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ECJ: Previous Austrian rules discriminating dividends received from third countries are compatible with free movement of capital under grandfathering clause – details — Orbitax Tax News & Alerts

On 24 May 2007, the European Court of Justice (ECJ) gave its decision in the case of Winfried L. Holböck v. Finanzamt Salzburg-Land (C-157/05). Details of the judgment are summarized below.

Issue. The issue in the case was whether or not the different taxation of dividends received by Austrian resident shareholders holding two-thirds of the capital of a company resident in a third State (non-EU country), as compared to dividends received by such shareholders from companies resident in Austria, was compatible with the principle of the free movement of capital.

According to the Austrian rules applicable at the time of the case, profit distributions by domestic companies which were made to individuals resident in Austria were taxed at the reduced "half-tax rate" (Hälftesteuersatz). By contrast, profit distributions by foreign companies made to individuals resident in Austria were subject to ordinary income tax. Although there were changes to those rules in 1993 and 1996, they did not affect the general system of taxation of dividends, thus the legal position described above remained essentially unchanged after 31 December 1993.

(d) Decision. The ECJ first examined whether the challenged Austrian provisions fall within the scope of the freedom of establishment (Art. 43 of the EC Treaty) or the free movement of capital (Art. 56 of EC Treaty). By reference to its settled case law (Cadbury Schweppes, Fidium Finanz, AXT IV, FII,Thin Cap GLO), the Court stressed that the purpose of the national legislation at issue must be taken into account in order to decide which fundamental freedom applies. Distinguishing the present case from the Cadbury Schweppes and the Thin Cap GLO cases, the Court pointed out that the Austrian provisions are not intended to apply only to those shareholdings which enable the holder to have a definite influence on a company's decisions and to determine its activities. As the rules apply irrespective of the extent of the holding which the shareholder has in the company making the distribution, they may fall simultaneously within the scope of both the freedom of establishment and the free movement of capital. However, the Court found that neither of those freedoms precludes the application of the Austrian provisions in the present case.

First, the Court recalled that the freedom of establishment is only applicable to intra-Community scenarios and therefore cannot be invoked in the underlying case.

Second, with regard to the free movement of capital, the Court referred to its judgement in Lenz and found that the Austrian legislation in question constitutes a restriction on the free movement of capital. The Austrian legislation not only deters Austria residents from investing their capital in companies established outside their home State, but also produces a restrictive effect in relation to those companies, inasmuch as it constitutes an obstacle to their raising capital within Austria.
However, the Court found that the Austrian legislation falls under the derogation from the prohibition on the restriction of the freedom of capital provided by Art. 57(1) of the EC Treaty. It follows from the latter provision that that Art. 56 is without prejudice to the application to third countries of any restrictions with respect to the movement of capital to or from third countries involving, inter alia, direct investments provided that the restriction existed on 31 December 1993. In order to decide whether this derogation applies to the Austrian provisions, the Court interpreted the concept of "direct investment". Although the concept of "direct investment" is not defined by the EC Treaty, it has nevertheless been defined in the nomenclature of the capital movements set out in Annex I to Council Directive 88/361/EEC of 24 June 1988 for the implementation of Art. 67 of the EC Treaty. Accordingly, investments, which serve to establish or maintain lasting and direct links between the shareholder and the company concerned and which allow the shareholder to effectively participate in the management of the company or in its control, qualify as direct investments. In the present case, Mr. Holböck held two-thirds of the share capital in the Swiss company, which shareholding qualifies as direct investment in the above sense.

Next, the Court examined whether the Austrian legislation can be regarded as existing on 31 December 1993 as required by the derogation of Art. 57(1). In this respect, the Court recalled its settled case law according to which if the provision enacted after a fixed date is, in substance, identical to the previous legislation or is limited to reducing or eliminating an obstacle to the exercise of Community rights and freedoms in the earlier legislation, it will be covered by the derogation. As the amendments to the relevant Austrian legislation made after 31 December 1993 did not change the applicable legal framework introduced before that date, the Austrian legislation must be regarded as having existed on 31 December 1993 for the purposes of Art. 57(1) of the EC Treaty.

Thus, the Court concluded that the Austrian provisions in question, although restricting the free movement of capital between Member States and third countries, fall under the derogation of Art. 57(1) of the EC Treaty, and therefore, are not prohibited by Art. 56 of the EC Treaty.