The Dutch National Grid Indus BV (capital company) moved its administrative headquarters to Great Britain on December 15, 2000 and thus triggered double taxation, as it was still subject to corporate tax in the Netherlands due to its statutory seat (foundation theory), but also became subject to corporate tax in Great Britain, as its administrative headquarters was now moved there. Due to the resulting double taxation, the DTA Netherlands/Great Britain intervened and found that due to the administrative headquarters, the taxation sovereignty now belongs to Great Britain. The abolition of Dutch taxation sovereignty thus leads to immediate taxation and the discovery of hidden reserves. The ECJ therefore examined in its judgment of 29.11.2011 – Az. C-371/10 whether the freedom of establishment was disproportionately (and thus unjustifiably) restricted by the immediate taxation. In his critical analysis, Kanzlei Meyers & Partner AG addresses the ECJ’s reasoning and examines the judgment in its individual pieces, such as the justification and proportionality of the measures.

National Grid Indus BV, established under Dutch law, maintained its statutory seat and effective administrative seat in the Netherlands until 15 December 2000 and was subject to unlimited corporate tax there. Since 10.6.1996 the company had a foreign currency claim of GBP 33.113,000 against the British National Grid Company plc. Due to currency differences, the loan developed price gains and thus hidden reserves in the amount of NLG 22.128.160 until 15.12.2000.

As of December 15, 2000, National Grid Indus BV moved its effective administrative seat to the United Kingdom. Dutch company law follows the founding theory, so that the transfer of the actual administrative seat did not lead to the extinction of the company under company law and thus not to the liquidation taxation. However, from a fiscal point of view, the limited liability company established a fiscal nexus in two Member States: the company’s statutory seat in the Netherlands and the effective administrative seat in the United Kingdom. These led to a dual residence of the company and thus to an unlimited corporate tax liability in both countries. The resulting double taxation was introduced by the in art. 4, par. 3 DBA Netherlands/United Kingdom of Great Britain avoided the tie breaker rule, according to which the company was deemed to be domiciled exclusively in the State of its effective administrative seat and thus in the United Kingdom for purposes of agreement law.

1.1. Tax assessment based on DBA Netherlands/UK

On the basis of the order for reference, the ECJ has assumed that the right of taxation on the claim according to art. 13 para 4 DTA Netherlands v United Kingdom of Great Britain is to be assessed. According to that provision, profits from the sale of other assets should be taxed ‘only in the State in which the vendor is resident’. This scheme complies with Article 13(5) OECD-MA. Consequently, the ECJ has assumed in a judgment that the right to tax the foreign currency loan has been transferred in full to the United Kingdom by the transfer of the effective seat of administration on 15 December 2000. [692] Thus, the ECJ followed the assumption that the right of the Netherlands to tax the profit from the sale of the loan claim was excluded by the transfer of the head office.

Since National Grid Indus BV ceased to ‘make profits taxable in the Netherlands’, the company had to draw up a final account under Dutch tax law which led to the final taxation of the deferred gains which had arisen up to that point (Art. 8 Wet VPB i.V.m. Art. 16 Wet IB).

The ECJ found that a Dutch limited company suffers a liquidity disadvantage if it transfers its administrative seat to another Member State. For the present situation, national law provides for an immediate taxation of the unrealised gains, whereas the transfer of the administrative headquarters within the Netherlands would only have led to taxation if it had actually been realised. As already in the judgments in Cases Lasteyrie de Saillant[694] and N[695], the ECJ considered the differential taxation of capital gains to be suitable for preventing a company from transferring its administrative seat to another Member State.[696]

2.2 Justification of restriction of freedom of establishment

In order to justify the restriction, the Dutch Government argued that the fixing and immediate collection of the tax ensures a balanced distribution of taxation powers between Member States in accordance with the territoriality principle. As in Cases Marks & Spencer[697], N[698], Oy AA[699], and Lidl Belgium[700], the ECJ recognised in principle that a balanced allocation of taxation powers should be maintained as a justification for a breach of the freedom of establishment.[701] In principle, each Member State has the right, under the principle of territoriality, to tax the gains acquired in its territory. If a company withdraws from the territory of a Member State by relocating its seat of administration, this cannot lead to the State of origin having to waive its right to tax on the hidden reserves which have been created up to that point.[702] In the case in the main proceedings, the ECJ has therefore held that the Netherlands, as the exiting State, is entitled to adopt a national measure which safeguards Dutch taxation interests. However, these arrangements must be capable of safeguarding the interests of taxation and must not go beyond what is necessary to achieve this objective.

2.3. Review of the proportionality of the measure

By relocating the seat of administration, the judges have assumed that the right of taxation on the hidden reserves previously created in the Netherlands is subject to Art. 13 para 4 of the Agreement (corresponding to Article 13 para 5 OECD-MA) is transferred to the United Kingdom. In view of this bilateral agreement and the resulting loss of Dutch taxation rights, the imposition and immediate collection of the tax on these hidden reserves by way of the final account is appropriate to safeguard the Dutch taxation powers.

It is questionable, however, whether the 16 Wet IB is absolutely necessary to safeguard the taxation powers or whether the objective pursued can not also be achieved by a milder measure. In this respect, it should be noted that the final invoice is accompanied not only by the determination of the final tax but also by its immediate collection. In this context, Dutch tax law has neither a deferral scheme nor an extension of the payment to several annual instalments. Accordingly, for the purposes of the proportionality assessment, the ECJ distinguishes between the determination and the collection of the final account tax as follows:

The determination of the tax at the time of the departure is, in the opinion of the ECJ, proportionate, although the ECJ had already ruled in case N on the departure of a natural person that the exiting State has to take account of impairments occurring later, insofar as the impairments are not taken into account in the host state.[703] Obviously, the ECJ assumed that the host state does not always take account of fluctuations in the value of assets of private property.[704] In the main proceedings, however, the ECJ did not see the exiting State as being obliged to take account of any subsequent impairments. In the case of business assets, the ECJ did not seem to make a tax entanglement to the common value in the host state a prerequisite, but as usual. In the case of a tax entanglement at the common value, the host state would capitalize the acquired assets at the common value in the tax balance sheet and take account of impairments due to tax-recognized scheduled and unscheduled depreciation and, in the event of disposal, increased acquisition costs.[705]

This means that taxation powers are distributed in a balanced manner in the operational area. Until the time of departure, the departing State has both the right to tax any increases in value and the obligation to take account of impairments in a tax-reducing manner. The departure transfers these rights and obligations to the host state. It is also intended to avoid the risk of double taxation or double loss-taking. [706] However, there is no obligation under the TFEU for the host Member State to align its taxation with the taxation system of other Member States in the event of accruals and thus entangle the assets at common value. The host state would thus not violate the fundamental freedoms if it only capitalizes the transferred assets with the book value and thus does not take future impairments into account. The resulting systemic double taxation – consisting of the difference between book value and common value at the time of departure – is not avoided by the fundamental freedoms. According to the ECJ, such remaining tax advantages and disadvantages are the risk associated with the transfer of the registered office and borne by the company.[708]

However, the immediate collection of the final tax associated with the Dutch final invoice does not respect the principle of proportionality. After all, a subsequent collection of the tax – e.g. at the time of the actual realisation of the increase in value – equally safeguards the division of taxation powers between the Member States, but is the less intrusive measure.[709] Thus, while there is an additional administrative burden for the exiting State with regard to the supervision of the assets concerned, this can be reduced by imposing on the company the obligation to declare in an annual declaration the ownership of the assets concerned.[710] Depending on the size of all assets in fixed and working capital, this obligation of proof can also constitute a greater restriction than the immediate payment of the final tax. Therefore, according to the ECJ, it is necessary to grant the company the choice between the immediate payment of the final tax and the annual obligation to provide proof of the whereabouts of the assets, so that the company can opt for the option which imposes the least restriction on its freedom of establishment.[711]

This also explains why a deferred tax collection cannot constitute an excessive administrative burden for the tax administration of the country of origin. If the company deliberately accepts additional proof obligations for a later tax collection, the effort of the authority with regard to the control of the proof cannot be considered excessive. [712]

Moreover, according to the ECJ, it is still proportionate to make the tax deferral dependent on the provision of a bank guarantee[713] and the collection of interest.[714]

3rd Opinion of the ECJ

3.1. Lack of consideration of subsequent operating income and the requirement of consistency

However, on a detailed examination of the facts on which the main proceedings are based, it is clear that the ECJ based its decision on a factual situation according to which the profit from the sale of the transferred asset (here: the claim) was wholly owned by the incoming State: ‘Since National Grid Indus no longer had a permanent establishment within the meaning of the agreement within the Netherlands after the transfer of its registered office, the power to tax the profits of the company and the proceeds of the assets after that transfer of its registered office came under the art. 7 par. 1 and 13 par. 4 of the Agreement exclusively to the United Kingdom. This assumption is based on the observations of the referring Dutch court, which in turn refers to the established case law of the Hoge Raad of the Netherlands. According to that provision, the transfer of the place of management of a Dutch company to the United Kingdom would result in the company ceasing to ‘receive taxable profit from companies in the Netherlands’ under the DTA [716]. The Advocate General therefore assumed that the DTA was “apparently understood in the Netherlands as meaning that the Netherlands will lose the right to tax these hidden reserves for the future”[717].

However, this understanding of the DTA contradicts the new understanding of the BFH agreement, according to which the exiting state is not prevented from taxing the hidden reserves created in the country at a later date “on the basis of the provisions of the agreement”[719]. Accordingly, Wassermeyer also states that “either the legal interpretation of the BFH or that of the Advocate General can be correct” [720].

Nevertheless, on the basis of the facts put forward and used by the ECJ in its decision, the ECJ has correctly ruled, on the basis of the requirement of consistency, that a final exclusion of the Dutch taxation law may justify an early setting of the tax. However, the principles of that judgment can only be applied to situations in which the right of taxation of the State of origin is also excluded on the hidden reserves arising up to the date of the de-entangling. A restriction on the freedom of establishment can only be justified by ensuring a balanced distribution of taxation powers if the taxation power of a State (here: the Netherlands) is jeopardised[721], i.e. the right of taxation of the State of origin is also lost on the hidden reserves created up to the time of departure. For cases in which, in accordance with BFH’s new understanding of the DTA, the domestic taxation law is maintained even after the departure, the decision-making principles are therefore irrelevant.

With the Rs. National Grid Indus, the ECJ confirmed for the first time that it considers the early setting of the tax in the case of de-knitting operations in the business sector – as well as in private assets – as proportionate if the taxation right is finally excluded. In contrast to its previous case law on private cases of de-engagement, the exiting state in the Rs. National Grid Indus did not need to take into account any subsequent impairments and was allowed to demand both collateral and interest for the deferral amount. It was initially unclear whether this tightening of the previous jurisprudence only affects the operational area or also brought about a change in jurisprudence for private de-engagement processes.[722]

In this context, the ECJ misjudged the view held here that both the setting of the tax and the provision of a bank guarantee lead to a not insignificant restriction on the freedom of establishment. On the one hand, a fixed tax constitutes a liability of the company and, as such, reduces the company’s balance sheet assets. On the other hand, a bank guarantee makes use of the company’s credit line (unnecessarily) and can therefore make future investment projects impossible. The reasons for this are incomprehensible, since the loss of taxation rights associated with the transfer of the administrative headquarters to Great Britain did not change the Dutch government’s ability to enforce its tax claims with National Grid Indus BV as a company under Dutch law.

Nor was the claim a tangible asset physically removed from the territory of the Netherlands, thereby reducing the possibilities for enforcement. In addition, the EU Enforcement Directive[723] also secured the recovery of Dutch tax claims in the UK.[724] Due to its statutory seat in the Netherlands, the company remained subject to tax returns, which ensured that the Dutch tax authorities had access to tax-related information, such as the sale or recovery of the claim. It is therefore considered that a separate determination of the value of the asset or the neutralisation of the capital gains by a tax offset at the time of unencumberment is sufficient to ensure that the Netherlands is not placed in a worse position as regards the hidden reserves accumulated up to the date of departure than if the administrative headquarters of the company had remained in the country.