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ECJ: Swedish legislation on dividend tax relief in relations with third countries is compatible with EC law – details

On 10 May 2007, the European Court of Justice (ECJ) gave its decision by reasoned order in the case of Skatteverket v. A and B (Case C-102/05). According to Art. 104(3) of the Rules of Procedure, when the answer to the question referred to the ECJ can be clearly deduced from existing case law, the ECJ may issue its decision by reasoned order. In this case, the Advocate General delivered no opinion. Details of the judgment are summarized below.

(a) Facts. A and B, two shareholders of the Swedish company X, were employed by X and received dividends from X. Company X was considered a closely-held company according to Swedish legislation and had a permanent establishment in Russia, which later was transferred to X's subsidiary Y. In year 1997, subsidiary Y established a new branch in Russia, while the old branch was dissolved.

(b) Legal background. The case concerns the Swedish tax rules relating to closely-held companies, i.e. companies where less than five individuals own more than 50% of the share capital. Under Swedish tax laws, income from employment is taxed at a higher rate than income from capital, including dividends. To prevent closely-held companies from paying dividends instead of salaries to employed shareholders, and thus becoming subject to a lower taxation on the dividends than on the employment income, the legislation sets a limitation of the dividend tax relief available to shareholders.

The exempt amount is computed as a fixed percentage of the taxable base, which is calculated on the basis of the invested capital. According to a special "salary-rule", the taxable base, in addition to the invested capital, also includes a certain amount of the salaries paid-out by the company, its subsidiary or branch provided that those salaries are subject to Swedish social contributions or payroll tax. The salary-rule also applies to salaries paid to employees in other Member States. As a result of the application of the salary-rule, a higher amount is taxed as income from capital, i.e. at a lower rate, in the hands of the shareholders.

A and B requested a ruling from the Revenue Tax Commission regarding the computation of the dividend relief on the dividend that they received from X. In particular, they asked whether they were entitled to take into account, based on the "salary rule", the salaries that the Russian branch of subsidiary Y paid out, which salaries have not been subject to social security contributions or payroll tax in Sweden.

The Revenue Tax Commission decided that they were entitled to take into account the salaries borne by the Russian branch, since the "salary-rule", which excluded those salaries, was incompatible with the free movement of capital set out in Art. 56(1) of the EC Treaty. The Revenue Tax Commission ruled that the freedom of establishment (Art. 43 of the EC Treaty) was not applicable to the case, as it involved investment in third States (non-EU countries).

The National Tax Agency appealed that ruling to the Supreme Administrative Court, which requested a preliminary ruling from the ECJ.

(c) Issue. The two questions the Supreme Administrative Court raised were the following:

(1)   Whether it is contrary to the provisions on free movement of capital between Member States and third countries, in a situation like the present case, for A and B to be taxed less favourably in respect of dividends from X because X's subsidiary Y conducts business in Russia rather than Sweden.
(2)   Whether it has any relevance whether A and B acquired shares in X before or after business in Russia was commenced or modified.

(c) Decision. The ECJ held that the Swedish rules at issue primarily affect the freedom of establishment, as they have the effect of hindering Swedish companies from setting up secondary establishments outside the EU. However, the freedom of establishment cannot be relied on in situations when a company of a Member State has a permanent establishment in a third country. The Court, referring to existing case-law (Cadburry Schweppes; Thin Cap GLO), ruled that if in the in the present case the national rules at issue have a restrictive effect on the freedom of capital that is only an unavoidable consequence of the restriction on the freedom of establishment, which does not justify the examination of those rules in the light of the free movement of capital.

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