European Union: Advocate General's Opinion Is That An Immediate Exit Charge On Unrealised Gains On Branch Assets On Cessation Of Trade Or Transfer To Another EU Member State Breaches Freedom Of Establishment

Last Updated: 14 August 2012
Article by Ashley Greenbank

Advocate General Mengozzi has recently delivered his opinion in the case of European Commission v Portuguese Republic ECJ Case C-38/10. Under Portuguese law, where a Portuguese permanent establishment of a company resident in another EU member state closes down its Portuguese branch activity or transfers assets out of Portugal back to the non-resident company's head office or to a permanent establishment which it has in another member state, there is an immediate charge to tax on the unrealised capital gains which have arisen on the branch's assets or on the assets which are transferred. The European Commission brought infraction proceedings before the ECJ alleging that this "exit charge" breaches freedom of establishment under what is now article 49 TFEU. Applying the reasoning of the ECJ in National Grid Indus BV Case C-371/10, the Advocate General proposes in his opinion that the ECJ should uphold the European Commission's complaint and declare that the Portuguese exit charge is an unlawful restriction on freedom of establishment.

In the National Grid Indus BV case, the ECJ held that, where a company transferred its place of effective management from the Netherlands to another member state, article 49 TFEU did not preclude Dutch legislation under which unrealised capital gains on the company's assets were liable to tax and the amount of tax was fixed definitively at the time of the transfer. Such legislation was appropriate for ensuring the balanced allocation of powers of taxation between the member states, as it charged tax on capital gains to the extent that they arose in the territory. However, article 49 did preclude Dutch legislation which provided for the immediate charging and recovery of that tax. An immediate charge to tax was not proportionate to the objective being pursued and was discriminatory, as there was no such immediate charge on a comparable transaction carried out in a wholly domestic context and, therefore, no equivalent cash flow disadvantage. Furthermore, the resulting restriction on freedom of establishment could not be justified, as there were other, less onerous measures which would both safeguard that freedom and preserve the right of the Netherlands to tax capital gains arising in its territory.

In particular, recovery of the tax on the unrealised gains could be deferred until the capital gains are realised, thereby avoiding the cash flow disadvantage and ensuring equivalence with a wholly domestic situation. As deferred recovery of the tax would require the company to trace the various assets until the time of realisation and could, therefore, in cases involving large numbers of assets, give rise to an excessive administrative burden which could itself hinder freedom of establishment, an option could be given to the company to elect for immediate or deferred payment of the tax to suit its own needs. Where a company elects for deferred payment, the existing machinery for mutual assistance between the revenue authorities of the member states should be sufficient to enable them to check the accuracy of the company's asset tracing records. An election for deferred payment might involve the taxpayer incurring interest in accordance with applicable national legislation and the risk of non-recovery of the tax might be averted by the requirement of a bank guarantee.

In his opinion in thePortuguese Republic case, the Advocate General effectively extends the reasoning of the ECJ in National Grid Indus BV, with some minor modifications, to comparable transactions involving permanent establishments. Portuguese legislation under which tax on unrealised capital gains on the assets of a Portuguese permanent establishment of a company resident in another EU member state was fixed definitively at the time when it ceased trading in Portugal or transferred assets out of Portugal back to the head office or to another permanent establishment of the non-resident company was, in his view, proportionate. However, the immediate charging and recovery of the tax at that time was disproportionate, if it would not be immediately charged and recovered in a wholly domestic situation.

On the charging of interest between the date on which the tax is fixed (but deferred) and the date when it is recovered (on realisation of the asset), the Commission argued that this was intrinsically discriminatory, since resident taxpayers were not charged interest in a wholly domestic situation. The Advocate General did not agree. Where tax is fixed but payment is deferred, the interest charged is equivalent to interest on a loan to the company. Accordingly, charging interest is not discriminatory, provided national legislation generally applicable to the recovery of tax claims charges interest in equivalent situations where taxpayers can opt for deferred payment.

On the requirement for a bank guarantee, the Advocate General pointed out that the systematic imposition of such a requirement could have an equally restrictive effect on freedom of establishment as the immediate recovery of the tax. The Commission argued that member states should only be permitted to require a bank guarantee if there was a genuine and serious risk of non-recovery of the tax. The Advocate General agreed and added that the guarantee should not necessarily be for the full amount of the tax. However, the Advocate General was of the view that, where branch assets are transferred out of Portugal by a continuing branch, the option for deferred recovery should not be made subject to the provision of a bank guarantee, since the host member state retains fiscal sovereignty over the branch and, in principle, that guarantees recovery of the tax.

It surely cannot be long before the UK is obliged to amend its exit charge regime relating to permanent establishments (in particular, TCGA 1992 s.25) and possibly other taxes on comparable cross-border transactions which are less favourable than the tax treatment of equivalent transactions in a wholly domestic UK situation. The European Commission has recently requested the UK to amend its exit charge on companies ceasing to be resident in the UK (TCGA 1992 s.185).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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