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ECJ: Interprets anti-avoidance clause under the Merger Directive with respect to Danish rules on taxation of exchanges of shares – details

On 5 July 2007, the European Court of Justice (ECJ) gave its decision in the case of Hans Markus Kofoed v. Skatteministeriet (C-321/05). The case concerned the interpretation of the term 'cash payment' (Art. 2(d)) under the Merger Directive (Council Directive 90/434/EEC) and the anti-avoidance clause (Art.11(1)(a)) of the latter Directive in the context of an exchange of shares transaction where such transaction is closely followed by a dividend distribution by the acquiring company. Details of the judgment are summarized below.

(a) Facts.  Mr. Kofoed, a shareholder of a Danish company transferred his shares in that company to an Irish company and in return acquired shares in the Irish company. A few days later, as planned from the outset, the Irish company effected a distribution of profits in favour of Mr. Kofoed. Both the exchange of shares and the resolution concerning the distribution of profits were effected shortly before the entry into force of a new Danish-Irish double taxation convention. The new convention would have replaced the exemption applied by Denmark as a double tax relief for dividends received by Danish residents from Irish companies (applicable under the previous convention) by the credit method, i.e. by a less favourable treatment.

Mr. Kofoed claimed an exemption for the dividends received from the Irish company pursuant to the double taxation convention in force at the time of the distribution and an exemption for the proceeds from the preceding exchange of shares pursuant to the Danish rules implementing the Merger Directive. The Danish tax authorities, treated the exchange of Mr Kofoed's shares in the Danish company in return for shares in the Irish company and the latter company's subsequent distribution of profits, however, as one single transaction. Accordingly, the distribution of profits was considered to be in reality part of the proceeds of sale, and thus a cash payment within the framework of an exchange of shares. Since that cash payment exceeded 10% of the nominal value of the shares transferred, the provisions on the tax-exempt exchange of shares, otherwise applicable pursuant to Art. 8(1) of the Merger Directive and the Danish legislation implementing the latter, were denied to Mr. Kofoed.

(b) Issue. The first issue of the case concerned the interpretation of the term "cash payment" included in Art. 2(d) of the Merger Directive (Council Directive 90/434/EEC). In particular, the question was whether or not that term covers a distribution of profits, which is closely connected with a cross-border exchange of shares effected shortly before such distribution. Specifically, is the tax authority allowed to treat such distribution as partial consideration and, thus, as a cash payment made by the acquiring company for the majority shareholding of the acquired company and as a result deny the exemption (roll-over relief) to the shareholders of the acquired company on gains realized through the exchange of shares? The second issue was whether or not the denial of the exemption for an exchange of shares closely followed by a profit distribution can be achieved by having recourse either to the anti-avoidance clause included in the Merger Directive or to similar national provisions..

(c) Decision. Regarding the interpretation of the term 'cash payment' within the meaning of Art. 2(d) of the Merger Directive, the ECJ found that that concept covers monetary payments having the characteristics of genuine consideration for the acquisition, namely payments agreed upon in a binding manner in addition to the allotment of shares of the acquiring company, irrespective of any reasons underlying the acquisition. In the light of that interpretation, a monetary payment made by an acquiring company to the shareholders of the acquired company cannot be classified as a 'cash payment' merely because of a certain temporal or other type of link to the acquisition, or possible fraudulent intent. The Court pointed out that, in the case at issue, there is nothing in the case-file demonstrating that the dividend distributed by the Irish company (acquiring company) formed an integral part of the necessary consideration to be paid to Mr. Kofoed (shareholder of the acquired company). Therefore, the dividend in question in the case cannot be included in the calculation of the 'cash payment' provided for in Art. 2(d) of the Merger Directive and. Thus, the exchange of shares is covered by Art. 8(1) of the Directive and should not be subject to tax.

However, the Court continued by pointing out that a taxation of an exchange of shares could be justified by the application of Art. 11(1)(a) of the Merger Directive. That provision sets out that, by way of exception and in specific cases, Member States may refuse to apply all or any part or withdraw the benefit of the provisions of the Directive, inter alia, where the exchange of shares has tax evasion or tax avoidance as its principal objective or as one of its principal objectives. That same provision also provides that the fact that the operation is not carried out for valid commercial reasons, such as the restructuring or rationalisation of the activities of the companies participating in the operation, may constitute a presumption that the operation has such an objective. The ECJ stated that the latter provision reflects the general Community principle that abuse of rights is prohibited. Referring to the Halifax and Cadbury Schweppes cases, the Court explained the meaning of that principle. Namely, the application of Community legislation cannot be extended to cover abusive practices, that is to say, transactions carried out not in the context of normal commercial operations, but solely for the purpose of wrongfully obtaining advantages provided for by Community law.

Thereafter, the Court continued to analyze the question whether, in the absence of a specific provision transposing Art. 11(1)(a) of the Merger Directive in Danish law, that provision may apply in the present case. In that regard the ECJ, concurring with the opinion of Advocate General Kokott, held that the transposition of a directive may, depending on its content, be achieved through a general legal context, so that a formal and express re-enactment of the provisions of the directive in specific national provisions is not necessary. This conclusion is also supported by the principle according to which all authorities of a Member State, in applying national law, are required to interpret it as far as possible in the light of the wording and purpose of the Community directives in order to achieve the result pursued by those directives.

Based on the above reasoning the ECJ held that it is for the national court to determine whether there is, in Danish law, a provision or general principle prohibiting abuse of rights or other provisions on tax evasion or tax avoidance which might be interpreted in accordance with Art. 11(1)(a) of the Merger Directive and thereby justify taxation of the exchange of shares at issue in the case.

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