EC Law and the Sovereigntyof the Member States

in Direct Taxation

Mathieu Isenbaert

Thesissubmitted to the Catholic University of Leuven,

in fulfilment of the requirements for the degree ofDoctor of Laws (PhD)

Degree awarded on 12 December 2008

Volume 19, Doctoral SeriesIBFD - Academic Council

Table of Contents

Chapter 1: Introduction

Chapter 2: The Concepts of Sovereignty and of Income TaxSovereignty

2.1. Introduction

2.2. Brief history of the sovereignty concept 82.2.1. Sovereignty: An evolving concept 82.2.2. Preconditions and emergence of the sovereignty

concept 102.2.2.1. State, society, segmentation and external authority 102.2.2.1.1. State and society 102.2.2.1.2. The segmentary state and external authority 112.2.2.2. Emergence of "sovereignty" and the sovereignty

concept 132.2.2.2.1. "Sovereignty" in the Roman Empire that dared not

speak its name 132.2.2.2.2. The prehistory of the sovereignty concept 142.2.2.2.3. The early writers on sovereignty 162.2.2.3. Confirmation by the Peace of Westphalia of the

sovereignty of nation-states 282.2.2.4. Thomas Hobbes 322.2.2.5. The further evolution of the Westphalian paradigm of

sovereignty 362.2.2.5.1. The internal component of sovereignty: Towards a

constitutionally shared concept 362.2.2.5.2. External sovereignty: The classical theory of

sovereignty as state independence 47

2.3. 20th and 21st centuries' concept of sovereignty 542.3.1. The establishment of supranational organizations and

the impact on the sovereignty concept 552.3.1.1. The League of Nations and the United Nations as the

first globally accepted limitation on sovereignty 552.3.1.2. Economic integration and external sovereignty 572.3.1.3. Human rights and internal sovereignty 582.3.2. The fundamental change of the sovereignty concept

and constitutional pluralism 59

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2.3.2.1. Sovereignty questioned and confirmed as functionalfreedom 61

2.3.2.1.1. Non-legal instances of authority 622.3.2.1.2. The impact of inter-and supranational law 642.3.2.2. Constitutional pluralism and the concept of function-

sovereignty 682.3.2.2.1. "Delegation" of sovereignty by the state to the

supranational level 682.3.2.2.2. Division of sovereignty between the supranational

level and the state 702.3.2.2.3. Constitutional pluralism and function-sovereignty:

Sovereignty over a functionally defined body politic 712.3.2.2.4. Sovereignty, function-sovereignty and competence 752.3.2.2.5. Functions and objectives: The setting of new

boundaries 77

2.4. Conclusion 78

Chapter 3: Function-Sovereignty in the EC and Income TaxSovereignty of the Member States 81

3.1. Introduction 81

3.2. The Community model: Federation, confederation oronstitutional pluralism? 83

3.2.1. Federalism, federal political systems, federation andconfederation 84

3.2.1.1. Condition 1: The federal legal norms affect both theconstituent states as the individual citizens of thefederation 87

3.2.1.2. Condition 2: Do the federal (EC) institutions exercisetheir own legislative competences independently fromthe legislative institutions of the constituent level? 88

3.2.1.2.1. The constitutional level of the legislative process 883.2.1.2.2. The normal level of the legislative process 903.2.1.2.3. Conclusion 973.2.1.3. Condition 3: Have foreign affairs become a

predominantly federal competence in which theconstituent parts of the federation have ceased toexercise extensive competences? 100

3.2.1.3.1. The external identity of the EC and the EU 101

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3.2.1.3.2. External competences of the EC and EU 1033.2.1.3.3. Conclusion: Foreign affairs has not become a

predominantly EU/EC competence 1153.2.1.4. Condition 4: The EU/EC holds independent and

extensive implementation powers 1163.2.2. Conclusion: The EU/EC configuration does not

resemble a typical federal nation-state 117

3.3. The constituting elements of the EC as a body politic 1193.3.1. Direct effect 1213.3.1.1. Monism and dualism 1213.3.1.2. The Van Gend en Loos case 1233.3.1.3. Further evolution of the direct effect doctrine 1263.3.2. Supremacy 1283.3.2.1. The Costa v. ENEL case 1293.3.2.2. Further evolution of the supremacy doctrine 1343.3.2.2.2. Obligation to set aside national rules of procedure

prohibiting application of Community law 1363.3.2.2.3. Obligation to comply with Community law extends to

administrative authorities 1413.3.3. Conclusion 142

3.4.

3.4.1.3.4.1.1.3.4.1.2.3.4.1.3.3.4.1.4.3.4.1.5.3.4.1.6.3.4.1.6.1.3.4.1.6.2.3.4.1.6.3.

Acceptance of these self-asserted elements by theMember StatesCompliance by the Member States' courtsBelgiumFranceGermanyItalyThe NetherlandsThe United KingdomThe European Communities Act of 1972Supremacy of Community lawConclusion

144144146149151157167160161161163

3.4.2. The absence of intervention by national politicalactors 163

3.4.2.1. Political opposition to the ECJ's doctrines of directeffect and supremacy 165

3.4.2.2. Incapability of political actors to curtail the ECJ'sjurisdiction 167

3.4.2.2.1. Member States' rights unaffected or traded-off 1683.4.2.2.2. The differing time horizon of national political actors 168

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3.4.2.2.3. The institutional constraints to altering Communitylaw 169

3.4.2.2.4. Member States' political actors stayed within theCommunity rules for changing Community law 171

3.4.2.3. Political acceptance of a comprehensive jurisdictionoftheECJ 172

3.4.3. Conclusion 172

3.5. The framework of constitutional pluralism and theconcept of function-sovereignty 174

3.5.1. The constitutional pluralist theory and the legal andpolitical system of the EC and its Member States 176

3.5.2. Function-sovereignty and constitutional pluralism 1783.5.3. Constitutional pluralism and the supremacy doctrine

oftheECJ 1803.5.4. Functions and objectives: The new boundaries 1833.5.5. Competence and the boundaries according to

functions and objectives 1843.5.6. Legislative and interpretative "competence-

competence" 186

3.6. Direct taxation and function-sovereignty of the ECand the Member States 189

3.7. Normative implications of the theory of constitutionalpluralism and function-sovereignty 197

3.7.1. Functions and objectives of income tax sovereignty 2003.7.1.1. Direct taxation as a method of raising government

revenue 2013.7.1.1.1. Alternative sources of government revenue 2013.7.1.1.2. Macroeconomic analysis of the ability to raise

government revenue through direct taxation 2043.7.1.2. Income redistribution 2133.7.1.2.1. Income redistribution as an essential element of the

direct taxation policy area 2133.7.1.2.2. Income redistribution as a major concern for the

establishment of the internal market 2143.7.1.3. Stabilization policy 2163.7.2. The internal market as part of the function-

sovereignty of the EU/EC vs. direct taxation as partof the function-sovereignty of the Member States 218

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3.8. Conclusion 222

Chapter 4: Free Movement of Goods 229

4.1. Customs Union (Arts. 23-27 EC Treaty): Customsduties, charges having equivalent effect and aCommon Customs Tariff 229

4.2. Quantitative restrictions and measures havingequivalent effect (Arts. 28-29) 232

4.2.1. Quantitative restrictions 2334.2.2. Measures having an equivalent effect to a quantitative

restriction (MEQRs) 2354.2.2.1. The Dassonville decision and the discrimination-

based approach 2384.2.2.2. The Dassonville decision and the causal link between

the national measure and its restrictive effect 2404.2.2.3. The meaning of "trading rules enacted by Member

States" in the Dassonville formula 2424.2.2.3.1. Trading rules 2424.2.2.3.2. "Measures enacted by Member States" 2434.2.2.4. The Cassis de Dijon decision: Clarity on the

restriction-based approach and the elaboration ofthe "rule of reason" test 246

4.2.2.4.1. Indistinctly applicable measures 2474.2.2.4.2. The "rule of reason" test 2484.2.2.4.3. Confirmation of the Cassis de Dijon case law and

minor inconsistencies 2514.2.2.4.4. Impact on direct taxation 2524.2.2.5. Further expansion of the Cassis de Dijon

jurisprudence 2534.2.2.6. Keck and Mithouard: A U-tum in the ECJ case law? 2594.2.2.7. Further developments following Keck and Mithouard 262

4.3. Income tax provisions and Arts. 28-31 EC Treaty 2664.3.1. The French Newspaper Publishers case 2674.3.2. The Krantz case 268

4.4. Art. 30 EC Treaty [36 TFEU]: Justifications 270

4.5. Conclusion 270

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Chapter 5: Citizenship Rights, Free Movement of Personsand Capital and the Freedom to Provide Services 275

5.1. Introduction 2755.2. The free movement and citizenship provisions in the

general case law of the ECJ 2765.2.1. Subjective scope of application 2765.2.1.1. Direct effect 2765.2.1.1.1. Free movement of persons and the freedom to provide

services 2765.2.1.1.2. Union citizenship provisions 2785.2.1.2. Beneficiaries: Workers and equivalent categories and

citizens 2805.2.1.2.1. Workers 2805.2.1.2.2. Work seekers 2825.2.1.2.3. The previously employed 2835.2.1.2.4. Other categories and secondary legislation 2845.2.1.2.5. Union citizens rights of non-discrimination

(Art. 12 EC Treaty) and free movement(Art. 18 EC Treaty) 285

5.2.1.2.6. Specific Union citizen rights 2905.2.1.2.7. Conclusion 2905.2.1.3. Beneficiaries: Right of establishment 2905.2.1.3.1. Genuine economic activity 2915.2.1.3.2. Place of establishment and the intra-Community

transfer of a company's seat 2925.2.2. The relation of the free movement of capital with

other Treaty freedoms 3125.2.3. Territorial scope of application 3155.2.3.1. Entitlement to Treaty benefits: An intra-Community

situation 3155.2.3.2. Free movement of capital and third countries 3175.2.4. Material scope of application: Non-discrimination

and free movement 3215.2.4.1. The concept of "discrimination" 3235.2.4.2. Overt or direct discrimination 3275.2.4.3. Covert or indirect discrimination 3285.2.4.4. Most-favoured-nation treatment 3325.2.4.4.1. An EC Treaty basis for an MFN obligation? 3335.2.4.4.2. MFN treatment in the non-tax case law of the ECJ 3375.2.4.5. Non-discriminatory restrictions 3425.2.4.5.1. Free movement of persons 343

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5.2.4.5.2. Freedom to provide services 3535.2.4.5.3. Free movement of capital 3545.2.4.5.4. Union citizenship rights under Art. 18 EC Treaty 3565.2.4.6. Effective or potential consequences of a

discriminatory or restrictive national measure 3625.2.4.7. Justifications 3685.2.4.7.1. Treaty-based exceptions: Grounds of public policy,

public security and public health and the publicservice exception 368

5.2.4.7.2. Treaty-based exceptions: Art. 58 EC Treaty[ex 73d /65 TFEU] 369

5.2.4.7.3. "Rule of reason": Mandatory requirements of generalinterest 370

5.2.4.7.4. "Rule of reason": Proportionality 3725.2.5. Temporal limitations of the effects of an ECJ

judgment 3745.2.5.1. Request made by a Member State and temporal

5.2.5.2.5.2.5.3.5.2.5.4.5.2.5.4.1.5.2.5.4.2.5.2.6.

5.3.

5.3.1.5.3.2.

5.3.3.

5.3.3.1.5.3.3.2.5.3.3.3.5.3.3.4.5.3.3.5.5.3.3.6.5.3.3.7.5.3.3.8.5.3.3.9.

limitation in the judgment itselfLegal uncertainty and good faithSevere economic consequencesConsequences of the temporal limitationExclusionsTemporal reference pointConclusion

Free movement provisions and the direct tax case lawoftheECJIntroductionEntitlement to Treaty benefits: An intra-CommunitysituationNon-discrimination and the free movementprovisionsAvoir FiscalBiehl (1)Bachmann and Commission v. BelgiumCommerzbankSchumackerWielockxSvensson and GustavssonAsscherSafir

377379381384384385387

389389

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5.3.3.10. Gilly All5.3.3.10.1. Double taxation 4205.3.3.10.2. Allocation of taxing competence 4205.3.3.10.3. Credit mechanism and refusal of personal allowances 4235.3.3.10.4. MFN clause 4245.3.3.11. Royal Bank of Scotland 4255.3.3.12. Gschwind and Zurstrassen 4265.3.3.13. Saint-Gobain 4285.3.3.14. Vestergaard 4305.3.3.15. Metallgesellschaft and Hoechst 4315.3.3.15.1. The UK system of ACT 4315.3.3.15.2. Decision of the Court 4335.3.3.15.3. MFN application 4355.3.3.16. Danner 4365.3.3.17. Gerritse 4375.3.3.17.1. The disallowance of business expenses 4385.3.3.17.2. The denial of the tax-free allowance 4395.3.3.17.3. The deduction at source of 25% 4405.3.3.17.4. Discussion 4405.3.3.18. Skandia 4425.3.3.19. Lindman 4435.3.3.20. Wallentin 4445.3.3.21. Laboratoires Fournier 4475.3.3.22. D. case 4485.3.3.22.1. The MFN obligation in preceding income tax cases 4485.3.3.22.2. Legal literature on MFN prior to the D. case 4505.3.3.22.3. MFN and tax treaties: The distinction between the

allocation and the exercise of taxing competence 4535.3.3.22.4. Facts of the D. case 4565.3.3.22.5. Discrimination vs. the situation of Dutch residents 4575.3.3.22.6. MFN-treatment or discrimination vs. the situation of

Belgian residents 4585.3.3.22.7. Observations on the national treatment issue 4605.3.3.22.8. Observations on the MFN issue 4615.3.3.23. Blanckaert 4685.3.3.24. Bouanich 4705.3.3.24.1. Facts 4705.3.3.24.2. The judgment 4715.3.3.24.3. Observations 4735.3.3.25. CLT-UFA 4765.3.3.26. Ritter-Coulais 4785.3.3.27. Conijn 480

XIV

5.3.3.28.5.3.3.29.5.3.3.30.5.3.3.31.5.3.3.32.5.3.3.33.5.3.3.34.5.3.4.5.3.4.1.5.3.4.2.5.3.4.3.5.3.4.4.5.3.4.5.5.3.4.6.5.3.4.7.5.3.4.8.5.3.4.9.5.3.4.10.5.3.4.11.5.3.4.12.5.3.4.13.5.3.4.14.5.3.4.15.5.3.4.16.5.3.4.17.5.3.4.17.1.5.3.4.17.2.5.3.4.17.3.5.3.4.17.4.5.3.4.18.5.3.4.19.5.3.4.20.5.3.4.21.5.3.4.21.1.5.3.4.21.2.5.3.4.22.5.3.4.22.1.5.3.4.22.2.5.3.4.22.3.

5.3.4.22.4.

Table of contents

StaufferTurpeinenLakebrinkRennebergCommission v. SpainRufflerCommission v. GreeceNon-discriminatory restrictionsThe concept of "non-discriminatory restrictions"Daily MailAvoidance of the NDR issue by the ECJFutura ParticipationsImperial Chemical Industries {ICY)XABandYABBaarsVerkooijenAMIDXandYDe GrootLankhorst-HohorstBosalDe Lasteyrie du SaillantLenz (capital)Manninen (capital)SchemppFactsApplicable Treaty rightsArt. 12 EC Treaty: Non-discriminationArt. 18 EC Treaty: Free movement rightsMarks & SpencerKeller HoldingN. caseCadbury SchweppesFactsAbuse of Community lawKerckhaert-Morres (capital)FactsThe judgmentObservations: Misunderstanding of the BelgianregimeObservations: The nature of a withholding tax

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5.3.4.22.5. Observations: Potential restrictive effect is acceptable 5545.3.4.23. ACT Group Litigation 5555.3.4.23.1. The refusal of a tax credit for UK-sourced dividends

to non-residents 5575.3.4.23.2. MFN with regard to the dividend tax credit 5585.3.4.23.3. Limitation of benefits clause 5585.3.4.24. FII Group Litigation 5605.3.4.24.1. Exemption of nationally sourced dividends versus

imputation for foreign-sourced dividends 5615.3.4.24.2. No imputation of ACT for foreign-sourced dividends 5625.3.4.24.3. The imputation system is the cause of surplus ACT,

which cannot be surrendered to non-residentsubsidiaries 563

5.3.4.24.4. The cash flow disadvantage of having to claim backsurplus ACT and the denial of a tax credit to theultimate shareholder 564

5.3.4.24.5. The free movement of capital and third countries 5655.3.4.24.6. Repayment of sums unduly levied or compensation

for damages 5655.3.4.24.7. Limitation of the temporal effects of the judgment 5665.3.4.25. Denkavit (II) Internationaal 5665.3.4.26. Meilicke 5685.3.4.27. Thin Cap Group Litigation 5695.3.4.28. Rewe Zentralfinanz 5715.3.4.29. OyAA 5725.3.4.30. Amurta 5745.3.4.30.1. Facts and judgment 5745.3.4.30.2. Observations 5765.3.4.31. Columbus Container Services 5785.3.4.31.1. Facts 5785.3.4.31.2. Judgment 5795.3.4.31.3. Observations 5825.3.4.32. Lammers & Van Cleeff 5845.3.4.33. Heinrich Bauer Verlag 5845.3.4.34. Deutsche Shell 5865.3.4.35. Lidl Belgium 5885.3.4.36. Orange European Smallcap Fund (capital) 5895.3.4.36.1. The refusal of the tax credit for the German and

Portuguese withholding taxes 5905.3.4.36.2. Horizontal comparison of investments in different

Member States 591

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5.3.4.36.3.

5.3.4.36.4.

5.3.4.37.5.3.4.38.5.3.4.39.5.3.4.40.5.3.4.41.5.3.4.41.1.5.3.4.41.2.5.3.4.42.5.3.4.43.5.3.4.44.5.3.4.45.5.3.5.5 3 5 1.5.3.5.2.5.3.5.2.1.5 3 S 2.2

5.3.5.2.3.

5.3 5 35 3 S4.5.3.5.5.5 1 S6.5.3.5.7.5.3.5.8.5 15 9.5 3 5 10.5.3.5.11.5.3.5.12.5.3.6.

5.3.6.1.5.3.6.2.5.3.6.3.

5.3 6.3.1.

The reduction of the tax credit proportional to theshares held by non-resident intra-EuropeanshareholdersThe reduction of the tax credit proportional to theshares held by non-resident shareholders establishedor resident in third countriesBurdaKrankenheim RuhesitzPapillonJohraTruck CenterFacts and the ECJ decisionObservationsSTEKO (capital)Passenheim-van SchoolAberdeenDamseaux (capital)Free movement of capital and third countriesFidium FinanzFlI Group LitigationFree movement of capital and third countriesThe "grandfathering" clause of Art. 57( 1) EC Treaty:Direct investmentsThe "grandfathering" clause of Art. 57( 1) EC Treaty:Restrictions existing on 31 December 1993Thin Cap Group LitigationLasertecA and BHolbockStahlwerk Ergste Westig (SEW)Skatteverket v. AOrange European Smallcap FundSTEKOKBC BankConclusionThe rule of reason: Justification grounds in directtaxationFree movement of capital and Art. 5Kl I) EC TreatyLoss of tax revenueThe need to pre\ent the abuse of law and taxevasionICI

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5.3.6.3.2. Lankhorst-Hohorst 6595.3.6.3.3. Cadbury Schweppes 6605.3.6.3.4. Thin Cap Group Litigation 6645.3.6.3.5. Lammers & Van Cleef 6665.3.6.3.6. Observations 6675.3.6.4. Effectiveness of fiscal supervision 6685.3.6.4.1. Futura Participations 6705.3.6.4.2. Manninen 6715.3.6.4.3. "R&D" cases 6725.3.6.4.4. Passenheim-van Schoot 6735.3.6.5. Cohesion of the national tax system 6765.3.6.5.1. The Bachmann doctrine 6765.3.6.5.2. The progressive restriction on the cohesion

justification: Wielockx 6795.3.6.5.3. The progressive restriction on the cohesion

justification: The "direct link" requirement 6835.3.6.5.4. Implementing a restrictive approach 6855.3.6.5.5. Innovating and transforming the cohesion defence 6905.3.6.5.6. Krankenheim Ruhesitz 6955.3.6.5.7. Papillon 6965.3.6.5.8. Observations 6975.3.6.6. The justificatory aspects of double tax conventions

and Community tax directives 6995.3.6.6.1. Gilly 7005.3.6.6.2. Saint-Gobain 7015.3.6.6.3. Gottardo 7065.3.6.6.4. De Groot 7075.3.6.6.5. Bosal 7075.3.6.6.6. D. case and the Community MFN issue 7095.3.6.6.7. Bouanich 7115.3.6.7. Territoriality and a balanced allocation of taxing

competence between Member States 7115.3.6.7.1. Gilly 7125.3.6.7.2. Bosal 7125.3.6.7.3. Marks & Spencer 7145.3.6.7.4. N. case 7245.3.6.7.5. Cadbury Schweppes 7275.3.6.7.6. Rewe Zentralfinanz 7285.3.6.7.7. OyAA 7295.3.6.7.8. Amurta 7325.3.6.7.9. Deutsche Shell 7325.3.6.7.10. Lidl Belgium 733

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5.3.6.7.11. Jobra 7365.3.6.8. The precluded national measure can be legally

remedied by other means or could easily have beenavoided 736

5.3.6.9. Tax disadvantages on intra-Community situationcompensated by tax advantages 738

5.3.6.10. The Community rules on competition are beinginfringed 741

5.3.6.11. Promotion of research and development 7425.3.7. Limitation of the temporal scope of ECJ decisions 7435.3.7.1. Meilicke 7435.3.7.2. FII Group Litigation 7475.3.7.3. Thin Cap Group Litigation 7485.3.7.4. Observations 749

5.4. Quantitative analysis of the ECJ case law on directtaxation 751

Chapter 6: Final Observations 755

6.1. Member States' function-sovereignty and the function-sovereignty of the EU/EC level 755

6.2. Internal references: Direct taxation in the ECJ generalcase law 759

6.2.1. Scope of application ratione personae 7606.2.2. Scope of application ratione materiae 7616.2.3. The status of double tax conventions 7646.2.4. The causal link between a national tax measure and

infringement of Community law 7666.2.5. The late maturity of direct taxation ... 7676.2.6. ... But now at the vanguard of Community law? 768

6.3. External boundaries: Self-limitation by the Court of itsinterpretative autonomy by allowing for non-Treatyjustification grounds 771

6.3.1. Double taxation, NDRs in the strictest sense andredistributive functions 771

6.3.2. Justification grounds accepted and rejected by theECJ 778

6.4. Final conclusions 783

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List of abbreviations 789

References 793

Index 901

Other titles in the IBFD Doctoral Series 903

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