European Union: EU Tax Alert 200

Highlights in this edition

European Parliament approves EU Emission Trading System reform and new EU Carbon Border Adjustment Mechanism

On 18 April 2023, the European Parliament approved important components for the 'Fit for 55' legislative package, which includes a reform of the EU Emissions Trading System (ETS) and the creation of the EU Carbon Border Adjustment Mechanism (CBAM).

The ETS will see a significant change in the phase-out of free allowances, which will take place between 2026 and 2034. The revisions will also increase the overall goal for emissions reductions to 62% by 2030 compared to 2005 levels, and increase the annual reduction rate of the cap to 4.3% from 2024 to 2027, and 4.4% from 2028 to 2030. The EU ETS will be extended to maritime transport and include non-CO2 emissions such as methane and nitrous oxide. A new EU Social Climate Fund will be established in 2026 to support vulnerable households and micro-enterprises.

The CBAM is a climate policy designed to prevent carbon leakage by establishing an equivalent carbon price for imports and EU domestic production that are subject to carbon costs under the EU ETS. The scope of goods covered has significantly increased and will apply to downstream products as well. The product list will also likely be extended to cover all product categories subject to the EU ETS by 2030.

The new CBAM rules require importers to report the total verified greenhouse gas emissions in goods imported in a given calendar year. CBAM payments will be facilitated through the purchase of CBAM certificates.

CJ judgment on the compatibility of German tax rules for non-resident closed-end real estate funds with the free movement of capital (L Fund, C-537/20)

On 27 April 2023, the CJ delivered its judgment in the case L Fund (C-537/20). The case deals with the issue of whether the German corporate income tax, which applies to non-resident closed-end real estate funds, is in line with the free movement of capital.

The case involved a Luxembourg closed-end fund (L Fund), which generated revenue by renting and selling real estate properties in Germany. The fund had two institutional investors, both of which were located outside Germany and had no central administration or registered office in that country. According to German tax law, closed-end real estate funds based in Germany with exclusively non-resident investors are exempt from paying corporate income tax at the level of the fund. In these cases, the immovable property income is attributed directly to the non-resident investors and the relevant tax is withheld by the German fund. Differently, non-resident closed-end real estate funds are not exempt from German corporate tax in relation to their immovable property income, which is taxable at the fund level. L Fund considered that this treatment was not in line with the free movement of capital.

In its judgment, the CJ first evaluated whether the distinction in treatment made by the aforementioned German law was linked to situations that are objectively comparable. The CJ found that the sole criterion of distinction in the German law was the tax residency of the fund, as the corporate income tax exemption and the obligation to withhold tax on behalf of non-resident investors only applied to domestic funds. Thus, the Court concluded that resident and non-resident closed-end real estate funds were in a comparable situation.

Next, the CJ analysed the justifications put forward by the German government to defend the rules in question. Such alleged justifications referred to: (i) the need to ensure the coherence of the German tax system, and (ii) the need to ensure a balanced allocation of taxing rights. First, the Court stated that justifying a tax benefit on the grounds of tax system coherence required a direct correlation between such benefit and its offsetting with a relevant tax charge. The CJ left to the referring Court the task of determining whether such correlation exists or not. In any case, and regardless of whether such a direct link exists, the CJ found that the measure in question was disproportionate because a less restrictive measure was available. Pursuant to the Court, such a measure would be to exempt foreign closed-end real estate funds, as long as the investors pay a tax equal to that paid by investors in a German closed-end real estate fund. Furthermore, the CJ held that the rules in question might not meet the objective of the legislation, as German investors in foreign closed-end real estate funds may be subject to double taxation, with property income taxed initially at the fund level, followed by taxation at the investor leve

Second, the CJ dismissed the justification of ensuring a balanced allocation of tax jurisdiction, based on the understanding that this justification could not be invoked in cases where a Member State chose not to tax domestic funds on the income received from immovable property.

Considering these lack of justifications, the CJ therefore ruled that the aforementioned treatment of non-resident closed-end real estate funds with exclusively foreign investors under German law is against EU law.

AG Kokott's opines that the Commission erred in finding that Luxembourg had granted unlawful State aid to the Engie group in the form of a tax advantage

On 4 May 2023, AG Juliane Kokott delivered her Opinion in the case Engie Global LNG Holding and Others v Commission (Case C-454/21 P). In her Opinion, Kokott proposed that the CJ set aside the judgment of the General Court and annul the Commission decision which found that Luxembourg had granted unlawful State aid to the Engie group in the form of tax advantages.

The Commission found, by decision of 20 June 2018, that Luxembourg had granted the Engie group unlawful State aid in connection with restructuring operations in Luxembourg. In the Commission's view, the group had been granted (by means of tax rulings) tax treatment whereby almost all profits made by two subsidiaries in Luxembourg would ultimately remain untaxed. Even though there was only low taxation at the level of the operational subsidiaries through an agreed basis of assessment, the parent companies benefited from the tax exemption for participation income (group relief). As a result, a selective advantage was granted to the Engie group in derogation from Luxembourg tax law. The Commission considered that a relevant principle of correspondence (tax exemption at the level of the parent company only after taxation at the level of the subsidiary) can be inferred from national law. Moreover, according to the Commission, the tax authorities unlawfully failed to apply an anti-abuse rule.

In a judgment issued on 12 May 2021, the General Court of the European Union, hearing the actions brought by the Engie group and Luxembourg, fully endorsed the Commission's view and dismissed the actions (see Luxembourg e.a./Commission, T-516/18 and T-525/18). The Engie group and Luxembourg thereupon lodged appeals before the CJ.

In her Opinion, AG Kokott proposed that the CJ uphold the appeals and, consequently, set aside the judgment of the General Court and annul the Commission's decision. The AG first emphasised that tax rulings do not, in themselves, constitute illegal State aid and that they are an important instrument for creating legal certainty. Pursuant to Kokott, tax rulings are unproblematic in terms of State aid law as long as they are open to all taxpayers and are in line with the relevant national tax law, which forms the sole reference framework.

In that respect, the AG found that the Commission and the General Court proceeded on the basis of an incorrect reference framework. According to Kokott, both had assumed that the Luxembourg tax law in force at the time contained a principle of correspondence, according to which a tax exemption for participation income at the level of the parent company is contingent on taxation of the underlying profits at the level of the subsidiary. However, the AG considered that such a link is not apparent and cannot simply be interpreted into Luxembourg law because it might be preferable. In Kokott's view, the EU institutions cannot use State aid law to shape an ideal tax law.

In addition, the AG argued in favour of only a restricted standard of review in respect of tax law decisions taken by the tax authorities that is limited to a plausibility check. Not any incorrect tax ruling, but only tax rulings which are manifestly erroneous in favour of the taxpayer may constitute a selective advantage and be considered an infringement of State aid law. Otherwise, the Commission would become a de facto supreme inspector of taxes and the Courts of the European Union, by dint of reviewing the Commission's decisions, would become de facto supreme tax courts, which would impinge on the Member States' fiscal autonomy in the field of non-harmonised taxes. On such basis, Kokott found that, in the present case, the tax rulings were not manifestly erroneous. She further noted that the standard of review should also be reduced to a plausibility check in respect of national tax authorities' review of the application of anti-abuse rules under State aid law. Pursuant to the AG, a manifest misapplication can be assumed only where it is not possible to explain plausibly why the case in question should not be considered a matter of abuse. On such grounds, Kokott found that in the case at hand, the existence of abuse of legal structural possibilities under Luxembourg law was not obvious and has not been established by the Commission.

European Commission Adopts DAC7 Implementing Regulation for Exchange of Information with Third Countries

On 13 April 2023, the European Commission adopted an implementing regulation regarding the assessment and determination of information equivalence in an agreement between a non-EU jurisdiction and a Member State under the seventh version of the EU Directive on Administrative Cooperation (DAC7). The regulation establishes criteria for assessing whether the national law of a non-EU jurisdiction and an agreement between competent authorities ensure that information automatically received by a Member State is equivalent to that required under DAC7 reporting rules for digital platforms. The criteria are: to assess relevant definitions, due diligence procedures, reporting requirements, and administrative procedures, and that the assessment is performed by the European Commission. If the criteria are met, the information exchanged will be deemed DAC7 equivalent and non-EU platform operators will be released from the obligation to register in an EU Member State to comply with their DAC7 reporting obligations.

CJ judgment on VAT liability relating to newly constructed real estate (Promo 54 SA, C239/22)

On 9 March 2023, the CJ delivered its judgement in the case Promo 54 SA (C239/22).

Promo 54 and Immo 2020 concluded a cooperation agreement regarding the transformation of an old school building into newly constructed residential apartments and offices. Buyers of these units concluded a purchase agreement with Immo 2020 for the land. Buyers separately concluded a contracting agreement for the renovation works with Promo 54. The transfer of the land and the realization of the new residential apartments and offices therefore, were split up from each other.

Promo 54 applied the 6% Belgian VAT rate to its contracting supplies. The Belgian tax administration disagreed by arguing that this split-contracting structure was artificial: the parties had, in fact, intended to transfer newly created residential apartments and offices. These supplies would instead have been subject to 21% Belgian VAT. This VAT treatment would then also apply to the contracting supplies of Promo 54. In order to assess whether the 21% VAT rate could apply to the services of Promo 54, it should first be established if the supply takes place before first occupation of the building. As a main rule, the transfer or real estate is exempt from VAT. An exception to this VAT exemption applies to transfers of buildings before their first occupation, which are then deemed VAT taxed. Based on Article 135(1)(j) in conjunction with Article 12(1)(a) VAT Directive, Member States are allowed to indicate in their national VAT legislation when the first occupation of a building takes place.

Promo 54 argued that Belgium did not make use of the possibility to define the conditions under which the 'first occupation' of a building is deemed present in the case of transformation of old buildings. Therefore, according to Promo 54, the Belgian tax administration could not extend the concept of 'first occupation' to a renovated building for which a first occupation had already taken place before its conversion. The referring court asked to CJ to clarify whether the exception to the VAT exemption also applies to the supply of a building which was first occupied before its transformation if the Member State has not laid down the detailed rules for applying the criterion of first occupation to conversions of buildings.

The CJ considered that although Member States are entitled to lay down the detailed rules regarding the application criterion of 'first occupation' to conversions of buildings, Member States are not authorised to alter the concept of 'first occupation' in their national laws. The CJ also stated that the concept of 'conversion of a building' implies that the building concerned must have been subject to substantial modifications intended to modify the use or alter considerably the conditions of occupation of the building. Further, the CJ ruled that the supply of a renovated building can also be subject to VAT if the Member State did not lay down the detailed rules for applying the criterion of first occupation to conversions of buildings.

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