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ECJ: temporal effects of judgment in Meilicke against Germany should not be limited – details

On 6 March 2007, the European Court of Justice (ECJ) gave its decision in the case Meilicke and Others v. Finanzamt Bonn-Innenstadt (C-292/04). Advocate General (AG) Tizzano gave his Opinion in the case on 10 November 2005 and a second Opinion was delivered by AG Stix-Hackl on 5 October 200. Details of the ECJ's judgment are summarized below.

(a) Facts. A German-resident individual in 1995 to 1997 derived dividends from shareholdings in Danish and Netherlands joint-stock companies. In 2000, his heirs applied for an imputation credit in respect of the foreign corporate income tax due. The German tax authorities rejected the request. The legislative background to the case is that, under the old German imputation system, relief from the economic double taxation of dividends was available for resident individual shareholders in the form of a credit for the corporate income tax attributable to the dividends received from shareholdings in resident companies. This amounted to 3/7 of the actual dividends received (Sec. 36(2), No. 3 of the Income Tax Law (Einkommensteuergesetz, or EStG)). In respect of shareholdings in non-resident companies, however, no imputation credit was available. The Tax Reduction Law (Steuersenkungsgesetz) replaced the imputation system with a classical system, which generally applies from 2002. Under this system, 50% of the dividends received are exempt from individual income tax (the half-income system).

(b) Issue. The question referred to the ECJ was whether or not Sec. 36(2)(3) of the ITL (as applicable in the relevant years), according to which only corporate income tax payable by a domestic corporation amounting to 3/7 of the income within the meaning of Sec. 20(1)(1) or (2) of the ITL (most importantly, in regard to dividends) is set off against income tax, is compatible with the free movement of capital under Arts. 56(1) and 58(1)(a) of the EC Treaty.

(c) Decision. On the substantive issue, the ECJ followed the solution proposed by the two AGs. In particular, the ECJ ruled that the free movement of capital (Arts. 56 and 58 of the EC Treaty) precludes the rules applied under the old German imputation system according to which, on a distribution of dividends by a capital company, a shareholder who is fully taxable in Germany is entitled to a tax credit, calculated by reference to the corporation tax rate on the distributed profits, if the dividend-paying company is established in Germany but not if it is established in another Member State.

The ECJ pointed out that:

(i) these rules constitute a restriction on the free movement of capital; and

(ii) contrary to the German Government's argument, the above restriction cannot be justified by the need to safeguard the cohesion of the national tax system:

-   first, it can be questioned whether the legislation at issue meets the requirement of a direct link between the tax advantage concerned and the offsetting of that advantage by a particular tax levy, which was established by the previous case law with regard to the above justification (see Manninen (C-319/02)); and
-   second, the German legislation at issue is disproportionate. Having regard to the objective of that legislation, i.e. to prevent double taxation of distributed profits, the cohesion of the German tax system is assured as long as the correlation between the tax advantage granted in favour of the shareholder and the tax payable by way of corporation tax is maintained. The granting to a fully taxable resident shareholder receiving dividends from a company of another Member State, of a tax credit calculated by reference to the corporation tax payable by that company in that latter Member State would not threaten the cohesion of the German tax system and would constitute a measure less restrictive of the free movement of capital than that laid down by the German tax legislation.

With regard to the temporal effect issue, the ECJ, following the proposal of AG Stix-Hackl, did not limit the temporal effect of its judgment. In this respect the ECJ, first, recalled that the interpretation given by the ECJ to a rule of EC law determines the meaning of that rule as it must be or ought to have been understood and applied from the time of its entry into force. Such rule, as thus interpreted, must be applied by the courts even to legal relationships which arose and were established before the judgment that interpreted the given rule. The ECJ emphasized that it is only in exceptional cases that the right to rely upon a provision, which has been so interpreted, can be restricted in applying the general principle of legal certainty.

Further, the ECJ referred to the principle that a temporal restriction may be allowed only in the actual judgment ruling upon the interpretation sought. According to the ECJ, this is necessary in order to guarantee an equal treatment of the Member States and of other persons subject to EC law, fulfilling, at the same time, the requirements arising from the principle of legal certainty.

In this respect, the ECJ considered its decision in Verkooijen (C-35/98)to be the first judgment that had ruled upon a similar interpretative issue to the present case, as Verkooijen also concerned the tax treatment of dividends received from a company of another Member State in the framework of a national system designed to prevent economic double taxation of dividends. Contrary to AG Stix-Hackl, the ECJ attributed decisive importance to the fact that it did not limit the temporal effect of that judgment. On this basis, the ECJ held that it is not appropriate to limit the temporal effects of the judgment in the present case.

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