INTM603140 - Transfer of assets abroad: Exemptions from charge: Genuine transaction exemption - EU law implications

Brief consideration of EU law is needed to understand the background to the genuine transactions exemption. This is considered under:

  • EU law generally
  • EU Treaty freedoms, including restrictions, justifications and proportionality
  • abuse of the freedoms, and
  • ‘wholly artificial arrangements’.

EU law generally

EU law, reflecting its origins in the European Economic Community (EEC) founding States, is strongly influenced by Continental civil law which is more purposive in its approach than English common law. There is no strict rule of precedent, although there is a principle of ‘legal certainty’. The problems of dealing with 24 official languages and 27 Member States lead to a tendency to repeat standard phrases. These do not necessarily carry the same significance as judicial dicta in English common law.

Conventionally, the working language of the Court of Justice of the European Union (ECJ) is French though the decision will be authoritative in a specified language, usually that of the referring domestic court.

Where there is an issue with EU law, a lower domestic court may make a ‘preliminary reference’ under the Treaty to the ECJ for a ruling; the highest domestic court must make a reference (though this leaves room for different views of what is an issue). If the ECJ believes the issues are clear, or acte clair, it may issue a reasoned order rather than a judgment. Its judgments are in any case often hard for those familiar with UK law to follow as they are collegiate and sparingly argued.

A few cases are referred to below. These may be easily found by searching for Eur Lex, then ‘Case Law’ and entering the case year and number. There will usually be an opinion of the Advocate General (AG), perhaps containing rather more argument, followed by a decision of the court which usually, but not always, reflects the AG opinion.

EU Treaty freedoms, restrictions, justifications and proportionality

Direct tax falls within the competence of the Member States, but States must exercise that competence consistently with EU law, which includes the fundamental freedoms set out in the Treaty on the Functioning of the European Union (TFEU). Anti-avoidance legislation with a cross border element may result in a restriction of the freedoms and the transfer of assets legislation is a possible example of this.

Although it was recognised when the transfer of assets legislation was introduced in 1936 that there was a need to exclude commercial transactions, reflected currently in the avoidance purpose exemption at ITA07/S737, this may not be enough to meet the requirements of EU law. It is a feature of the single market that individuals may appraise the characteristics of different regimes and opt for the most beneficial to suit their purpose. But this depends on the transactions and arrangements being a genuine exercise of market freedoms and not what EU law often calls an ‘abuse’ of them.

It follows that, even though freedoms such as freedom of establishment and freedom of movement of capital may be restricted, that restriction may be justified. Justifications may be set out in the Treaty itself or in ECJ case law.

For example, a tax authority may be able to show that the domestic legislation is compatible on the basis that there are ‘compelling or overriding reasons in the public interest’. Prevention of tax avoidance (or ‘abuse’) is one possible justification. Balanced allocation of taxing rights is another. But the authority has to demonstrate that any counteractive measure does no more than is necessary to achieve the aim of preventing abuse, thus respecting the principle of ‘proportionality’. In particular this requires that:

  • the circumstances must be considered on a case-by-case basis,
  • the taxpayer must have the opportunity to explain, for example, why the relevant transactions are genuine and not artificial and abusive, and
  • any disagreement must be capable of being resolved before an appeal tribunal without undue difficulty.

In practice, the EU Commission (in its communication COM (2007) 0785), has indicated that national anti-abuse rules may incorporate ‘safe harbour’ criteria, aimed at situations where the probability of abuse is highest. These may set out reasonable presumptive criteria which contribute to a balanced application of domestic anti-abuse measures in the interests of legal certainty for taxpayers and workability for tax authorities, (AG Geelhoed in Case C-524/04 Thin Cap).

Abuse of the freedoms

The ECJ has held that a person who would otherwise be in a situation covered by EU law, may forfeit the rights under it where there is an attempt to abuse them. The criteria were set out in a case involving the Common Agricultural Policy, Case C-110/99 Emsland-Stärke, paragraphs 52 and 53:

A finding of abuse requires, first, a combination of objective circumstances in which, despite formal observance of the conditions laid down by Community [EU] rules, the purpose of those rules has not been achieved. It requires, second, a subjective element consisting in the intention to obtain an advantage from the Community rules by creating artificially the conditions for obtaining it.

The principle has been applied to VAT (Case C-255/02 Halifax Bank), and more recently in a different way to direct tax in Case C-196/04 Cadbury Schweppes. Paragraph 51 of the court’s decision in Cadbury Schweppes is as follows:

On the other hand, a national measure restricting freedom of establishment may be justified where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned (see to that effect Case C-264/96 ICI, paragraph 26; Case C-324/00 Lankhorst-Hohorst, paragraph 37; Case C-9/02 De Lasteyrie du Saillant, paragraph 50; and Case C- 446/03 Marks & Spencer, paragraph 57).

It is an established principle that loss of tax is not in itself an abuse (see, for instance, Case C-294/97 Eurowings) and the importance of market freedoms is illustrated by company law cases such as Case C-212/97 Centros and Case C167/01 Inspire Art. These suggest that the circumvention of national rules by exercising the freedoms does not itself amount to abuse. But those cases involved companies and creditor protection. There is a clear application of market principles in a company choosing lighter regulation in a particular territory. Similarly, there is an exercise of market freedoms where a commercial entity chooses to take advantage of a reduced rate of taxation in another member state. This is illustrated by Cadbury Schweppes. A fiscal authority, however, may continue to tax without breaching those freedoms where there is no real application and serving of the Treaty freedoms, (see below) but rather tax driven artificial arrangements.

Wholly artificial arrangements

‘Wholly artificial arrangements’ is a phrase first employed in the ICI case mentioned above. The authoritative text was English, but in the French working language the phrase was montages purement artificiels, which no doubt explains why it is sometimes in ECJ cases expressed as ‘purely artificial arrangements’, as for example in Case C-231/05 Oy AA.

The EU Commission (in its communication mentioned above), takes the view that ’the detection of a wholly artificial arrangement … amounts in effect to a substance over form analysis’. That is a more effective approach than attempting to understand in what sense an arrangement can be ‘wholly artificial’.

A scheme may thus be regarded as artificial if it lacks genuine economic substance born of commercial purpose, (‘devoid of economic reality’, as expressed at paragraph 63 of Oy AA), but is inserted to gain an advantage not within the aims of the Treaty. These aims are, for freedom of establishment ‘economic interpenetration’, a phrase taken from Cadbury Schweppes; and for freedom of movement of capital the efficient allocation of capital.

Paragraph 63 of Oy AA reads as follows:

Even if the legislation at issue in the main proceedings is not specifically designed to exclude from the tax advantage it confers purely artificial arrangements, devoid of economic reality, created with the aim of escaping the tax normally due on the profits generated by activities carried out on national territory, such legislation may nevertheless be regarded as proportionate to the objectives pursued, taken as a whole.

The ECJ’s decision in that case was based on the application of both the ‘prevention of tax avoidance’ and ‘balanced allocation of taxing rights’ justifications. It demonstrates that counteraction may be applied by an authority, where there are gratuitous transfers of income from one tax jurisdiction to another within a group of companies. This ‘profit shifting’ is a common theme. It is easier to justify counteraction where there are transfers of assets or income without commercial exchange, threatening the balanced allocation of taxing rights.

In Case C-135/17 X GmbH, at paragraph 84, the court said:

Therefore, in the context of the free movement of capital, the concept of ‘wholly artificial arrangement’ cannot necessarily be limited to merely the indications, referred to in paragraphs 67 and 68 of the judgment of 12 September 2006, Cadbury Schweppes and Cadbury Schweppes Overseas (C‑196/04, EU:C:2006:544), that the establishment of a company does not reflect economic reality, since the artificial creation of the conditions required in order to escape taxation in a Member State improperly or enjoy a tax advantage in that Member State improperly can take several forms as regards cross-border movements of capital. Indeed, those indications may also amount to evidence of the existence of a wholly artificial arrangement for the purpose of applying the rules on the free movement of capital, in particular when it proves necessary to assess the commercial justification of acquiring shares in a company that does not pursue any economic activities of its own. However, that concept is also capable of covering, in the context of the free movement of capital, any scheme which has as its primary objective or one of its primary objectives the artificial transfer of the profits made by way of activities carried out in the territory of a Member State to third countries with a low tax rate.