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Communication published on application of anti-abuse measures in area of direct taxation – within the EU and in relation to third countries

On 10 December 2007, the European Commission published a Communication (COM(2007) 785 final), entitled "The application of anti-abuse measures in the area of direct taxation – within the EU and in relation to third countries". The Communication seeks to provide a framework for further discussions with the Member States and stakeholders on the possibilities for coordinated solutions in the area of anti-abuse rules. This Communication follows up on the Commission's 2006 Communication regarding the coordination of the Member States' direct tax systems in the Internal Market and results from the various decisions of the European Court of Justice (ECJ) on the application of anti-abuse measures.
In the light of these decisions, the Commission considers that it is necessary to:

-   strike a proper balance between the public interest of combating abuse and the necessity to avoid disproportionate restrictions on cross-border activity within the EU; and
-   better coordinate the application of anti-abuse measures in relation to third countries in order to protect the Member States' tax bases.

ECJ case law

The Communication indicates that the leading principle developed in the ECJ's case law is that abuse only occurs where, despite the fact that the conditions laid down in the relevant Community rules are formally observed, their purpose is not achieved and an intention exists to obtain an advantage by artificially creating the conditions to obtain it (Halifax and Emsland-Stärke, C-110/99). The Commission further observes that it follows from the ECJ's case law that anti-abuse measures can only target wholly artificial arrangements aimed at circumventing the application of the relevant Member State's legislation.

Referring to the ECJ's judgments in Cadbury Schweppes and Thin Cap GLO, the Commission observed that the detection of a wholly artificial arrangement requires a substance-over-form analysis. Objective factors to determine the existence of sufficient substance include (i) the effective place of management, (ii) tangible presence of the establishment and (iii) the real commercial risk borne by that establishment. The Commission also notes that it is not entirely clear how the above-mentioned criteria may apply in respect of, for example, intra-group financial services and holding companies, whose activities generally do not require significant physical presence.

While acknowledging that the application of the principles derived from the ECJ's case law will ultimately depend on the facts of particular cases, the Commission proposes to explore together with the Member States and with input from the business community the practical application of these principles to different types of business activities and structures.

Application of anti-abuse rules within the EU/EEA

According to the Commission, taxpayers must have the possibility to prove, without undue administrative constraints, that a commercial justification exists for the transaction challenged under anti-abuse rules, to ensure that genuine establishments and transactions are not affected.

The Commission is not in favour of extending the scope of anti-abuse measures, designed to counter cross-border tax avoidance, to purely domestic situations where no risk of abuse exists, in order to avoid the charge of discrimination. This approach would undermine the competitiveness of the relevant Member State and is not in the interest of the internal market.

To avoid qualification mismatches arising from the interaction of the Member States' tax systems, which may result in non-taxation and provide scope for abuse, the Commission suggests improving administrative cooperation to identify potentially abusive practices (unless the mismatches are already successfully tackled at source).

Common types of anti-abuse provisions

(a) CFC rules. With respect to CFC rules, the Commission notes that it is necessary to ensure that these rules are targeted at wholly artificial structures and that taxpayers have the opportunity to prove that their transactions serve a bona fide business purpose.

(b) Thin capitalization provisions. In respect of thin capitalization rules, the Commission is of the opinion that Member States should be able to protect their tax bases from artificial erosion through structured debt financing. The Commission observes that some Member States have automatically extended the scope of their thin capitalization rules to purely domestic situations, following the ECJ's judgment in Lankhorst-Hohorst, to avoid the charge of discrimination; this is not a desirable development in view of the competitiveness of those Member States and the internal market. Referring to the Thin Cap GLO case, the Commission noted that thin capitalization rules are not per se impermissible, provided that they are targeted at purely artificial arrangements. According to the Commission, the principles set out in the ECJ's decisions regarding thin capitalization provisions also apply to transfer pricing rules, which are essential to the continued existence of national tax systems.

Application of anti-abuse provisions in relation to third countries

As regards the application of CFC and thin capitalization rules in relation to third countries, the Commission observed that these rules must comply with the free movement of capital (Art. 56 of the EC Treaty), if they are not confined to situations and transactions between companies in a corporate group or otherwise related parties where one has a definite influence over the other. Thus, whenever and to the extent that these measures fall within the scope of Art. 56 (which applies vis-à-vis third countries) CFC and thin capitalization rules may be applied to wholly artificial arrangements only, unless there is no adequate exchange of information with the third country concerned.

Finally, the Commission considers that the Member States should improve the coordination of their anti-abuse measures with respect to third countries through the exchange of information and sharing best practices.

Conclusions

To reach coordinated solutions in the area of anti-abuse rules, the Commission proposes to:

-   develop common definitions for abuse and wholly artificial arrangements, in order to provide guidance on their application in the area of direct tax;
-   improve the administrative cooperation, in order to detect and contain abuse and fraudulent tax schemes more effectively;
-   share best practices compatible with EC law, to ensure the proportionality of anti-abuse measures;
-   reduce potential mismatches resulting in inadvertent non-taxation; and
-   ensure a better coordination of anti-abuse measures in relation to third countries.

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