement of capital is
not. Article 57(1) of the EC Treaty provides for significant and potentially permanent
derogations from Article 56(1) in relation to third countries. The ECJ has indicated that
it views the third country dimension as operating in a different legal context,16 so
that justifications for a restrictive measure that would not be valid as between Member
States may be accepted in relation to third countries. There are other impediments in
ECJ jurisprudence to the application of Article 56 to third country capital movements
that do not have the same constraining effect within the EU. Despite these limitations,
the potential impact of the third country dimension on Member States direct tax laws
cannot lightly be dismissed.
When the Member States agreed to insert Articles 56 to 58 in the EC Treaty in
December 1991 the ECJs jurisprudence on direct taxation was in its early stages, with
only a few cases decided (and no direct tax cases on free movement of capital). Article
56 was not judicially recognised as an independent basis for challenging direct taxation
13
14
15
16
Free movement of capital between Member States and third countries (2004) EC Tax Review
47 and D.S. Smit, Capital movements and third countries: the significance of the standstill-clause
ex-Article 57(1) of the EC Treaty in the field of direct taxation (2006) EC Tax Review 203.
Stahl, fn.12 at 52. The entry into force of new EC Treaty Art.73a-h (now Arts 5661) on January 1,
1994 coincided with the commencement of the second stage of EMU, the third stage of which was the
adoption in 1999 of the euro as the common currency of 11 of the then 15 Member States.
See D.Smit, fn.12 at 204.
Case C-101/05 December 18, 2007.
Skatteverket v A Case C-101/05 [2007] ECR I-11531 at [37], echoing Case C-446/04 Test Claimants
in the FII Group Litigation (FII Test Claimants) [2007] STC 326; [2006] ECR I-11753 at [170][171].
631
BRITISH TAX REVIEW

measures until almost a decade later. It may thus be surmised that the huge impact17 of the
Courts intra-EU fundamental freedoms jurisprudence on Member States tax systems
was unforeseen, and that the potential significance of the extension of free movement of
capital to third countries was equally outside the drafters frame of reference. By 2004,
when the Treaty establishing a Constitution for Europe was drafted and agreed, the
Member States were clearly aware of the potential impact of Article 56(1) on their tax
systems. New powers of Commission and Council in that Treaty (which was not ratified),
and in the subsequent Treaty of Lisbon, to limit the third country dimension in respect
of direct taxation indicates consensus among Member State governments of the need to
ensure that the ECJ alone does not determine the impact of the third country dimension
on their tax sovereignty.
The intra-EU scope and application of Article 56
Defining capital movements
Although Directive 88/361 is no longer technically in force, it is settled law that the
nomenclature in Annex I of the Directive (Annex I), listing the transactions and
activities which are to be regarded as movements of capital, is still the most important
and authoritative reference.18 The ECJ also frequently reiterates that the list in Annex I,
as expressly stated in it, is non-exhaustive, signalling that it is willing to consider other
transactions and activities as constituting movements of capital.
The list in Annex I is nevertheless very extensive. Some of the defined capital
movements of most relevance to the issues discussed in this article are: investments in real
estate, direct investments in undertakings, establishment and extension of branches or
creation of new undertakings or the acquisition of existing undertakings, participation in
new or existing undertakings, and the making of long term loans with a view to establishing
or maintaining lasting economic links between lender and borrower. Extension of short,
medium and long term credit related to commercial transactions or the provision of
services, as well as financial loans and credits of any term, operation of bank accounts,
personal capital movements such as loans, gifts, inheritances and transfers of assets
connected with emigration or immigration are all defined as movements of capital, as are
all operations necessary for the purposes of capital movements, and related transfers.
Intra-EU jurisprudence on free movement of capitalcases not concerning direct taxation
The non-tax intra-EU cases in which a restriction on free movement of capital has been
found to exist can be divided into two dominant categories: (a) challenges to laws requiring
17
18
Ruth Mason cites the cost of ECJ (intra-EU) direct tax rulings to the UK treasury annually as
16 to 20 billion dollars in Made in America for European Tax working paper dated September
2007, electronic copy available at: http://ssrn.com/abstract=1025531 (accessed September 25, 2008)
at 3, fn.3.
Case C-22/97 Trummer and Mayer [1999] ECR I-1661 at [20-21]; Case C-386/04 Centro de Musicologia
Walter Stauffer [2006] ECR I-8203 (Stauffer) at [22] and more recently Commission v Germany Case
C-112/05 23 October 2007 (Volkswagen) at [18].
632

prior official authorisation for certain transactions or activities,19 and (b) golden share
cases.20 In addition to these two types of cases, national measures providing an interest
subsidy or preferential treatment for guarantee fees in respect of loans from domestically
established lenders were successfully challenged.21 A requirement that financial charges
on land be denominated in the national currency or gold in order to be registered in
the land registry22 and a requirement to make a guarantee deposit in a bank on national
territory in order to provide services in that territory were also held to be a restriction
of free movement of capital.23 A ban on Belgian residents acquiring bonds issued by the
Belgian government through the Eurobond market was also incompatible with Article
56(1).24 Thus it can be seen that the prohibition on free movement of capital within the
EU is upheld as rigorously as the other free movement guarantees. For example, in one
of the early golden share cases, Commission v France (Elf Aquitaine)25 the Court stated:
40. (. . .) Article 73b [now 56(1)] of the Treaty lays down a general prohibition on
restrictions on the movement of capital between Member States. That prohibition
goes beyond the mere elimination of unequal treatment, on grounds of nationality,
as between operators on the financial markets.
41. Even though the rules in issue may not give rise to unequal treatment, they
are liable to impede the acquisition of shares in the undertakings concerned and to
dissuade investors in other Member States from investing in the capital of those
undertakings. They are therefore liable, as a result, to render the free movement of
capital illusory.
In Manninen, the Court confirmed the equality of free movement of capital with the other
fundamental freedoms in the field of direct taxation:
Any measure that makes the cross-border transfer of capital more difficult or less
attractive and is thus liable to deter the investor constitutes a restriction on the free
movement of capital. In this respect the concept of a restriction of capital movements
corresponds to the concept of a restriction that the Court has developed with regard
to the other fundamental freedoms, especially the freedom of movement of goods.26
19
20
21
22
23
24
25
26
These would include currency exports, as in Joined Cases C-358/93 and 416/93 Bordessa [1995]
ECR I-361 and C-250/94 Sanz de Lera [1995] ECR I-482; purchases of land by non-residents or
non-nationals, as in Case C-452/01 Ospelt Unabhangiger Verwaltungssenat des Landes Vorarlberg [2003]
ECR I-9743 and Case C-302/97 Konle [1999] ECR I-3099; or investment in the host country by
certain groups as in Case C-54/99 Eglise

de Scientologie [2000] ECR I-1335.
Recent examples are Joined Cases C-282/04 and C-283/04 Commission v Netherlands [2006] ECR I9141 in which special rights retained by the Netherlands government in respect of privatised national
postal and telecommunications companies were incompatible with Art.56(1); and Case C-112/05
Commission v. Germany 23 October 2007 in which restrictions on voting powers which prevented a
private investor from gaining control of Volkswagen AG were held to restrict free movement of capital.
C-484/93 Svensson and Gustavsson [1995] ECR I-3955. The EFTA Court has also ruled on guarantee
fees in respect of foreign loans under Art.40 of the European Economic Area Agreement in EFTA
Case E-1/00, State Debt Management Agency v Islandsbank

-FBA, July 14, 2000.
Case C-22/97 Trummer and Mayer [1999] ECR I-1661.
Case C-279/00 Commission v Italy [2002] ECR I-1425.
C-478/98 Commission v Belgium [2000] STC 830, [2000] ECR I-7587 (Belgian Eurobonds).
Case C-483/99 [2002] ECR I-4871.
Case C-319/02 [2004] STC 1444; [2004] ECR I-7498 at [28]. See Snell, fn.8 at 349 for the view that
the Court still relies more heavily in tax cases on finding discrimination than on restrictive effects
633
BRITISH TAX REVIEW

The ECJ has also made clear that the concept of restriction in Article 56(1) applies to
outflows as well as inflows of capital. Measures which are liable to dissuade investors from
investing their capital in other Member States, as well as those that make it more difficult
for non-residents to acquire investment assets in a host state or an undertaking established
in one Member State to raise capital in other Member States, are prohibited.27 This
corresponds to the jurisprudence on other fundamental freedoms to the effect that these
freedoms prohibit restrictions of free movement by either host or home Member
States. In short, the laggard freedom has caught up with the others.
Exceptions and justifications: Article 58
Article 58(1)28 applies to both intra-EU and third country capital movements. The ECJ
has ruled that Article 58(1) must, as an exception to a fundamental freedom, be strictly
interpreted.29
The language of Article 58(1)(a) obviously derives from the analysis of what constitutes
discrimination in the early ECJ jurisprudence on the fundamental freedoms, when the
Court focused on whether the impugned Member State law discriminated directly or
indirectly on the basis of nationality.30 Discrimination was defined as the treating of
similar situations differently, or different situations the same. Different treatment of
non-residents could be indirect (or covert) discrimination on the basis of nationality,
given that non-residents were much more likely to be non-nationals than were residents.
Most of the more recent direct tax jurisprudence emphasises the restrictive effects of a
national law on the exercise of a fundamental freedom rather than the discriminatory
nature of the law. However, the same situation test in Article 58(1)(a) is an important
part of the determination of restriction in some cases.31
In interpreting Article 58(1)(a) it might have been anticipated that the international
taxation norm that forbids discrimination based on nationality, but generally allows
27
28
29
30
31
alone. Professor Snells comparison of direct tax measures with regulatory restrictions, especially in
respect of free movement of goods is of particular interest in light of this quotation from Manninen.
Kingston, fn.9 at 1328 describes the evolution of the ECJs approach through pure restriction to a
more nuanced discrimination based analysis since 2005.
Case C-35/98 Verkooijen [2002] STC 654; [2000] ECR I-4071at [34][35]. See also C-484/93 Svensson
and Gustavsson [1995] ECR I-3955 at [10][11].
Article 58(1) provides: The provisions of Article 56 shall be without prejudice to the right of Member
States: a. to apply the relevant provisions of their tax law which distinguish between taxpayers who
are not in the same situation with regard to their place of residence or with regard to the place where
their capital is invested; b. to take all requisite measures to prevent infringements of national law and
regulations, in particular in the field of taxation and the prudential supervision of financial institutions,
or to lay down procedures for the declaration of capital movements for purposes of administrative or
statistical information, or to take measures which are justified on grounds of public policy or public
security.
Case C-54/99 Eglise

de Scientologie [2000] ECR I-1335 at [17], as to the justifications on grounds of
public policy or security in 58(1)(b). This was confirmed to apply also in relation to 58(1)(a) in Case
C-315/02 Lenz [2004] ECR I-7063 at [26], and in Case C-386/04 Stauffer [2006] ECR I-8203 at [31].
J.A. Usher, Capital Movements and the Treaty on European Union [1992] 12 YEL 35-57 at 40
suggests that the failure of the Commissions original, unsuccessful proposal for a common system of
withholding tax on interest income put forward under para.5 of Directive 88/361 may help to explain
the presence of Art.58(1)(a) as a derogation for tax measures in particular.
See Kingston, fn.9. The application of Art.58(1)(a) in relation to third countries is discussed in the
subheading Comparability of restriction and justifications in third country cases below.
634

discrimination based on residence,32 would be adopted by the Court in assessing whether
direct tax restrictions on cross-border capital movements are prohibited. Indeed, the ECJ
has clearly and frequently stated the basic principle that, in relation to direct taxation,
residents and non-residents are not generally in comparable situations, so that different
tax treatment of residents and non-residents is not automatically incompatible with Treaty
freedoms. However, the Court places the burden on Member States to demonstrate that,
in a given case and in relation to the effects of the particular tax measure, the situation
of a non-resident is not objectively comparable to that of a resident.33 If in fact residents
and non-residents are in the same position with respect to a particular tax liability, then
the less favourable treatment of non-residents is prohibited. The Schumacker principle,
originally applied in relation to free movement of workers, is generally applicable in
respect of services34 and establishment35 as well. It was applied to a distinction based
on where capital is invested in Verkooijen and more clearly reiterated and applied in
subsequent cases on direct taxation and free movement of capital. Thus the limitation
in Article 58(1)(a) corresponds to the judicially developed principles regarding unequal
treatment in the context of the other fundamental freedoms.
Article 58(1)(b) provides a justification especially pertinent to direct taxation in allowing
Member States to take all requisite measures to prevent infringements of national law
and regulations, in particular in the field of taxation. . .. However, this has not had any
particular effect on the resolution of cases concerning Article 56 and direct taxation. The
Court had already accepted that overriding reasons in the general interest, could justify
restrictive tax measures, and such overriding reasons include ensuring effective fiscal
supervision,36 the prevention of tax evasion,37 and preservation of the cohesion of the
national tax system,38 before the first case concerning a direct tax measure and Article 56(1)
was decided. The balanced allocation of taxing jurisdiction between Member States is a
more recent addition to the accepted justifications.39 It is much more common for Member
States to defend their tax laws on these bases than to rely directly on the wording of Article
58(1)(b). The (possibly now abandoned) principle that overriding reasons cannot justify
directly discriminatory measures arises infrequently in direct taxation cases, because
32
33
34
35
36
37
38
39
The OECD Model Tax Convention on Income and on Capital, OECD Committee on Fiscal Affairs,
(OECD, Paris, 2003) (OECD Model) Art.24 Non-Discrimination provides in para.1: Nationals of a
Contracting State shall not be subject in the other Contracting State to any taxation or any requirement
connected therewith, which is other or more burdensome than the taxation and connected requirements
to which nationals of that other State in the same circumstances, in particular with respect to residence, are
or may be subjected. (Emphasis added) This wording has been taken to permit Contracting States to
discriminate on the basis of residence, whether or not residents and non-residents are in comparable
situations. See L. Friedlander, The Role of Non-Discrimination Clauses in Bi-lateral Income Tax
Treaties After GATT 1994 [2002] BTR 71.
C-279/93 Schumacker [1995] STC 306; [1995] ECR I-225.
Case C-234/01 Gerritse [2004] STC 1307; [2003] ECR I-5933.
See as an early example, C-270/83 Avoir Fiscal [1986] ECR 273 at [20] and more recently, Case
C-446/04 FII Test Claimants [2007] STC 326; [2006] ECR I-11753 at [46] and Case C-170/05
Denkavit Internationaal [2007] STC 452; [2006] ECR I-11949 (Denkavit) at [25].
Case C-120/78 Rewe-Zentrale AG v Bundesmonopolverwaltung fur Branntwein [1979] ECR 649 (Cassis
de Dijon) at [8].
C-478/98 Belgian Eurobonds [2000] STC 830; [2000] ECR I-7587 at [38][39].
Case C-204/90 Bachmann v Belgium [1994] STC 855; [1992] ECR I-249 at [28]
Case C-446/03 Marks & Spencer [2006] STC 237; [2005] ECR I-10837 [51] and Case C-231/05 Oy
AA [2008] STC 991 July 18, 2007 at [55].
635
BRITISH TAX REVIEW

direct tax measures rarely discriminate on the basis of nationality.40 The Member State
whose legislation is challenged has accordingly not been limited to those justifications
expressly set out in the Treaty.41
Survey of intra-EU case law on direct taxation and free movement of capital
The interaction of Article 56(1) with Member States direct taxation systems has already
yielded a large number of cases, rivalling if not exceeding the number of non-tax cases
on free movement of capital. Taxation rules with respect to dividends, interest payments,
capital gains, wealth and inheritance, and income of charities have all been successfully
challenged as unjustified restrictions of free movement of capital.
The following sections of this article are a non-exhaustive overview of the intra-EU
cases in which direct taxation measures have been held incompatible with Article 56(1),
including an examination of the various justifications which have been put forward. The
objective is to indicate the potential substantive scope of the third country dimension
of Article 56(1), before turning to the limitations in the EC Treaty and the ECJs
jurisprudence that may apply in third country cases.42
Dividends
The cross-border payment and receipt of dividends are movements of capital. In Verkooijen
the Court stated that, although not expressly listed in Annex I (of Directive 88/361),
the payment and receipt of dividends presupposes participation in new or existing
undertakings which does appear in Annex I. Further, since in that case the company
paying the dividends was resident in another Member State and its shares were quoted
on the stock exchange, the receipt of the dividends could be linked to the acquisition
. . . of foreign securities dealt in on a stock exchange, and was thus indissociable from
a capital movement.43
It is important to note that, within the EU, taxation of cross-border dividends has been
partially harmonised by the Parent-Subsidiary Directive44 which eliminates taxation of
dividends paid from a subsidiary company in one Member State to a parent company
in another Member State. In the original version in force from 1992 to 2004, a parent
company had to hold at least 25 per cent of the capital of a subsidiary. The minimum
40
41
42
43
44
In Case C-386/04 Stauffer [2006] ECR I-8203 the German tax legislation was directly discriminatory
in that it treated charities formed under the laws of another Member State less favourably than
German charities. The Court did not address this point and proceeded to assess the restriction on free
movement of capital in relation to overriding reasons.
The public policy and public security justifications in Art.58(1)(b) have not been relied on by Member
States in direct taxation cases, although they have been put forward in non-tax cases such as Case
C-54/99 Eglise
de Scientologie [2000] ECR I-1335 and Case C-452/01 Ospelt [2003] ECR I-9743.
See the discussion below under the heading: The third country dimension of free movement of
capital.
Case C-35/98 [2002] STC 654; [2000] ECR I-4071 at [27][30].
Council Directive 90/435 on the common system of taxation applicable in the case of parent companies
and subsidiaries of different Member States [1990] OJ L 225/6 (Parent-Subsidiary Directive) amended
by Council Directive 2003/123 on the common system of taxation applicable in the case of parent
companies and subsidiaries of different Member States [2003] OJ L 7/41.
636

level of capital ownership was reduced to 20 per cent on January 1, 2005, to 15 per cent on
January 1, 2007, and will be further reduced to 10 per cent as of January 1, 2009, pursuant
to amendments to the directive adopted in 2003.
The directive requires EU Member States to abolish withholding tax on dividends paid
to a non-resident parent company. In addition, the parent companys home state must
either refrain from taxing dividends received from subsidiaries (exemption method), or
provide a tax credit which reduces the parent companys corporate tax liability by the
amount of the subsidiarys corporate tax paid in its home state in respect of such dividends
up to the amount of tax payable in respect of such dividends by the parent company (credit
method). From 2005, the directive also requires Member States to provide a credit to the
parent company for any lower tier subsidiarys corporate tax paid in another Member State.
The courts rulings on free movement of capital and dividends can usefully be divided
into cases on inbound dividends and cases on outbound dividends. With three important
ECJ decisions in as many days on free movement and dividends released in December
2006,45 followed by a number of other indicative rulings, it is now possible, at least
tentatively, to identify some basic principles about the types of tax measures that will
infringe these freedoms both within the EU and with respect to third countries.46
Inbound dividends
The established principle is that a Member State must not, under its domestic law, impose
a heavier tax burden on the recipient shareholder in respect of inbound dividends than it
does on domestic dividends. In Verkooijen a tax exemption for domestic dividends that
was not available for inbound dividends was accordingly held to restrict free movement
of capital in that it both discouraged Netherlands residents from investing in foreign
companies, and made it more difficult for foreign companies to raise capital in the
Netherlands. Verkooijen has been followed in a number of cases challenging dividend
taxation measures applicable to individual shareholders, among them Lenz,47 Manninen,48
and Meilicke.49
FII Test Claimants concerned the United Kingdoms former advance corporation tax
(ACT) and franked investment income (FII) dividend tax system utilised from 1973
45
46
47
48
49
Case C-446/04 FII Test Claimants [2007] 326; [2006] ECR I-11753 (December 12, 2006); Case
C-374/04 Test Claimants in Class IV of the ACT Group Litigation [2007] STC 404, [2006] ECR
I-11673 (12 December 2006) (Grand Chamber) (ACT IV ) and Case C-170/05 Denkavit [2007] STC
452; [2006] ECR I-11949 (December 14, 2006). For a discussion of the issue raised by these cases,
especially in relation to DTCs, see P. Pistone, Expected and Unexpected Developments of European
Integration in the Field of Direct Taxes (2007) 35 Intertax 70.
See in particular F. Vanistendael, Denkavit Internationaal: The Balance between Fiscal Sovereignty
and the Fundamental Freedoms? [2007] 47 European Taxation 210 and M.J. Graetz and A.C. Warren,
Jr., Dividend taxation in Europe: When the ECJ makes tax policy (2007) 44 Common Market Law
Review 1577.
Case C-315/02 Lenz [2004] ECR I-7063 involved a special preferential tax rate for domestic dividends
that was not available for inbound dividends.
Case C-319/02 [2004] STC 1444; [2004] ECR I-7498. In Manninen and Meilicke, individuals receiving
domestic dividends were granted an imputation credit which was not allowed in respect of dividends
from other Member States.
Case C-292/04 [2007] ECR I-1835. A case related to differential taxation of inbound and domestic
dividends is Case C-242/03 Ministre des Finances v Weidert-Paulus (decided the same day as Lenz)
[2005] STC 1241; [2004] ECR I-7379.
637
BRITISH TAX REVIEW

(1994 in the case of the foreign income dividend or FID system) to 1999. Although this
system was particularly complex and idiosyncratic and is no longer in force, the judgment
contains some very important rulings of principle.
The test claimants challenged the different treatment of domestic and inbound dividends
as incompatible with both freedom of establishment and free movement of capital. At least
one of the test claimants received dividends from a company resident in a third country.
The Court ruled that cases where the foreign distributing company was controlled by
the UK resident recipient company were to be assessed in light of Article 43, freedom of
establishment,50 and in light of free movement of capital in any other case.
Following the earlier cases, the Court held that foreign dividends may not be subject
to less favourable tax treatment than domestic dividends in the recipients home state.
To ensure equal treatment of foreign and domestic dividends, the tax credit provided to
the UK company in respect of foreign dividends had to at least equal the tax paid by the
distributing company on its profits in the source state, up to the limit of the recipients UK
tax liability in respect of the dividends. This eliminates the economic double taxation of
company profits by one country and dividends by the other to the same extent the United
Kingdom relieved such double taxation in the case of domestic dividends. In short, if the
parent companys home state provides tax relief for underlying corporate tax for domestic
dividends, it must provide equivalent relief for foreign underlying corporate tax when it
taxes foreign dividends.
Of particular relevance to third countries and free movement of capital, the Court held
that where the UK company held less than 10 per cent of the voting rights of the foreign
distributing company, the tax credit had to compensate for the underlying corporate tax
as well as the dividend withholding tax imposed by the source country, since domestic
dividends received this favourable treatment.
Another issue of particular interest here was the compatibility with Article 56(1) of the
FID regime introduced from July 1, 1994. The FID regime was intended to mitigate
the less favourable treatment faced by UK companies receiving dividends from foreign
companies in comparison with UK companies that received only domestic dividends.
However, even after the FID regime was introduced, cash flow disadvantages remained
for UK companies receiving foreign dividends (and their shareholders).51 The fact that
FID treatment was optional did not change the conclusion that it was incompatible with
the Treaty.
Kerckhaert-Morres,52 a challenge by a Belgian couple to the Belgian method of taxing
foreign dividends, clarified the ECJs assessment of restriction of capital movements.
Belgium applied equivalent taxes to both inbound and domestic dividends. The Court
ruled that Belgium had no obligation to provide a tax credit to compensate the shareholder
for the withholding tax imposed by the source country, France. The unequal tax burden
50
51
52
It is now settled that an investment in shares that gives the shareholder definite influence over the
companys decisions and allows it to determine the companys activities and operations (i.e. effective
control) is an exercise of the right of establishment and only indirectly concerns free movement of
capital. This delineation originated in Case C-251/98 Baars [2000] ECR I-2787 at [21][22], and has
been reaffirmed in several subsequent judgments. See also Case C-196/04 Cadbury Schweppes [2006]
STC 1908; [2006] ECR I-7998 at [31][33].
This followed from the rulings in Joined Cases C-397/98 and 410/98 Metallgesellschaft et al [2001]
STC 452; [2001] ECR I-1727.
Case C-513/04 [2007] STC 1349; [2006] ECR I-10967 (Grand Chamber).
638

on foreign and Belgian dividends arose as a consequence of the exercise in parallel by two
Member States of their fiscal sovereignty, not as a result of Belgiums non-discriminatory
dividend tax system. This confirms that, with respect to inbound dividends, the Court
is concerned with unequal treatment that arises solely from the application of the tax
system of the shareholders home country, and does not view juridical double taxation as
a prohibited restriction of free movement of capital.
Although the judgment in Kerckhaert-Morres was criticised,53 the ECJ confirmed and
extended its reasoning in Orange European Smallcap Fund (OESF).54 The Netherlands
system for taxation of collective investment entities such as OESF was designed to
impose the same tax burden on income earned through a fund as would be borne by a
Netherlands resident individual investing directly in shares of Netherlands and foreign
companies. OESF was not subject to Netherlands tax on either foreign or domestic
dividends, provided its profits were distributed to its shareholders within a given period
after its year end. The Netherlands provided a full refund of Netherlands tax withheld at
source on domestic dividends, and a concession payment for withholding tax imposed by
other countries to the extent a Netherlands resident individual would be entitled to claim
a credit against Netherlands tax under a DTC between the Netherlands and the source
country.
The Court made two clear and significant rulings regarding prohibited restrictions of
free movement of capital. The first was that there is no obligation on the recipients home
country to compensate for economic double taxation in the source state. Secondly, it is
legitimate to treat dividends from one Member State differently to dividends received
from other Member States because an investor receiving dividends from a country that
does not have a DTC providing for a tax credit is not in the same situation as an investor
in receipt of dividends from a country with which the Netherlands had such a DTC.
Article 58(1)(a) allows this difference in treatment: it is not arbitrary discrimination nor
a disguised restriction since it is necessary for the attainment of the policy goal of taxing
dividend income received through investment in a collective investment entity in the
same way as dividends received by an individual who had invested directly in shares of
the foreign or Netherlands company.
In OESF the Court found that one aspect of the Netherlands taxation of collective
investment funds was a restriction of free movement of capital. This was the reduction
in the concession in respect of foreign withholding tax in proportion to the non-resident
investors in the fund. The reduction affected the income received by all investors,
whether or not resident in the Netherlands as it was paid to the fund and became part of
its distributable profit. The Court held that this made funds with non-resident investors
(whether in other Member States or in third countries) less attractive investments for
Netherlands residents, and reduced the funds ability to raise capital in the Netherlands
53
54
See Snell, fn.8 at 361; Graetz and Warren, fn.46 at 1612; R. Mason and G. Kofler, Double Taxation:
A European Switch in Time? (2007) Columbia Journal of European Law 14.1; electronic version at
20, available at: http://ssrn.com/abstract=979750 (accessed September 25, 2008). However, Kingston,
fn.9 at 1341-1343, approves the approach in Kerckhaert-Morres as illustrating rationality, simplicity
and predictibility.
Case C-194/96, May 20, 2008, (Grand Chamber). This case addressed issues relating to third countries
as well, as is further discussed in Conclusions below. Case C-101/05 Skatteverket v A December 18,
2007 is another third country inbound dividends case primarily of interest in respect of the justification
ensuring effective fiscal supervision. It is discussed in relation to justifications in Conclusions below.
639
BRITISH TAX REVIEW

compared with funds that had only Netherlands resident investors and so constituted a
prohibited restriction.
Outbound dividends
The Courts primary concern with respect to outbound dividends is, as with inbound
dividends, that measures imposed by a single Member State do not result in a restriction
on cross border capital movements. The Court regards the subjection of corporate profits
to a series of tax charges (first on corporate profits and then on the dividends distributed
out of the after-tax profits, or economic double taxation) by a single Member State as
restricting free movement of capital where the Member State offsets the double taxation
for its residents, but not for non-residents.55 Article 56(1) thus prohibits source state
withholding tax on outbound dividends in many cases.
In Amurta56 the Court ruled that Netherlands withholding tax levied on dividends
received by a Portuguese company holding 14 per cent of the share capital of a
Netherlands company was a prohibited restriction on free movement of capital. The
Netherlands exempted domestic dividends received by companies holding 5 per cent
or more of the shares or capital of the distributing company from Netherlands tax.
The Parent-Subsidiary Directive exempted dividends from other Member States from
withholding tax provided the Netherlands recipient held at least 25 per cent of the
subsidiary. The Court further ruled that unilateral tax relief provided by the recipients
home state could not neutralise the restrictive effect of the Netherlands withholding
tax. At least in theory, the Court accepted that relief provided in a DTC could neutralise
the restriction,57 but the Court gave no guidance as to what type of relief would have
this effect. Amurta indicates that withholding tax on dividends will in many instances be
incompatible with free movement of capital,58 and it is difficult to see how this would not
also constitute a prohibited restriction in the third country context.
Test Claimants in Class IV of the ACT Group Litigation (ACT IV )59 concerned UK
taxation of outbound dividends under the former ACT system. It illustrates the exception
55
56
57
58
59
See the Courts conclusions as to the existence of a restriction in Case C-374/04 ACT IV [2007] STC
404; [2006] ECR I-11673 at [55], [70] and in Case C-446/04 FII Test Claimants [2007] STC 326;
[2006] ECR I-11753 at [87].
Case C-379/05 Amurta S.G.P.S. v Inspecteur van de Belastingdienst (November 8, 2007). The December
2006 ruling in Denkavit (Case C-170/05 [2007] STC 452; [2006] ECR I-11949) that withholding taxes
were incompatible with the right of establishment where domestic dividends were effectively exempt
from the second layer of tax gave advance notice of the outcome in Amurta.
In Case C-265/04 Bouanich [2008] STC 2020; [2006] ECR I-923, the Court left it to the national court
to determine if the effect of the withholding rate reduction in the relevant DTC was to eliminate the
unequal treatment of resident and non-resident shareholders.
The Commission has initiated infringement proceedings based on Art.56 against numerous Member
States regarding withholding taxes on dividends received by foreign pension funds and others. See
Commission Press Release IP/08/1022 of June 27, 2008 available at: http://europa.eu/rapid/press
ReleasesAction.do?reference=IP/08/712&format=HTML&aged=0&language=en&guiLanguage=en
(accessed September 25, 2008). The implications of the Denkavit case for withholding taxes are
discussed by Jerome Delaurière, Does Denkavit signal the end of withholding tax? (2007) 45 Tax
Notes International 303 and in the series of articles published in the Denkavit Special Issue of (2007)
European Taxation, fn.46.
Case C-374/04 Test Claimants in Class IV of the ACT Group Litigation [2007] STC 404; [2006] ECR
I-11673.
640

to Amurta, holding that if the home state of the distributing company imposes no
withholding tax on outbound dividends, and there is thus no economic double taxation
within a single Member State, there is no discrimination or restriction.
To summarise the jurisprudence on Article 56(1) and dividends, the Court begins by
considering the restrictive effects of the tax rules of the particular Member State whose
law has been challenged. If the domestic rules have the effect of imposing a heavier burden
on inbound or outbound dividends than on domestic dividends, then in principle there is
a restriction of free movement of capital. The Court accepts that a DTC may neutralise
the effect of the more burdensome taxation of non-residents, but leaves the assessment of
the actual effect of the DTC to the referring court.
Interest
Annex I to Directive 88/361 does not expressly include payment or receipt of interest
in the list of movements of capital, but it does list personal, commercial and financial
loans and credits of all kinds, and states that all operations necessary for the purposes of
capital movements, conclusion and performance of the transaction and related transfers
are covered by the directive. In Svensson and Gustavsson60 it was held that housing loans
were included in financial loans and credits listed as capital movements under Annex I,
and that movements of capital related to such loans were liberalised by the directive. That
an interest payment in respect of a cross-border loan or debt is a movement of capital
has never been directly questioned, and would undoubtedly be held to be an operation
necessary for performance of the transaction or a related transfer under Annex I. As the
Court held with respect to dividends and investment in company shares in Verkooijen,
the payment or receipt of interest pre-supposes a loan or credit and, therefore, interest is
within the definition of movement of capital.
There are fewer cases on free movement of capital and direct taxation of interest income
than there are on dividends. This is no doubt because the potential for economic double
taxation of interest is very limited, as interest is normally a deductible expense for the
paying entity, and is therefore only taxable in the hands of the recipient. The lender may
be taxed on the interest by both the Member State where the borrower is resident and by
its home state, but such juridical double taxation is usually mitigated or eliminated by tax
credits available in the home state, whether or not provided for in a tax treaty, so that the
actual tax burden on the interest is no greater than for domestic interest.
Another reason for a dearth of cases on cross-border interest is the partial harmonisation
achieved by the Interest and Royalty Directive.61 It requires Member States to abolish
withholding taxes on interest paid by a company in one Member State to an associated
company (that is, a company holding at least 25 per cent of the capital or voting rights
in the paying company, or a sister company where payer and recipient are both at least
25 per cent held by another company) in another Member State, provided the recipient
is subject to tax on the payment in its home Member State. This reduces the possibility
that domestic measures impose a higher tax burden on interest paid to a recipient in
another EU Member State than on domestic interest. However, it does not reduce the
60
61
C-484/93 [1995] ECR I-3955.

Directive 2003/49 on a common system of taxation applicable to interest and royalty payments made
between associated companies of different Member States [2003] OJ L 157/49.
641
BRITISH TAX REVIEW

potential for unequal taxation of interest received from foreign and domestic sources, and
certain idiosyncratic provisions in Member State tax laws have resulted in a few indicative
cases.
An example of a direct tax restriction in respect of interest received from another
Member State is Commission v France.62 France allowed individuals resident in France
to elect to pay a fixed rate of tax on interest income received from a debtor resident
or established in France, but taxed interest received from debtors outside France at
the individuals normal marginal rate. The fixed tax rate was generally lower than the
progressive marginal rate applicable to most taxpayers, and the ECJ had no difficulty in
concluding that the measures discouraged investment outside France and made it more
difficult for borrowers outside France to raise debt capital in France.
The Commission has referred Portugal to the ECJ for failure to repeal its 20 per
cent withholding tax on interest paid by Portuguese residents to non-resident banks and
other lenders.63 The withholding tax applies to the gross amount of interest; Portuguese
lenders are taxed on their net income, so that they are able to deduct their expenses of
making capital available in computing their tax liability. The Commission relies on the
judgments in Gerritse64 and Scorpio,65 where withholding taxes on payments for services
made to foreign service providers were held to be permissible, but not where they were
imposed on gross payments without allowing for deduction of expenses and so resulted in
higher taxation. The Commissions case is based on both Article 49, freedom to provide
services and free movement of capital. There are infringement proceedings underway
against certain Member States for discriminatory treatment of interest paid to foreign
recipients.66
There are a number of cases on thin capitalisation67 measures which deny full deduction
of interest paid by a subsidiary to a parent company in another Member State in order to
prevent a reduction in taxable income of the subsidiary which is considered inappropriate
by the Member State concerned. These cases have been decided on the basis of freedom
of establishment, as such measures have been found to apply only within company groups
where the subsidiary amounted to an establishment of the parent. The implications of
these cases in the third country context is discussed in detail below.68
62
63
64
65
66
67
68
Case C-334/02 [2007] STC 54; [2004] ECR I-2229 (Fixed Levy).
Pending Case C-105/08 [2008] OJ C 116/26.
Case C-234/01 [2004] STC 1307; [2003] ECR I-5933.
C-290/04 FKP Scorpio Konzertproduktionen GmbH [2007] STC 1069; [2006] ECR I-9461.
See, e.g. against Lithuania for discriminatory treatment of interest paid to foreign companies,
investment funds and pensions funds: Commission Press Release IP/08/334 of February 28, 2008
available at: http://europa.eu/rapid/pressReleasesAction.do?reference=IP/08/334&format=HTML&
aged=0&language=en&guiLanguage=en (accessed September 25, 2008) and against Germany in
respect of foreign pension funds: Commission Press Release IP/08/143 of 31 January 2008
available at: http://europa.eu/rapid/pressReleasesAction.do?reference=IP/08/143&format=HTML&
aged=0&language=en&guiLanguage=en (accessed September 25, 2008).
Case C-324/00 Lankhorst-Hohorst [2003] STC 607; [2002] ECR I-11779; Case C-524/04 Test
Claimants in the Thin Cap Group Litigation [2007] STC 906; [2007] ECR I-2107 (Thin Cap) and Case
C-492/04 Lasertec [2007] ECR I-3775.
See the discussion under the heading: The third country dimension of free movement of
capital.
642

Capital gains
Annex I lists many types of investment in capital property as movements of capital.
Among these are investments in real estate, including purchases of buildings and land and
the construction of buildings by private persons for gain or personal use, and investments
in shares and securities whether or not normally dealt in on the capital market, and units
of collective investment undertakings. The ECJ has held that national capital gains tax
rules are incompatible with Article 56(1) in several intra-EU cases.
In Commission v Spain69 the preferential tax rate applied to gains realised by Spanish
residents on shares listed on Spanish stock exchanges, relative to the rate applied to gains
realised on shares listed on foreign exchanges, was held to infringe free movement of
capital. In Gronfeldt v Finanzamt Hamburg-Am Tierpark70 the taxation by Germany of
gains realised on sales of shares representing only 1 per cent of foreign companies, while
capital gains realised on sales of up to 10 per cent of the shares of German companies
were exempt from tax, infringed free movement of capital, even though the difference in
treatment was temporary.
Three recent judgments of the ECJ have addressed discriminatory taxation of capital
gains on private residences. In Commission v Portugal,71 the deferral of tax on a capital
gain realised on the sale of a residence located in Portugal, if a replacement residence in
Portugal was purchased within two years of the sale, was held to infringe free movement
of workers, establishment and citizenship rights under the EC Treaty, and free movement
of workers and establishment under the EEA Agreement. The Commission also relied
on free movement of capital but the Court ruled that it was not necessary to consider
separate arguments on that ground, having already found incompatibility with the other
freedoms. Swedish capital gains tax deferral rules have been held incompatible on the
same grounds.72 A Portuguese tax measure that exempted residents of Portugal from 50
per cent of the gain realised on sale of real property in Portugal while non-residents were
subject to taxation on the full gain has been held incompatible with Article 56(1).73
Inheritance tax
Inheritances and legacies are listed under personal capital movements in Annex I, so
that where at least two of the inherited assets, the deceased testator or the heirs are in
different Member States (or a third country), Article 56(1) may apply.74 Taxpayers have
successfully challenged provisions that allow a particular deduction in calculating the
value of property inherited from residents, but not from non-residents.75
69
70
71
72
73
74
75
Case C-219/03, December 9, 2004 (unpublished): available in Spanish and French at: http://
curia.europa.eu/en/content/juris/index.htm (accessed September 15, 2008).
Case C-436/06 December 18, 2007.
Case C-345/05, October 26, 2006 [2006] ECR I-10633.
Case C-104/06 Commission v Sweden January 18, 2007 [2008] STC 2546; [2007] ECR I-671.
Case C-443/06 Erika Hollman v Fazenda Publica, October 11, 2007 [2008] STC 1874. As with
dividends and interest, the Commission has announced additional infringement proceedings.
Case C-513/03 Heirs of van Hilten-van der Heijden v Inspecteur van de Belastingdienst [2008] STC
1245; [2006] ECR I-1711 (van Hilten).
Case C-364/01 Barbier [2003] ECR I-5013. Old Art.67 and Directive 88/361 were in force at the time
this case arose. See also Case C-11/07 Eckelkamp v Belgium, September 11, 2008, in which the ECJ
643
BRITISH TAX REVIEW

Different rules for valuing inherited property, or availability of a partial tax exemption,
depending on whether the property is situate in the taxing jurisdiction or abroad have
also been held incompatible with free movement of capital.76
Taxation of charities and charitable gifts
In Stauffer,77 the ECJ held that the German tax law which exempted German charities
from tax but did not exempt the German rental income of charities established in other
Member States was an unjustified restriction on free movement of capital. The Italian
charity in the case would have qualified as a tax exempt charity in Germany if it had been
created under German law. The taxation of its rental income in circumstances in which a
German charity would have been exempt was therefore a restriction on capital investment
in Germany by a non-German charity.
Stauffer supports the view that less favourable tax treatment of cross-border charitable
donations, at least where the foreign charity would qualify as a charity for tax purposes
under the laws of the donors Member State are incompatible with free movement of
capital.78 A German measure refusing a deduction for a gift in kind to a charity resident in
another Member State is at issue in a pending case.79 Charitable gifts made by a resident
of one Member State to a charity in another EU Member State may be considered
capital movements under Annex I, as a gift or endowment listed under personal capital
movements.
Pensions and insurance contributions, premiums and benefits
Annex I lists transfers in performance of insurance contracts and premiums and
payments in respect of life assurance as movements of capital. There have been several
cases considering various types of unfavourable tax treatment of disability and life
assurance premiums and contributions to pensions contracted with insurance and pension
companies that are not resident or established in the same Member State as the person
who makes the contribution and/or will later be entitled to the insurance or pension
benefits. Although in many of these cases the denial of tax relief was challenged as a
restriction on the free movement of capital, the ECJ has never expressly held that the
measure was incompatible with free movement of capital, basing its ruling in each case on
76
77
78
79
ruled that legislation allowing a deduction for financial charges against real property in computing
the value of the property for Belgian inheritance purposes only where the deceased was resident in
Belgium is a prohibited restriction under Art.56(1).
Case C-256/06 Jager v FA Kusel-Landstuhl January 17, 2008.
Case C-386/04 [2006] ECR I-8203.
See M.H. Robson, Case Note Centro di Musicologia Walter Stauffer v Finanzamt Munchen fur
Korperschaften Je, sans frontieres, soussigne. . . transnational gifts to charity within the European
Union [2007] BTR 109 and S.J.C. Hemels, The Implications of the Walter Stauffer Case for
Charities, Donors and Governments (2007) 47 European Taxation 19.
Pending case C-318/07 Persche. The Commission is pursuing action based on Art.56 against
Belgium, Ireland, Poland and the United Kingdom regarding their less favourable tax treatment of
donations to charities resident in other Member States in comparison with donations to charities
which are resident in the donors state of residence. See Commission Press Release IP/06/1879
of December 21, 2006 available at: http://europa.eu/rapid/pressReleasesAction.do?reference=IP/06/
1879&format=HTML&aged=0&language=en&guiLanguage=en (accessed September 25, 2008).
644

one or more of free movement of services, establishment or workers. On the other hand,
the Court has never completely excluded the possibility that such tax measures infringe
free movement of capital since the early Bachmann case.80
The Court in Bachmann held that the denial by Belgium of a tax deduction for
contributions to a sickness or disability insurance plan or a pension fund carried by
an insurance company not established in Belgium was a restriction on free movement
of workers and the freedom of foreign insurers to provide services in Belgium, but
was justified as necessary for preserving the cohesion of the Belgian tax system. In
the Courts view, there was no less restrictive way of ensuring the cohesion of the
offsetting deductions and inclusions, and the restriction was therefore justified in the
public interest.
At the relevant time in relation to Bachmann, Article 67 was still in its original form and
Directive 88/361 had not been adopted. The Court held that the denial of the tax deduction
was not contrary to Article 67 (or to former Art.106 on liberalisation of payments) because
it did not prohibit restrictions which did not relate to the movement of capital but which
result indirectly from restrictions on other fundamental freedoms.81 There have been
several cases since Bachmann in which taxpayers and the Commission have asked the
Court to find tax rules that favoured life assurance and pension arrangements contracted
with companies established in the same Member State as the beneficiary (or his or her
employer) making the contributions to the policy or fund. In all of these,82 the national tax
rules have been held incompatible with free movement of services and in some instances
also with free movement of workers or establishment. The separate consideration of free
movement of capital was considered not necessary.
Commission v Denmark83 is of interest not least because the Commission began its
infringement procedure in 1991, before the ECJs ruling in Bachmann. The Commission
argued that the Danish tax rules were incompatible with all four freedoms: workers,
services, establishment and capital. Denmark denied that its legislation restricted free
movement of capital, citing the Courts statements in Bachmann quoted above. The
Court found that the Danish rules restricted the first three freedoms, and that it was
therefore not necessary to consider the legislation separately in light of free movement of
capital.
From the above survey it can be seen that, in intra-EU cases, the Court has, perhaps
intentionally, avoided the issue of whether and when freedom to provide insurance and
pension services overlaps with the freedom to invest in life and disability insurance and
pension funds in other Member States by ruling that it was not necessary to consider
Article 56. This may indicate that the Court intends to return Article 56(1) to its early
subordinate status relative to the other freedoms, only applying it where no other freedom
is directly affected, as it did in the Bachmann case.84
80
81
82
83
84
Case C-204/90 [1994] STC 855; [1992] ECR I-249.

Case C-204/90 Bachmann [1994] STC 855; [1992] ECR I-249 at [34]
Case C-136/00 Danner [2002] STC 1283; [2002] ECR I-8147; Case C-422/01 Skandia and Ramstedt
[2003] STC 1361; [2003] ECR I-6817; and Case C-118/96 Safir [1998] STC 1043; [1998] ECR I-1897.
Case C-150/04 [2007] STC 1392; [2007] ECR I-1163. In Case C-522/04 Commission v Belgium [2007]
ECR I-5701, essentially the same result was obtained.
This is discussed further below under the heading: Overlapping freedoms: Fidium Finanz and its
implications in direct tax cases.
645
BRITISH TAX REVIEW

Justifications: overriding reasons in the general interest
Member States have been almost completely unsuccessful in justifying their direct tax
measures that restrict the exercise of a fundamental freedom. Whilst the ECJ has accepted
some justifications in principle, it has only very rarely found that a measure is actually
justified, and has rejected outright numerous bases of justification.
As noted, the Court accepts that ensuring effective fiscal supervision can justify a
restrictive tax measure.85 However, the Court has never ruled in an intra-EU case that
a particular national tax provision was justified solely on this basis.86 This is usually
attributable to the existence of the Directive on Mutual Assistance87 in direct tax matters.
In the Courts view, the directives provisions for the sharing of tax information within
the EU allow Member States to obtain the information they need to ensure proper
enforcement of their tax laws with respect to non-resident taxpayers and income from
foreign sources. Accordingly, the denial of tax relief that is available to domestic taxpayers
and income is not justified by the lack of available information from other EU jurisdictions.
At a relatively early stage in the development of its direct tax jurisprudence the Court
recognised that measures for the prevention of tax evasion could be justified despite their
restrictive effect on the exercise of a fundamental freedom.88 Again, however, the Court
has strictly limited the scope of this justification, usually finding that the legislation is not
justified because it is disproportionate to the objective.89 Anti-avoidance legislation will
not satisfy the proportionality test unless it is designed to apply only to purely artificial
arrangements aimed at circumventing tax laws, and in such a way as to allow a case by
case assessment of whether improper avoidance or evasion has in fact occurred.90 The
Court has shifted its position slightly in more recent cases, reversing the emphasis so that
an anti-avoidance measure may be justified except where it applies indiscriminately to all
transactions or payments of a given type.91 The Court now also allows the risk of tax
avoidance or evasion to be combined with another justification as discussed below in the
Marks & Spencer and Oy AA cases.92
The ECJ has repeatedly rejected the argument that a tax measure is justified as
necessary to prevent erosion of a Member States tax revenues or tax base, noting that an
infringement of a fundamental freedom cannot be justified on purely economic grounds.93
Nor will the Court permit a Member State to impose a higher tax on cross-border
85
86
87
88
89
90
91
92
93
Case C-120/78 Cassis de Dijon [1979] ECR 649.

In Case C-250/95 Futura Participations SA [1997] STC 1301; [1997] ECR I-2471, the Court
indicated that, although the disputed accounting requirements were not justified because they were
disproportionate to the objective, this justification would apply to a less onerous requirement.
Directive 77/799 concerning mutual assistance by the competent authorities of the Member States in
the field of direct taxation [1977] OJ L 336/15.
Case C-264/96 ICI [1998] ECR I-4695 at [26].
As in Case C-433/04 Commission v Belgium [2006] ECR I-10653.
Case C-324/00 Lankhorst-Hohorst [2003] STC 607; [2002] ECR I-11779 at [37]; Case C-9/02 de
Lasteyrie du Saillant [2004] ECR I-2409 at [50][51].
Case C-524/04 Thin Cap [2007] STC 906; [2007] ECR I-2107 and Case C-196/04 Cadbury Schweppes
[2006] STC 1908; [2006] I-7998.
Case C-446/03 Marks & Spencer [2006] STC 237; [2005] ECR I-10837 and Case C-231/05 Oy AA
[2008] STC 991.
Case C-315/02 Lenz [2004] ECR I-7063.
646

transactions or sources of income to equalise the total tax burden on a taxpayer
operating from a lower tax jurisdiction with the burden it imposes on its own taxpayers.94
In almost every direct tax case since Bachmann the preservation of cohesion of the
national tax system has been relied on as a justification for restrictive tax measures, but
it has never been applied by the Court to justify restrictive legislation in any subsequent
case. In many rulings, the necessity of a direct link between a tax advantage and a
corresponding charge to taxation applicable to a particular taxpayer was not met.95
As set out above, even in the more recent cases concerning taxation of insurance
and pension premiums and benefits, and in particular in Case C-150/04 Commission v
Denmark, the Court refused to accept this justification as the legislation did not satisfy
the proportionality requirement. The Danish tax rules carefully balanced deduction with
inclusion, so that if a taxpayer contributing to a foreign pension plan was unable to
deduct contributions, the benefits would be exempt from tax, similar to the Belgian
rules in Bachmann. However, the Court, following a new and stricter argument of the
Commission, imposed an important proportionality based limitation on the test of what
is necessary to ensure cohesion. The Commission argued that cohesion of the tax system
only became a basis for justifying denial of the deduction where Denmark cannot tax the
pension benefits when they are later paid to the individual. This is only the case where an
individual who, having paid into a foreign pension plan and claimed a deduction for such
contributions, later ceases to be resident in Denmark and receives pension benefits from
a non-Danish fund. The inability of Denmark to tax the pension benefits is the result
of the transfer of residence by the individual. Denying a deduction for all contributions
to foreign pension plans cannot therefore be justified by the need to preserve cohesion;
the tax measure must be tailored to recovering the tax relief provided to the emigrating
taxpayer.
A more flexible approach to justification is apparent in the judgments in Marks &
Spencer,96 and Oy AA,97 both concerning freedom of establishment and restrictions on
corporate group loss relief. In Marks & Spencer the Court accepted in principle that
certain restrictions on the deduction by a parent company of losses realised by subsidiaries
resident in other Member States may be justified as compatible with the international
tax principle of territoriality,98 that is, that since the parent companys home Member
94
95
96
97
98
C-294/97 Eurowings [1999] ECR I-7449 [44][45]. In Lenz Advocate General Tesauro asserted that
measures designed to combat competitive distortions in favour of low tax Member States could not
justify unequal treatment at [62].
Some commentators discern in Manninen (Case C-319/02 [2004] STC 1444; [2004] ECR I-7498) a
relaxation of the requirement that the advantage and tax charge apply to one and the same taxpayer.
This is apparent in the Opinion of Advocate General Kokott in that case of March 18, 2004 at [64][65]
but is not clear in the ECJs judgment.
Case C-446/03 [2006] STC 237; [2005] ECR I-10837. See for fuller discussion, among many other
articles, Melchior Wathelet, Marks & Spencer plc v Halsey: lessons to be drawn [2006] BTR 128;
Tom OShea, Marks and Spencer v Halsey (HM Inspector of Taxes): restriction, justification and
proportionality (2006) EC Tax Review 66; A. Cordewener and I. Dorr, Case C-446/03 Marks &
Spencer Plc v. David Halsey (HM Inspector of Taxes) Judgment of the Court of Justice (Grand
Chamber) of 13 December 2005, Common Market Law Review 43: 855-884 (2006); Michael Lang,
The Marks & Spencer CaseThe Open Issues Following the ECJs Final Word [2006] 46 European
Taxation 54.
Case C-231/05 [2008] STC 991.
In Case C-250/95 Futura Participations SA [1997] STC 1301; [1997] ECR I-2471 at [22] the Court
used this principle to allow a source state, Luxembourg, to limit the ability of a branch of a non-resident
647
BRITISH TAX REVIEW

State did not have the power to tax the subsidiarys profits earned abroad, it should not
be required to allow deduction of the subsidiarys foreign losses against profits earned in
the parents home state, as this could jeopardise the balanced allocation of the power to
impose taxes between Member States (at [46]). Combined with the risk of tax avoidance
if the losses were claimed twice (in both the subsidiarys home state and the parents)
or were transferred artificially within a corporate group so that they could be deducted
in another jurisdiction with higher tax rates, the restriction on deduction of losses of
non-resident subsidiaries was held to satisfy the test of fulfilling an overriding reason in
the public interest. Thus the cumulative effect of justifications that individually would
not be sufficient can protect an otherwise restrictive tax measure.
In Oy AA, the ECJ was even more willing to apply justifications cumulatively. In that
case a Finnish wholly-owned subsidiary wished to transfer (and deduct from its Finnish
tax base) profits to its loss-making UK parent, under Finnish rules which allowed such
transfers within 90 per cent owned corporate groups where transferor and transferee were
both resident in Finland. The Court accepted the justification of preserving a balanced
allocation of taxing power between Member States where the impugned rules are designed
to prevent conduct that might jeopardise the entitlement, according to that allocation,
of Member States to exercise their taxing powers over income from activities carried
on in their territory. If companies could elect to have their income taxed in another
Member State, this would undermine that balanced allocation of taxing power. It would
also encourage tax avoidance, or the use of artificial arrangements, to shift income within
corporate groups to low tax jurisdictions. The Court held that these two, linked, bases of
justification constituted overriding reasons in the general interest.
Another very significant aspect of the judgment is that the Court relaxed its usual strict
proportionality test, holding that the Finnish legislation was not disproportionate to its
objective, even though it was not specifically designed to exclude from the tax advantage
it confers purely artificial arrangements, devoid of economic reality, created with the aim
of escaping the tax normally due. . ..99
These two cases, particularly the strong statement in Oy AA, indicate that the Court
is more willing to give effect to the norms accepted internationally for allocating tax
jurisdiction. When the balanced allocation of taxing power is put in jeopardy, combined
with a clear risk of tax avoidance, the Court will be more lenient in applying the
proportionality principle.
From the above it can be seen that in intra-EU cases, the Court has not allowed Member
States to justify restrictive tax measures except in very limited circumstances. It is only
recently, with the new willingness of the Court to recognise the entitlement of Member
States to allocate taxing power unilaterally or by tax treaty as deserving of its protection,
that a broader base for justification of tax measures that would otherwise be incompatible
with fundamental freedoms is discernible.
99
company to carry forward losses of previous years to those losses which were economically linked to
income from activities carried on in Luxembourg. The territoriality or balanced allocation of taxing
power argument has been shifted from consideration in relation to the issue of whether there is a
restriction to the justification analysis, and applied to a residence state, by Marks & Spencer and Oy
AA.
Case C-231/05 Oy AA [2008] STC 991 at [63]. This relaxation in the application of the proportionality
principle is in sharp contrast with the more stringent application of it in connection with the cohesion
justification in Case C-150/04 Commission v Denmark [2007] STC 1392.
648

The significance of DTCs in EU direct tax law
The effect of the reciprocal commitments in DTCs on a Member States unilateral
obligations under Article 56(1) is a relevant but difficult and unresolved factor in
determining how the third country dimension of free movement of capital will apply in a
given situation.
The Court has recently reaffirmed the competence of Member States to define, by
treaty or unilaterally, the criteria for allocating their powers of taxation, particularly
with a view to eliminating double taxation.100 The criteria for allocating taxation power
commonly applied in tax treaties based on the OECD Model are generally acceptable to
the Court.101
Although the ECJs jurisprudence lacks clarity on many points concerning DTCs, it
can be stated with certainty that, at least within the EU, the provisions of a DTC do not
allow a Member State to avoid its obligations to uphold the fundamental freedoms.102
Conversely, it may not cite the lack of reciprocal relief (often provided in DTCs) for
its residents in the other Member State as a justification for denying the benefits of a
fundamental freedom to a resident or national of that Member State.103 The ECJ will take
into account, as part of the legal context, the provisions of a DTC to determine whether,
on the basis of domestic law and the actual effect of the tax treaty in combination, there
is unequal treatment or a restriction of a fundamental freedom.104 The application of a
relevant DTC in a particular case is usually left to the national courts.
The scope for reliance on DTCs to shape EU direct tax jurisprudence seems quite
limited because the Court is concerned with discriminatory treatment of residents and
non-residents that results from a single Member States tax law. DTCs are primarily
concerned with minimising or eliminating juridical double taxation by allocating tax
jurisdiction between the state of source and the state of residence, usually obligating the
treaty partners to reduce withholding tax rates and provide relief for income taxed in
the other state, either by exempting such income from tax or crediting the foreign tax
against the tax liability in the home state. The Court does not consider juridical double
taxation per se as constituting the restriction of a fundamental freedom.105 It is simply an
inevitable result of two countries exercising their sovereign tax powers according to the
allocation that has been established either unilaterally or in a DTC.
In Amurta, the ECJ confirmed the principle that the source Member State may not rely
on a tax advantage granted unilaterally (i.e. in its domestic law) by the home Member
State to avoid its obligation to treat outbound dividends equally to domestic dividends.
However, a tax advantage provided in a DTC may be taken into account. In principle, it
seems that if the effect of a DTC is to eliminate any inequality in treatment or a restrictive
effect, a Member States tax law will not be incompatible with a Treaty freedom.
100
101
102
103
104
105
This is the effect of EC Treaty Art.293 second indent; see Case C-524/04 Thin Cap [2007] STC 906;
[2007] ECR I-2107 at [49] and cases cited there.
Case C-513/03 van Hilten [2008] STC 1245; [2006] ECR I-1711 at [48].
C-270/83 Avoir Fiscal [1986] ECR 273 at [26]; Case C-170/05 Denkavit [2007] STC 452; [2006] ECR
I-11949 at [53] and Case C-379/05 Amurta at [78].
C-270/83 Avoir Fiscal [1986] ECR 273.
Case C-265/04 Bouanich [2008] STC 2020; [2006] ECR I-923 and Case C-170/05 Denkavit [2007]
STC 452; [2006] ECR I-11949.
Case C-513/04 Kerckhaert-Morres [2007] STC 1349; [2006] ECR I-1096752.
649
BRITISH TAX REVIEW

The Courts statements about what types of relief provided in a DTC will neutralise a
restriction are inconclusive. For example, there is no explicit ruling on whether a DTC
that provides for a tax exemption or tax credit for dividends in the shareholders home
state can neutralise economic double taxation of the outbound dividends in the other
state. In Amurta, the Court left it to the national court to determine whether the effect of
the DTC was to neutralise the restriction of free movement of capital resulting from the
series of charges to tax imposed by the source state on outbound compared to domestic
dividends.
It seems that a Member State can defend an otherwise restrictive tax measure in its own
domestic law by demonstrating that the measures restrictive or discriminatory effects are
offset by obligations imposed by a DTC on that Member State to provide relief.
ACT IV and FII Test Claimants are cases where a Member States grant of a tax credit
based on the existence of an obligation in a DTC (or domestic law in the case of FII
Test Claimants) prevented its taxation of outbound (in ACT IV ) and inbound (in FII
Test Claimants) dividends from constituting a restriction of free movement of capital.106
In ACT IV, the UK legislation granted a tax credit to foreign dividend recipients if
the relevant DTC permitted the United Kingdom to impose withholding tax on the
dividend. The ECJ considered that this eliminated economic double taxation by the
United Kingdom that would otherwise have applied to the outbound dividend subject to
withholding tax. In this way, the United Kingdoms system complied with its EC Treaty
obligations through the combined provisions of domestic law and DTCs. In FII Test
Claimants, tax credits provided by the United Kingdom, either in its domestic law or a
relevant DTC, for both foreign withholding tax on dividends and underlying corporate
tax on the income, equalised the UK tax burden on domestic and inbound dividends so
that the restrictive effect of taxing inbound dividends while exempting domestic dividends
was eliminated. These cases can also be viewed as simply recognising that obligations
imposed by DTCs are effectively part of the domestic law of the treaty partner, so that
they affect whether, under the law of a single Member State, the impugned tax treatment
is restrictive or discriminatory.
It is permissible for a Member State to discriminate amongst the other Member States
(or third countries) based on the existence of, or obligations contained in, a DTC with
the other country. In the D Case107 the ECJ ruled that there was no most favoured
nation principle that allowed a resident of Germany to insist on the favourable treatment
accorded by the Netherlands to residents of Belgium under the tax treaty between the
Netherlands and Belgium. Further, the existence and terms of a DTC determines whether
taxpayers are in the same situation under Article 58(1)(a). It is only those non-residents
who are in a comparable position to a resident of one of the contracting states who can
claim the benefits of the tax treaty, as in the Saint Gobain108 case. The D Case was
emphatically affirmed in OESF 109 in which the Court held that the Netherlands was not
106
107
108
109
Bouanich (Case C-265/04 [2008] STC 2020; [2006] ECR I-923) is another such case, where the issue
of whether the obligation imposed by the DTC on Sweden to reduce its withholding tax rate on
dividends paid to French residents eliminated the unequal treatment in Swedish domestic law was
left for determination by the Swedish referring court.
C-376/03 [2005] ECR I-5821 (Grand Chamber).
Case C-307/97 Compagnie de Saint-Gobain, Zweigniederlassung Germany v Finanzamt AachenInnenstadt [1999] ECR I-6161.
Case C-194/96, May 20, 2008.
650

precluded from making access to a tax benefit in respect of inbound dividends conditional
on the existence of a DTC with the source country providing for such relief. Dividends
received by OESF from companies in Portugal and Germany were not entitled to the same
treatment as dividends from countries that had such a DTC with the Netherlands, because
the investment of capital in Portugal and Germany was not objectively comparable to an
investment in a country with a DTC providing the relief.
The third country dimension of free movement of capital
General comments on third country jurisprudence to date
In just over two years, between February 2006 and May 2008, the ECJ issued 10 judgments
on the third country dimension of Article 56(1) and direct taxation.110 In seven, the Court
found either that there was no restriction (van Hilten, ACT IV ), that another Treaty
freedom excluded consideration of Article 56(1) (Thin Cap, Lasertec, Stahlwerk Ergste
Westig, Skatteverket v A and B), or that the disputed measure was protected by Article
57(1) (Holbock). In two cases, FII Test Claimants and Skatteverket v A, the Court referred
the determination of the application of Article 57(1) back to the national court for a
final ruling. In the latter case, the ECJ also accepted the justification of guaranteeing the
effectiveness of fiscal supervision. Thus taxpayers have been unsuccessful in relying on
Article 56(1) in all but FII Test Claimants and OESF (and may yet be unsuccessful in FII
Test Claimants). This is a very different record of success compared to intra-EU direct
tax cases generally, which have found measures to be incompatible with EU law in an
overwhelming majority of cases.
On the fundamental issue of what constitutes a prohibited restriction of free movement
of capital, it is now clear that the principle in Article 56(1) is the same in the third country
context as in intra-EU cases.111 The definitions of capital movements, and of direct
investment in Annex I apply equally in both contexts.112
From the variety of intra-EU cases surveyed above in which direct tax measures
have been found to be incompatible with Article 56(1) within the EU, it is evident that
there are many as yet untested possibilities for challenging Member States tax laws in
their application to third countries. However, there are a number of formidable (and
interconnected) obstacles that limit the possibilities for the third country dimension of
free movement of capital to parallel the intra-EU dimension. These are analysed in the
following sections.
110
111
112
For reference, these are Case C-513/03 van Hilten [2008] STC 1245; [2006] ECR I-1711; Case
C-446/04 FII Test Claimants [2007] STC 326; [2006] ECR I-11753; Case C-374/04 ACT IV [2007]
STC 404; [2006] ECR I-11673; Case C-524/04 Thin Cap [2007] STC 906; [2007] ECR I-2107 and
C-492/04 Lasertec [2007] ECR I-3775; Case C-102/05 Skatteverket v A and B [2007] ECR I-3871;
Case C-157/05 Holbock [2007] ECR I-4051; Case C-415/06 Stahlwerk Ergste Westig [2007] ECR
I-152; Case C-101/05 Skatteverket v A [2007] ECR I-11531 and Case C-194/06, OESF May 20, 2008.
Admittedly, ACT IV does not directly address third country issues but impliedly encompasses them,
and OESF is primarily concerned with intra-EU discrimination. There are three third country cases
that do not concern taxation, Case C-452/04 Fidium Finanz [2006] ECR I-9521; Case C-250/94 Sanz
de Lera [1995] ECR I-482; and Case C-358/93 and 416/93 Bordessa [1995] ECR I-361.
See Case C-101/05 Skatteverket v A [2007] ECR I-11531 at [31].
Case C-446/04 FII Test Claimants [2007] STC 326; [2006] ECR I-11753 at [179]; Case C-513/03 van
Hilten [2008] STC 1245; [2006] ECR I-1711 at [39].
651
BRITISH TAX REVIEW

Overlapping freedoms: Fidium Finanz and its implications in direct tax cases
In Fidium Finanz,113 the Court laid down a new and unanticipated rule, the effect of
which is to exclude Article 56 from consideration in many third country cases. In a very
broad range of circumstances a national measure may restrict the exercise of more than
one of the fundamental freedoms. In intra-EU cases, the Court had in the past sometimes
examined the effects of a particular measure on all the affected freedoms, or, particularly
where a measure restricted both goods and services, chosen one or the other as primarily
and directly affected. Until the judgment in Fidium Finanz, the Court had never selected
only one of two or more affected freedoms against which to judge the compatibility of
a measure in circumstances where this could change the practical result of the case. In
Fidium Finanz, the first third country case where the circumstances concerned both free
movement of capital and another freedom, the Court excluded consideration of Article
56(1).
Fidium Finanz concerned German legislation that required financial services providers
to obtain official authorisation to offer financial services to German residents unless
they were established in an EU or EEA Member State. Fidium Finanz AG was a
Swiss enterprise offering short term consumer loans via internet to German residents.
It challenged the German authorisation requirement on the basis that it restricted free
movement of capital with a third country.
The Court found that while the German measure concerned both services and capital,
the purpose or substance of the measure was to regulate access to the German financial
services market. The Court applied its principal aspect criterion, that in cases where
a Member States law relates to more than one freedom at the same time, the Court will
consider to what extent the exercise of each is affected, and whether, in the circumstances
of the case, one prevails over the other. The authorisation requirement was most directly
and primarily a restriction of the freedom to provide services without being established in
Germany, a Treaty freedom which does not extend to third countries. The obstacle to the
capital movement (the grant of consumer credit) was merely an inevitable and indirect
consequence of the regulation of financial services, and it was therefore not necessary
to consider the compatibility of the German law with Article 56(1). In reaching this
conclusion, the Court cited its judgment in Bachmann.114
113
114
Case C-452/04 [2006] ECR I-9521. For a fuller analysis of this case, see Martha OBrien, Case
Annotation Fidium Finanz AG v Bundesanstalt fur Finanzdienstleistungsaufsicht (2007) CML Rev. 44,
1483. For other critiques of the ECJs approach in Fidium Finanz as extended to the third country
tax cases, R. Fontana, Direct Investments and Third Countries: Things are Finally Moving . . . in
the Wrong Direction (2007) 47 European Taxation 431; S. Hindelang, The EC Treatys Freedom
of Capital Movement as an Instrument of International Investment Law?: The Scope of Article 56(1)
in a Third Country Context and the Influence of Competing Freedoms in International Investment
Law in Context (A. Reinisch and C. Knahr (eds), Eleven International Publishing, Utrecht, 2007);
D. Webber, Fidium Finanz AG v Bundesanstalt fur Finanzdienstleistungsaufsicht: the ECJ gives the
wrong answer about the applicability of the free movement of capital between the EC Member States
and non-member countries [2007] BTR 670; and D.S. Smit, The relationship between the free
movement of capital and the other EC Treaty freedoms in third country relationships in the field of
direct taxation: a question of exclusivity, parallelism or causality? (2007) EC Tax Review 252.
Case C-524/04 Thin Cap [2007] STC 906; [2007] ECR I-2107 at [34]. See text following fn. 80.
652

The Courts position in Fidium Finanz has solidified in four subsequent direct tax cases
concerning third countries. In Thin Cap115 two of the test claimants were UK companies
that had borrowed from a related company resident or established in a third country,
and either the direct lender was established in a third country, or the ultimate parent
company was resident in a third country. The UK tax rules denied or limited deduction
of interest paid to non-resident companies who were members of the same corporate
group in certain circumstances. These thin capitalisation rules were challenged as a
restriction of freedom of establishment,116 or, where the lender or parent company was
not resident in an EU Member State, free movement of capital. The Court considered
that since the restrictive tax rules only applied to loans between members of controlled
groups of companies, freedom of establishment was primarily and directly concerned. A
separate assessment of the compatibility of the thin cap rules in light of Article 56 was
not justified (as opposed to not necessary in Fidium) and, indeed, was positively
excluded.117 That there is no right to invoke Article 56 in such circumstances was
confirmed in Lasertec.118 In that case, although the rules did not apply exclusively where
the lender or a related company controlled a majority of the voting shares of the borrower,
the Court found that they were intended to apply only where there was effective control.
The underlying purpose of the legislation was thus the most significant factor. Freedom
of establishment was directly and primarily concerned, and as a matter of settled law, the
application of Article 56(1) was excluded. The same reasoning was applied in Stahlwerk
Ergste Westig,119 and in Skatteverket v A and B.120
The Fidium Finanz approach has a negligible impact on the result in intra-EU cases,
but is clearly having a very significant one in third country cases. The logic of denying
recourse to Article 56(1) by third country claimants on the basis that the impugned
measure is more directly concerned with another freedom which does not apply to them,
is somewhat questionable.121 Advocate General Stix-Hackl in her Opinion in Fidium
Finanz concluded that where both free movement of services and capital were concerned,
115
116
117
118
119
120
121
For a fuller discussion of this case supporting the ECJs ruling in relation to the third country
dimension, see Tom OShea, Thin Cap GLO and Third Country Rights: Which Freedom Applies?
(2007) Tax Notes International 371.
The thin capitalisation provisions were incompatible with Art.43 when the lender was established in
the EU so that the starkly different results for intra-EU and third country cases due to the Fidium
Finanz ruling were clear.
Case C-524/04 Thin Cap [2007] STC 906; [2007] ECR I-2107 at [104].
C-492/04 [2007] ECR I-3775.
Case C-415/06 [2007] ECR I-152. In this case the German rules denying deduction of losses realized
by a US permanent establishment in determining income of a German resident company were held to
concern freedom of establishment and free movement of capital was not applicable.
Case C-102/05 [2007] ECR I-3871. In this case, employees holding very small shareholdings in their
employer, a Swedish company, were taxed on dividends at the higher rate applicable to salary as
their salaries from working at a Russian branch were not included in the formula for determining if
salary was being converted inappropriately to dividend income. The ECJ saw this as a freedom of
establishment case, even though the more logical approach was that it was either free movement of
workers (to Russia) or free movement of capital, in respect of the dividends on the small proportion
(less than two per cent) of shares held. The tax rules only indirectly discouraged establishment by the
Swedish company in Russia, as there was no effect on the companys Swedish tax liability.
In Case C-102/05 Skatteverket v A and B [2007] ECR I-3871 the Swedish Tax Commission held that
since none of the other freedoms were applicable in third country cases, Art.56 had to be considered,
and was infringed in that case.
653
BRITISH TAX REVIEW

the Courts then existing jurisprudence did not exclude consideration of the measure
as a restriction of free movement of capital.122 She noted that the specific permission
provided to Member States in Article 57(1) to maintain in force measures which restrict
direct investment which amounts to establishment or financial services in respect of third
countries (discussed in the next section) would be meaningless if Article 56 was never to
apply if the movement of capital was connected to activities that amounted to exercise of
the right of establishment or free movement of services.
The application of the Fidium Finanz approach to determining which freedom is more
directly and primarily affected may have become more nuanced in some direct tax cases
as a result of the Holbock case.123 In that case, an Austrian individual held two-thirds of
the shares of a Swiss company. The less favourable tax treatment of inbound dividends
by comparison with domestic dividends under Austrian law had already been found
incompatible with Article 56(1) in Lenz.124 Given that Mr Holbock had definite influence
over the Swiss company, it might have been expected that the Court would follow Fidium
Finanz and rule that freedom of establishment was the only freedom to be considered.
However, it considered that the dividend taxation rules applied generally to dividends,
whether the recipient controlled the distributing company or held only a small percentage
of the shares. The dividend tax rules therefore fell within both freedom of establishment
and free movement of capital. However, as the Austrian rules had been in place as of
December 31, 1993, they were saved by the standstill provision in Article 57(1) in relation
to third countries even if Mr Holbock was entitled to invoke Article 56(1).
Following Holbock, the overlap issue is refined, but still fraught with uncertainty. From
a direct tax perspective, Holbock indicates that general tax measures that are not limited to
situations where a relationship of control exists between the shareholder and the company,
are not necessarily excluded from consideration in relation to Article 56(1), even where a
relationship of control exists in the particular case. This is a slightly different position to
that taken in FII Test Claimants, where it appeared the Court was drawing a line between
dividends received from controlled companies, in which case freedom of establishment
was concerned, and from companies in which the shareholder did not have a controlling
interest, in which case free movement of capital was engaged. In that judgment, it seemed
that a UK company receiving dividends from a controlled third country company had
no right to invoke Article 56(1) even though the same tax rules applied where the third
country company was not controlled by the UK company.
The small opening afforded by Holbock notwithstanding, the Fidium Finanz, Thin
Cap, Lasertec, and Stahlwerk Ergste Westig cases effectively exclude the third country
dimension of Article 56(1) in respect of four of the most important types of measures used
122
123
124
She based her views primarily on the Svensson and Gustavsson case (C-484/93 [1995] ECR I-3955)21
where both freedoms were considered equally applicable. See also the Opinion of Advocate General
Kokott, September 12, 2006 in Case C-231/05 Oy AA [2008] STC 991 at [16], and in Case C-265/04
Bouanich [2008] STC 2020; [2006] ECR I-923 at [71] for the view that freedom of establishment and
free movement of capital can be applied in parallel. These two Opinions, and the position taken by
the Commission in Case C-452/04 Fidium Finanz [2006] ECR I-9521, show how unexpected and even
surprising the position taken by the Court in the latter case was. It is nevertheless fully established
as settled law by the time of the judgment in C-492/04 Lasertec [2007] ECR I-3775 at [19]. The
oldest case cited in that paragraph is Case C-196/04 Cadbury Schweppes [2006] STC 1908; [2006] I(decided after AG Kokotts Opinion in Fidium Finanz).
Case C-157/05 [2007] ECR I-4051.
Case C-315/02 [2004] ECR I-7063.
654

by Member States to protect their corporate tax base: controlled foreign corporation,125
thin capitalisation, group loss relief126 and transfer pricing127 rules, because these all apply
only to controlled corporate groups.
The degree to which transactions and activities that constitute capital movements are
connected to and overlap with those that involve the exercise of freedom of services or the
right of establishment (and to a lesser degree, free movement of workers) is evident from
even a cursory examination of Annex I. This means that the issue of which is primarily
and directly concerned will arise very frequently in the third country dimension. The
Court has identified two bases on which it will determine that a freedom other than capital
is primarily and directly concerned and consequently exclude application of Article 56(1):
when the purpose of the restrictive measure is to regulate market access in respect of
services, as in Fidium Finanz, and where the measure applies exclusively to those factual
circumstances that constitute exercise of another freedom, even if those circumstances
also involve a movement of capital, as in Thin Cap. Both of these two determinants are well
entrenched in the jurisprudence already. They are defensible to the extent they address
directly the need to prevent third country investors from gaining other free movement
rights indirectly and illegitimately by invoking the free movement of capital. However,
these two bases for excluding Article 56(1) in third country cases provide no guidance on
when it may be invoked to challenge general tax measures, so that the impact of Holbock
remains unclear.
Evidence that the emergence of the third country dimension may be causing the Court
to avoid applying Article 56(1) in intra-EU cases can be seen in recent infringement
cases initiated by the Commission. When the challenge to compatibility of national tax
measures with fundamental freedoms is abstract, as in Article 226 actions, the Court is
quite willing to consider the restrictive tax measure in relation to more than one freedom,
yet still avoids consideration of Article 56(1). For example, in the decision in Commission
v Denmark,128 the Court held that free movement of services, workers and the right of
establishment were all restricted but that it was unnecessary to consider the measures
separately in relation to Article 56(1).
The following example illustrates the potential for inappropriate results based on the
exclusion of Article 56 where another freedom may also apply. In Article 226 infringement
cases brought by the Commission, the Swedish and Portuguese discriminatory rules on
capital gains tax relief were incompatible with free movement of workers, establishment
and citizenship rights, and separate consideration of Article 56 was not necessary.129 In
the taxpayer-initiated reference, Hollman,130 only free movement of capital was in issue
as the taxpayer did not move, whether in her capacity as worker, entrepreneur, citizen
125
126
127
128
129
130
As in Cadbury Schweppes (Case C-196/04 [2006] STC 1908; [2006] I-7998), at least where the
legislation applies only where the foreign subsidiary is under the effective control of the EU parent.
As in Case C-446/03 Marks & Spencer [2006] STC 237; [2005] ECR I-10837 and Case C-231/05 Oy
AA [2008] STC 991.
Although transfer pricing rules have not yet been challenged, since these also depend on a relationship
of control between the transferor and transferee, they will not be prohibited by Art.56(1) in respect of
third countries.
Case C-150/04 [2007] STC 1392; [2007] ECR I-1163.
Case C-345/05 Commission v Portugal October 26, 2006 [2006] ECR I-10633 and Case C-104/06
Commission v Sweden January 18, 2007 [2008] STC 2546; [2007] ECR I-671.
Case C-443/06 [2008] STC 1874.
655
BRITISH TAX REVIEW

or otherwise. This raises the incongruous prospect that the Court could find that a third
country national is not entitled to invoke Article 56(1) to challenge discriminatory taxation
on selling her home in one Member State to take a job or start a business in another
Member State, but could invoke Article 56(1) if she is simply an investor and not also a
worker.
The Commission has not to date commenced infringement proceedings under Article
226 in any third country case, and does not include the third country dimension of free
movement of capital when it takes action against Member States based on Article 56.131
However, the positions it takes in intra-EU cases should shed light on the scope of Article
56 in references for preliminary rulings. In the intra-EU cases under Article 226, it is
not clear that the Courts position that it is unnecessary to consider the measure in
light of free movement of capital means that Article 56(1) is to be absolutely excluded
from consideration as it is in the third country cases. The unanswered concern is whether
the willingness of the Court to consider compatibility of a national measure with more
than one freedom where the issue is presented in the abstract, while refusing to assess
the measure in relation to Article 56 even in intra-EU cases, indicates an intention to
subordinate Article 56(1) to the other freedoms in a manner that has not been evident
since Bachmann.
From the review above of the intra-EU direct tax case law on Article 56,132 two types
of direct tax measure that exclusively, or at least most directly and primarily, concern
free movement of capital are wealth and inheritance taxes and the taxation of charitable
donations. These are therefore the least likely to be excluded from the third country
dimension of Article 56(1) by the Fidium Finanz approach. An EU resident should be able
to claim the same tax relief for donations made to third country charities as to charities
in his home country, at least where the third country charity would qualify as a charity
in the donors country of residence. A German resident should be able to claim the same
favourable tax treatment in respect of inheritance tax for his Canadian real property as for
real property situated in Germany or France.
With respect to dividends, interest and capital gains, where free movement of services,
workers or establishment may overlap with free movement of capital, the third country
litigant should be able to invoke Article 56(1) in respect of direct tax measures that
apply generally to these types of receipts, following Holbock, and at the very least when
interest and dividend income flows from portfolio investments. A Chinese shareholder of
a French corporation should be able to claim an exemption from French withholding tax
on dividends if French (or Dutch) shareholders are not required to pay a second charge on
the French corporations profits. A Greek shareholder of a Canadian company should be
able to claim an exemption from Greek tax on the dividends received, if dividends from
Greek companies are exempt. A Spanish resident should be able to claim the same capital
gains tax relief under Spanish law on disposition of his home in Argentina as he would in
respect of Spanish or Portuguese real property. A French lender receiving interest from
an Australian borrower should be entitled to the same beneficial tax treatment in respect
of the interest as he is for interest from a French borrower.
131
132
The Commission does, however, submit observations, often supporting the taxpayer on at least some
points, in third country references for preliminary rulings. It may also be the case that third country
investors have not yet begun to complain to the Commission about tax restrictions of free movement
of capital.
See subheading: Survey of intra-EU case-law on direct taxation and free movement of capital.
656

Article 57(1): the standstill provision
Article 57(1)133 derogates substantially from the third country scope of Article 56(1),
allowing Member States to retain restrictions in existence on December 31, 1993 in respect
of certain enumerated categories of capital movement, even though these categories are
where one would anticipate the most extensive increase in international investment,
and so where the euro would gain the most international recognition. Article 57(2) was
apparently intended to protect reservations made by Member States under the OECD
Code of Liberalisation of Capital Movements and the OECD Code of Liberalisation of
Current Invisible Transactions.134
There are two direct taxation cases at the time of writing where Article 57(1) has been
applied to save a national measure that restricted free movement of capital, Skatteverket
v A and Holbock. In addition, in FII Test Claimants it seems clear that the High Court of
England and Wales will find that the pre-1994 UK legislation is also preserved in the case
of direct investments and controlled groups and likely that the 1994 FID amendments
will also be protected.
Article 57(1) requires a restrictive measure to form part of a Member States legal order
continuously from December 31, 1993 to the relevant time, so that Member States cannot
claim its protection for measures that had been repealed but were reintroduced after that
date. The ECJ has held that post-1993 amendments that do not change the substance
of a pre-1994 measure, or that reduce or eliminate obstacles to free movement of capital
are also grandfathered by Article 57(1).135 In Skatteverket v A,136 the ECJ ruled that the
impugned Swedish tax law was to be regarded as in existence on December 31, 1993,
because, despite the various changes to Swedish law before and after the critical date, there
was no point after December 31, 1993 when Swedish law extended the favourable tax
treatment accorded to domestic stock dividends to stock dividends from third countries.
This means that as Member States remove restrictions in their tax laws in respect of other
Member States and under the EEA, they may retain the pre-1994 restrictions vis-à-vis
third countries in the categories enumerated in Article 57(1).
As noted earlier, one of the implications of applying the Fidium Finanz approach for
assessing whether Article 56(1) may be invoked in third country cases is that the standstill
obligation in Article 57(1) will be far less important. All national tax laws, whether or
not in existence as of December 31, 1993, will be immune from challenge under Article
56(1) if the measure is more directly connected with another freedom than with capital;
the enumerated categories protected by the standstill will be largely irrelevant in this
situation. Hindelang137 points out that this allows Member States to exclude Article 56(1)
133
134
135
136
137
Art.57(1) provides: The provisions of Article 56 shall be without prejudice to the application to
third countries of any restrictions which exist on 31 December 1993 under national or Community
law adopted in respect of the movement of capital to or from third countries involving direct
investmentincluding in real estateestablishment, the provision of financial services or the
admission of securities to capital markets. The Treaty of Accession of the Republic of Bulgaria and
Romania adjusted Article 57(1) to permit restrictions existing in the national laws of Bulgaria, Estonia
and Hungary as of December 31, 1999. See the Act concerning the conditions of accession of the
Republic of Bulgaria and Romania [2005] OJ L157/209 at Article 16.
See Smit, fn.12.
Case C-157/05 Holbock [2007] ECR I-4051 at [41].
Case C-101/05 [2007] ECR I-11531 at [48][52], available at: http://curia.europa.eu/en/index.htm.
Fn.113 at 61.
657
BRITISH TAX REVIEW

selectively in respect of third countries by choosing a regulatory approach directed at
another freedom.
The interpretive issues of whether a national (or Community) law is adopted in respect
of the movement of capital to or from third countries and whether it involves one of
the enumerated categories of direct investment, establishment, the provision of financial
services or the admission of securities to capital markets are not easily resolved.138 This
is despite the statement of the Court in Sanz de Lera139 that Article 57(1) is precisely
worded, with the result that no latitude is granted to the Member States or the Community
legislature regarding either the date of applicability of the restrictions or the categories of
capital movements which may be subject to restrictions.
An objective interpretation of Article 57(1) would allow its application only to measures
that are primarily directed at capital movements between Member States and third
countries involving the enumerated categories. However, the ECJs application of Article
57(1) in Holbock rejects this approach. The impugned tax measures were general in
their application to all inbound dividends regardless of whether the Austrian shareholder
held all, or only a tiny fraction of, the shares of the foreign company and whether the
company was resident in the EU or a third country. Applying a subjective approach to
the application of Article 57(1) to Mr Holbocks particular circumstances, and specifically
his two-thirds shareholding in the Swiss company, the Court held that the impugned tax
measure involved direct investment or establishment. Article 57(1) therefore protected the
restrictive tax measure, which dated from before 1994, in its application to the dividends
received on the shares.
One might ask how a general dividend taxation measure can be adopted in respect of
the free movement of capital when it applies equally to all dividends whether derived
from a shareholding of only a fraction of one per cent, or from a shareholding amounting
to exercise of the right of establishment. The answer must be that the Court reads
Article 57(1) with emphasis on without prejudice to the application to third countries of
restrictions140 and interprets inclusively the condition that the law be adopted in respect
of free movement of capital. On this basis, a general law that, regardless of its primary
purpose, has restrictive effects on capital movements in its application to a third country
is saved by Article 57(1) if the circumstances of the case involve direct investment or
establishment (or the other categories). The Courts often repeated statement in other
circumstances, that limitations on fundamental freedoms are to be interpreted narrowly,
has not been made in relation to Article 57(1).
The Holbock approach to Article 57(1) based on the particular circumstances of the
case potentially gives this provision extraordinary scope. Article 57(1) could be applied
to grandfather restrictive capital gains taxation measures that apply generally to all
capital property where the property is real property, or a direct investment of any kind.141
This would mean that the application of Article 57(1) is not restricted to measures that
are within its purpose, that is, to allow Member States to retain their pre-1994 market
access restrictions protecting certain sensitive and regulated sectors from third country
138
139
140
141
See the analysis of D.S. Smit, fn.12.

C-250/94 [1995] ECR I-482 at [44]
Emphasis added.
At the extreme, it could apply to exclude the application of Art.56(1) to dividends on portfolio
investments in securities admitted to capital markets, but given the approach in FII Test Claimants
with respect to the dividends from third countries on portfolio holdings, this seems very unlikely.
658

investors. It would allow Member States to continue to apply general measures that restrict
free movement of capital with third countries, even when market access is unrestricted,
provided the capital movement is connected to any of the enumerated categories.
As outlined earlier, it seems that a third country resident who sells residential real
property in Finland in circumstances where an EU national (or resident) would be
entitled to capital gains tax relief should be able to rely on Article 56 to gain entitlement
to equivalent tax relief, based on Hollman. If the Finnish tax rules were in place at the
end of 1993, Article 57(1) may grandfather them as a restriction involving real estate
according to Holbock, even though the purpose of the tax rules is not to protect against
excessive foreign ownership of Finnish land. With respect to capital gains tax on shares
or units of collective investment undertakings listed for trading on capital markets, one
can anticipate an argument that Article 57(1) applies, as it protects restrictions involving
admission of securities to capital markets. The Holbock method of applying Article 57(1)
transforms it from a general provision allowing pre-1994 national restrictions on access
to the EU market to remain, to a provision that can be applied either where the specific
facts involve the enumerated categories of investment or the restrictive measure generally
applies to movements of capital including the enumerated categories.
Although direct investment is defined by Annex I and the Court has adopted this
definition in a number of judgments,142 there is still uncertainty as to its parameters.
The concept concerns investments of any kind, and in particular the acquisition of shares
in companies or the lending of funds which serve to establish or maintain lasting and
direct links between the persons providing the capital and the undertaking that receives
the capital for carrying out economic activities. With respect to company shares, a direct
investment implies that the shareholder holds sufficient shares to allow the shareholder,
either according to relevant law or in some other way (perhaps through a shareholder
voting agreement), to participate effectively in the management of that company or in
its control. However, direct investment is met at a lower threshold than establishment,
which implies the holding of actual legal (or de facto) control by a single shareholder, not
simply ability to participate in control. Portfolio investments in shares are made solely
with the intention of making a financial investment without any intention to influence the
management and control of the undertaking.143
The line between direct and portfolio investments is obviously critical in determining
whether Article 57(1) can protect a national measure. Direct investment is not a term
defined by international tax norms. There are a range of possible levels of investment in
shares that may amount to direct investment. In Amurta, 14 per cent was seen as falling
within free movement of capital but this does not necessarily lead to a presumption that
this was a portfolio holding, as Article 57(1) was not in issue in that case. Other possible
thresholds are 10 per cent,144 as is implied by the Parent-Subsidiary Directives definition
of parent and subsidiary as of 2009, or 25 per cent as is the threshold in the Interest
and Royalty Directive. In DTCs between OECD members, the reduced withholding rate
142
143
144
Case C-446/04 FII Test Claimants [2007] STC 326; [2006] ECR I-11753 at [180][181]; Case C157/05 Holbock [2007] ECR I-4051at [34]-[35]; Case C-284/04 Commission v Netherlands [2006] ECR
I-9141 at [19].
Case C-284/04 Commission v Netherlands [2006] ECR I-9141.
A.J. Easson, Taxation of Foreign Direct Investment: An Introduction Series on International Taxation
No. 24, (Kluwer Law International, The Hague, 1999) at 2 states that usually, a threshold figure of
10 percent is taken to distinguish direct from portfolio investment.
659
BRITISH TAX REVIEW

for inter-corporate dividends tends to fall between 10 per cent and 25 per cent, perhaps
indicating that the line between portfolio and direct investment falls within that range.
Since direct investment is a matter of EU law for the purposes of Articles 56 and
57, the definitions in national law and considerations applied by the national courts in
domestic cases and DTCs will not necessarily be adopted by the ECJ. The definition is
based in part on intention and circumstances, as is the definition of portfolio investment in
the ECJs case law. It will therefore have to be given substance on a case-by-case basis. A
10 per cent shareholding in a company may be a direct investment in some circumstances,
but not in others, depending on the relative voting power of the other shareholders and
the length of time the shares are held, or the intention of the holder in acquiring them.
The intra-EU direct tax case-law has compelled the Member States to amend their tax
rules in numerous areas, often in anticipation of, rather than in response to ECJ rulings.145
The Commission often takes a judgment in favour of a taxpayer against a particular
national tax law in a preliminary ruling reference as a model for infringement proceedings
against other Member States, so that the process of delineating the scope of Article 56 is
ongoing, even in the intra-EU context. The absence of direct tax rulings based on free
movement of capital before 2000 (and 2006 in relation to third countries) could mean that
since 1993 there have been many changes to Member States tax laws that restrict third
country capital movements and are not protected by Article 57(1).
Article 57(2): existing Community competence and amendments in the Treaty of Lisbon
Article 57(2) sets out the Councils power to legislate by qualified majority in the same
broad categories of capital movements as are listed in Article 57(1) with respect to
third countries, and requires unanimity where the measure constitutes a step back in
liberalisation of capital movements.146 In the case of direct tax measures, unanimity is
required for EU legislation in any event pursuant to Articles 94 and 95(2). Although
unanimity is very difficult to attain in an EU of 27 Member States, it is quite conceivable
that the Council could adopt a measure to protect national (or EU) direct tax laws from
challenges by third country litigants, and indeed the pending amendments in the Treaty
of Lisbon, described below, indicate that all Member State governments have approved
this in principle.
145
146
For example, many Member States amended their inbound dividend rules in response to the Verkooijen
line of cases and the Communication from the Commission to the Council, the European Parliament
and the European Economic and Social Committee, Dividend taxation of individuals in the Internal
Market COM(2003) 810 final, Brussels, December 19, 2003. These include Germany, France, the
United Kingdom, Italy, Belgium and the Netherlands. See R.J.Vann, General Report and U. Ilhi
et al., Dividend Taxation in the European Union in Cahiers de droit fiscal international (Kluwer,
Law International, The Hague, 2003) Vol. LXXXVIIIa 21 and 71 respectively; and the discussion of
The Demise of Imputation in M.J. Graetz and A.C. Warren Jr., Income Tax Discrimination and
the Political and Economic Integration of Europe (2006) 115 Yale Law Journal 1186 at 1208.
Art.57(2) provides: Whilst endeavouring to achieve the objective of free movement of capital between
Member States and third countries to the greatest extent possible and without prejudice to the other
Chapters of this Treaty, the Council may, acting by a qualified majority on a proposal from the
Commission, adopt measures on the movement of capital to or from third countries involving direct
investmentincluding investment in real estateestablishment, the provision of financial services
or the admission of securities to capital markets. Unanimity shall be required for measures under
this paragraph which constitute a step back in Community law as regards the liberalisation of the
movement of capital to or from third countries.
660

Article 57(2) is not easily interpreted. This provision has not been expressly relied
on as the legal basis of any Community tax measure, and the ECJ has not had occasion
to address its scope. It seems clear at least that liberalising measures on third country
movements of capital which involve the enumerated categories require only a qualified
majority. Measures which have the effect of placing additional restrictions on such
EU-third country capital movements require unanimity.
As discussed with respect to Article 57(1), it is not obvious how to determine whether
a measure is on capital movements to or from third countries involving (or not)
direct investment, etc. If the Court applies a strict approach, a measure would have to
be directly or primarily concerned with capital movements with third countries, and
involve the enumerated categories, for Article 57(2) to apply. If Article 57(2) covers any
measure that has effects on third country capital movements, whether or not this is the
intended, primary or direct effect, and also involves the enumerated categories, it is a very
broad basis of legislative competence given the extensive overlap of capital movements
with financial services, establishment, direct investment and securities admitted to capital
markets.
Article 2(60)147 of the Treaty of Lisbon will, when (and if) it enters into force, amend
Article 57(2) to clarify the legislative process for acts relating to the liberalisation of
capital movements with third countries. The European Parliament and the Council will
jointly adopt such measures in accordance with what is now the co-decision procedure
in Article 251. The second sentence of the current Article 57(2) will become paragraph
57(3), so that only the Council, acting in accordance with a special legislative procedure,
may unanimously, and after consulting the European Parliament, adopt measures which
constitute a step backwards in Union law as regards the liberalisation of the movement of
capital to or from third countries.148
Most significantly, a new paragraph (4) is added to Article 58, that applies where
no measure has been adopted pursuant to the new Article 57(3). It will empower the
Commission to adopt a decision, on the request of a Member State, that restrictive tax
measures adopted by a Member State concerning one or more third countries are to be
considered compatible with the Treaties in so far as they are justified by a Union objective
and compatible with the proper functioning of the internal market. If the Commission
fails to adopt such a decision within three months of the Member States request, the
Council may adopt the decision by unanimity.
New Article 58(4) reinstates a hierarchy between free movement of capital within the
EU and with third countries that was eliminated in 1994 by Article 56(1), empowering
the Union institutions to limit the latter in any situation where the restrictive tax measure
will not impede the functioning of the internal market. Since the purpose of the extension
of Article 56(1) to third countries in 1994 was ostensibly to support the euro as an
international reserve currency, and no specific objective related to the internal market has
been identified, it is difficult to make a case that tax measures that restrict free movement
of capital with third countries can impede the functioning of the internal market. The
147
148
In the consolidated versions of the new treaties as they will read after the Treaty of Lisbon is ratified,
[2008] OJ C 115/47 at 73, Art.58(4) will be renumbered as Art.65(4) of the Treaty on the Functioning
of the European Union.
New EC Treaty Art.249A states that a special legislative procedure refers to specific cases provided
for in the Treaties where the Council adopts an act with the participation of the European Parliament,
or vice versa.
661
BRITISH TAX REVIEW

euro has already achieved global status as an important international currency rivaling the
US dollar, so that it will be difficult to show that a restrictive tax measure could jeopardise
achievement of that goal.
More interesting will be the invoking of Union objectives to justify restrictive tax
measures, as these will be less a matter of Treaty interpretation by judges and more a
question of political and economic vision as to the future goals of the Union by Member
State and Union governance actors. New Article 58(4) could eliminate, from a practical
perspective, the standstill obligation on Member States in Article 57(1) with respect to
their tax laws, depending on the willingness of the Commission to approve new restrictive
measures, or the solidarity of the Member States in the Council in defending each
others tax sovereignty vis-à-vis third countries. The three-month time period for the
Commission to adopt a decision under Article 58(4) is very short, perhaps indicating that
Member States prefer to have control over the policy in the Council.
New Article 58(4) is also clearly a significant restriction of the Courts jurisdiction
to define the third country dimension of free movement of capital. The opportunity to
regain power for the Member States in negotiating tax treaties, and reinstate reciprocity
in the liberalisation of free movement of capital with third countries may well influence
Commission and Council in exercising their power under the new provision. The Court,
by contrast, has held that loss of negotiating power and reciprocity as a result of the
extension of free movement of capital to third countries is not a decisive consideration in
determining whether a tax measure is restrictive under Article 56(1) in respect of third
countries.149
Comparability of restriction and justifications in third country cases
As indicated at the beginning of this Part, the judgments in Skatteverket v A and FII Test
Claimants in particular confirm that the prohibition of restrictions on free movement of
capital applies in principle in third country cases as in intra-EU situations. However, the
Court also affirmed in these cases that it views the third country dimension in a different
legal context that results from the degree of legal integration within the EU.
The different legal context is relevant to both stages of the inquiry, that is, to whether
two differently treated situations are objectively comparable for the purposes of Article
58(1)(a), and thus whether a measure is incompatible with Article 56, as well as to whether
the measure is justified.150 Even though this has not been the basis of a ruling so far, in
a future case the Court may rely on differences between the legal context inside the EU
and in third countries to find that the situations are not the same, and that in the third
country situation Article 58(1)(a) precludes a finding of restriction.
With respect to justifications, those that have been accepted in intra-EU cases discussed
above151 are undoubtedly also valid in the third country context, supplemented by others
149
150
151
Case C-101/05 Skatteverket v A [2007] ECR I-11531 at [38].

Case C-446/04 FII Test Claimants [2007] STC 326; [2006] ECR I-11753 at [170][171]; Case
C-101/05 Skatteverket v A [2007] ECR I-11531 at [36][37] and Case C-194/06 OESF May 20, 2008
at [89][90].
See the subheading above: Justifications: overriding reasons in the general interest.
662

that have been rejected in intra-EU cases, based on the different legal context.152 The
justification, always unsuccessful in intra-EU cases, of preventing erosion of the national
tax base or diminution of government revenues is one of these. In FII Test Claimants,
this argument, made in the abstract, was dismissed by Advocate General Geelhoed, but
not rejected as untenable in all circumstances. In OESF,153 the Netherlands government
put forward this justification for the reduction in the concession it paid OESF, based
on the proportion of shareholders of OESF that were resident outside the Netherlands.
The reduction was designed to ensure that the Netherlands recouped the difference
in withholding tax on profits of the fund distributed as dividends to residents (25 per
cent) and the lower withholding tax of 15 per cent applied to dividends distributed to
non-residents. The ECJ rejected this argument as a justification in respect of reductions
related to investors resident in the EU since a reduction in tax revenue cannot justify
a restriction of a fundamental freedom. On the issue of whether the measure could be
justified in relation to residents of third countries, the Court did not reject outright the
possibility that a reduction in tax revenue could be justified in the third country context.
However, since the reduction had the same effect for residents of the EU and third
countries, it could not be justified on this basis. This may imply that the measure might
be justified if the less favourable tax treatment affected only third country investors, but
the judgment is not clear on this.
The justification of ensuring the effectiveness of fiscal supervision was accepted in
Skatteverket v A as an independent and sufficient justification for a tax restriction. In
that case, Swedish tax legislation provided a tax exemption for dividends consisting of
shares of a subsidiary of the distributing corporation received from companies resident
outside Sweden, subject to a number of conditions. One of the conditions was that
the DTC between Sweden and the country of the distributing corporation contain a
provision for the exchange of tax information. The Sweden-Switzerland DTC did not
allow for the exchange of tax information as fully as the Mutual Assistance Directive
or the OECD Model Treaty. The taxpayer and the Commission argued that making
the exemption dependent on the Swedish authorities ability under the DTC to ensure
the cooperation of the Swiss authorities was disproportionate given that Sweden could
require the taxpayer to provide that necessary information to establish that the necessary
conditions were fulfilled.154 However, the Court held that with respect to third countries,
capital movements take place in a different legal context which affects the application
of the principle of proportionality. Since the Community legislation on exchange of tax
information (and requirements to publish company accounts) were not applicable, the
Court held that it was legitimate for a Member State to refuse a tax advantage that was
dependent on conditions that it is not able to verify without obtaining information from
the third country and which that country is under no contractual obligation to supply.
The requirement to ensure effective fiscal supervision will undoubtedly be relied on
often in third country cases following Skatteverket v A. For third states, there is no
equivalent multilateral instrument to the Mutual Assistance Directive, although there are
152
153
154
FII Test Claimants at [171]. See the discussion of justifications in third country cases in Cordewener
et al., fn.6 at 114 and in particular the view that the Court may be willing to justify measures that
counteract competition from low tax jurisdictions at 117.
Case C-194/06, May 20, 2008 at [93].
This position has been upheld by the Court within the EU in many cases. Recent among these is Case
C-451/05 ELISA 11 October 2007 at [97][98].
663
BRITISH TAX REVIEW

other mechanisms for sharing of tax information, including the Convention on Mutual
Administrative Assistance in Tax Matters, sponsored by the Council of Europe and the
OECD. Belgium, Denmark, Finland, the Netherlands, Poland, Sweden and the United
Kingdom have ratified this Convention, as have a number of EEA and other non-EU
Member States including the United States.155
Some DTCs between EU Member States and third countries contain broad provisions
for exchange of tax information, and even mutual assistance in tax collection. However,
the provisions of the Convention and DTCs may not be seen as equivalent to the Mutual
Assistance Directive if they do not require the same level of automatic disclosure of
information and possibility for cooperation of tax authorities generally. The Court may
treat the Mutual Assistance Directive as having more significance as a tool for obtaining
information from foreign competent authorities because it is a domestic EU measure
with direct effect and of which the Court is the ultimate interpreter.
The justification of prevention of fiscal evasion is closely related to and overlaps with
that of ensuring effective fiscal supervision, so it may be anticipated that the ECJ will
be equally willing to accept the former justification more broadly in third country cases.
Moreover, given the Courts evident concern that Article 56(1) could be illegitimately
relied on to obtain access to the other fundamental freedoms, the doctrine of abuse
of law that allows the Court to refuse the benefit of a fundamental freedom if it is
improperly or fraudulently used to circumvent national law arises for consideration in the
third country dimension.
The issue arose in Fidium Finanz, where it was argued that the Swiss lender was
seeking to abuse Article 56(1) in order to circumvent the German law on supervision of
financial undertakings. The Advocate General recommended that this issue be referred
to the national court for an objective determination of whether the conduct of Fidium
Finanz was within the objectives of free movement of capital between the EU and third
countries, and a subjective determination of whether Fidiums intention was to artificially
create the conditions to use Article 56(1) to circumvent the law on supervision of financial
dealings.156 (The ECJ did not address this issue, having found that Article 56(1) was
inapplicable.)
In Cadbury Schweppes,157 the Court held that the fact that a Community national seeks
to take advantage of lower taxes in another Member State cannot of itself constitute an
abuse of the freedom of establishment. The purpose of freedom of establishment is to
allow EU nationals the opportunity to choose where to base their commercial activities,
and thereby to benefit from more favourable legislation in the host Member State.158 In
Barbier159 the Court held that a Community national cannot be deprived of the right to
rely on Article 56(1) just because he has taken advantage of a rule in another Member
State that legally permits him to avoid or delay a tax liability.
In the third country direct tax cases, the question of abuse of law has two aspects. It
could arise where a third country individual or undertaking seeks to rely on Article 56(1)
155
156
157
158
159
Norway, Iceland and Azerbaijan have also ratified this Convention. Canada and the Ukraine have
signed the Convention but it is not yet in force in these countries.
Case C-452/04 [2006] ECR I-9521 at [94][99].
Case C-196/04 Cadbury Schweppes [2006] STC 1908; [2006] I-7998 at [35][37].
Two leading cases on abuse of law in the area of freedom of establishment are Case C-212/97 Centros
[2000] STC 446; [1999] ECR I-159 and Inspire Art [2003] ECR I-10155.
Case C-364/01 Barbier [2003] ECR I-5013 at [71].
664

to gain access to other Treaty freedoms (as in Fidium Finanz), or when Article 56(1) is
invoked to challenge a national tax law that imposes a heavier tax burden on third country
capital movements. The first situation will likely arise infrequently, as the Court has
clearly signalled its intention to exclude application of Article 56(1) where another Treaty
freedom is directly concerned, though on a different legal theory. In the second situation,
where only free movement of capital is applicable, such as in respect of dividends on
shareholdings that do not amount to establishment, it is difficult to see reliance on Article
56(1) to obtain equal tax treatment as abusive unless there is an element of artificiality in
the investment.
Conclusions
Points of vulnerability in Member States tax laws
As discussed above, the taxation of income from portfolio investments, by third country
investors in EU shares and other securities, and by EU investors in such assets in third
countries, as well as wealth and inheritance tax, capital gains tax relief and donations to
and taxation of foreign charities are the least likely to be affected by the two primary
limitations resulting from the Fidium Finanz judgment and the effects of Article 57(1). It
is in these areas that the third country dimension is likely to have the greatest impact.
The discriminatory tax treatment of investments by third country pension and
investment funds in shares and interest-bearing debt issued by EU entities are potentially
subject to challenge, given the number of intra-EU infringement actions initiated by
the Commission within the EU based on Article 56. In many cases, Member States
provide tax exemptions or other relief for resident funds but impose withholding tax
on interest and dividends paid to foreign funds. In the other direction, third country
investors in a collective investment entity established in a Member State may be entitled
to equivalent tax treatment to investors resident in the relevant Member State. OESF
clearly prohibits more favourable treatment of collective investment funds that have only
resident shareholders over those that have shareholders resident in other Member States;
this most likely extends to funds that have shareholders resident in third countries.
With respect to inbound dividends received by an EU resident from a third country,
the Member States system for taxing domestic dividends will be compared to the tax
imposed on the foreign source dividends. Following FII Test Claimants, a measure
favouring domestic over foreign dividends will infringe the third country dimension of
Article 56(1) in the case of portfolio dividends. Article 57(1) will save tax restrictions
applied to non-portfolio dividends where the restrictive tax rule was in existence before
1994. The system of taxation of dividends in each Member State, particularly those that
acceded after 1993, will have to be analysed to see which restrictive measures are of
sufficient vintage to survive.
The future
The third country dimension of Article 56(1) is potentially very significant for the
international taxation of investment and income from capital. Given the very impressive
flows of capital between the EU and third countries, the implications for EU Member
States tax systems and revenues could be significant. The future third country direct tax
665
BRITISH TAX REVIEW

cases must address complex issues with regard to when a measure involves free movement
of capital and not, or not primarily, another freedom, the application of Article 57(1),
the role of DTCs in neutralising restrictions and the circumstances in which existing
justifications as well as new ones applicable to the third country dimension should be
applied.
The first of the issues that has yet to be fully illuminated is how to draw the line between
direct and portfolio investment for the purpose of applying the standstill in Article 57(1).
The Court (and Annex I) have provided broad parameters, but the actual determination
will often be left to the national court that referred the case. Nevertheless, it is to be hoped
that the Court will take future opportunities to refine the test in the interest of certainty
and uniformity. The related issue of the proper application of Article 57(1) has been fairly
well defined by the ECJ, allowing the national courts to carry out the factual analysis of
whether a measure is to be treated as in place from December 31, 1993.
Another unresolved issue is how the Court will develop the application of the
predominant aspect test in tax cases. At one end of the spectrum of possibility, the
Court may apply the Fidium Finanz/Thin Cap approach broadly to exclude Article 56(1)
wherever the impugned tax measures affect income or deductions derived in connection
with transactions which involve financial services or establishment, or in connection with
the exercise of free movement rights by workers and EU citizens. Or, less probably, it may
favour the Holbock analysis, treating general tax rules as not primarily concerned with
a particular freedom, so that recourse to Article 56(1) is not automatically excluded in
circumstances where another freedom would also be relevant if the movement of capital
was between EU Member States.
In looking to the future, it must be recognised that the new powers of the Commission
and Council under the Treaty of Lisbon, if and when it enters into force, to declare
restrictive Member State tax measures with respect to third countries to be compatible
with EU law could have the effect of excluding any significant impact of the third country
dimension on direct taxation. This will depend on the way these institutions, and the
Member States, perceive the scope and proper use of these powers. Although the ECJ will
still have ultimate power to determine whether Commission or Council has exercised the
power within the authority conferred by the EC Treaty in a given instance, the powers
accorded by new Article 58(4) are undoubtedly broad, and it is difficult to imagine a tax
restriction with respect to one or more third countries that would not be consistent with
the functioning of the internal market.
The potential impact of Article 56 in relation to free movement of capital between
Europe and the rest of the world is clear and significant. The actual impact will depend
on the degree to which investors in both third countries and the EU assert their rights in
Member State national courts.
EC law; Free movement of capital; Third countries
666

Free Movement of Capital and Third Countries Miha

Diunggah oleh

Informasi Dokumen

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

Free Movement of Capital and Third Countries Miha

Diunggah oleh

Hak Cipta:

Format Tersedia

Taxation and the Third Country

Dimension of Free Movement of

Sweet & Maxwell

Electronic copy available at: http://ssrn.com/abstract=1356125

Taxation and the Third Country Dimension of Free

Electronic copy available at: http://ssrn.com/abstract=1356125

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

certain groups as in Case C-54/99 Eglise

Case E-1/00, State Debt Management Agency v Islandsbank

BRITISH TAX REVIEW

Case C-54/99 Eglise

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

C-484/93 [1995] ECR I-3955.

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

Case C-204/90 [1994] STC 855; [1992] ECR I-249.

BRITISH TAX REVIEW

Case C-120/78 Cassis de Dijon [1979] ECR 649.

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

See the analysis of D.S. Smit, fn.12.

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

Case C-101/05 Skatteverket v A [2007] ECR I-11531 at [38].

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EU FREE MOVEMENT OF CAPITAL: THIRD COUNTRY ISSUES

BRITISH TAX REVIEW

EC law; Free movement of capital; Third countries

Anda mungkin juga menyukai